March 10, 2008

Kothari products demerger – an arbitrage opportunity ?

Kothari products has announced the following de-merger plan

has approved the proposal for scheme of arrangement between the Company and Pan Pang India Ltd., for demerger of Pan Masala Division, Bevarages Division and Trading Division into Pan Parag India Ltd., subject to approval of the Stock Exchanges, its shareholders and the Hon'ble High Court and the necessary approvals under various statutes. Further the Company has informed that, the Board of Directors has also approved valuation report of M/s. Haresh Upendra & Co. Chartered Accountants, recommending exchange ratio of 1 Equity Share of Rs 10/- each of Pan Pang India Ltd for every 1 Equity Share of Rs 10/- each held by the shareholders in the Company. The Scheme of Arrangement provides for the exit to small Shareholders holding Equity Shares in Physical Form.

My earlier views on kothari products are here and here

Following is a comment from the 2007 Annual report – director’s report
In view of the risks associated with the Pan Masala Industry in the form of Governmental bans, the Company has decided to diversify into the business of Real Estate, constructions, builders etc. which is a booming business presently and which is growing at a very high speed. The market presents an attractive investment opportunity in the area by virtue of diversification. Your Company with requisite financial strength and proven managerial skills, stands in a position to seize the opportunity. To avoid any adverse impact on the growth of new business, management is considering various options for restructuring to seperate other businesses in a most efficient and transparent manner.

I am looking at kothari products as a short term arbitrage opportunity based on the following hypothesis – demerger would unlock the value in the company.

Kothari product would demerge the pan masala and other associated business from the parent company. The post de-merger company will be into real estate and construction business. The sum of value of kothari products (post merger) and pan parag ltd should be greater than Kothari products (pre-merger)

My question
1. Does the shareholders get 1 share of panparag and Kothari products (post de-merger) each based on 1 share of Kothari products (pre-demerger) ?
2. What happens to the Investments and cash on the books ?

Would appreciate any inputs on my questions ?
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Ankur Jain said...

Hi Rohit,

The sum of parts valuation of the demerged companies may not quite add up to be more than the current market cap of Kothari Products.

Kothari Products is available at a market cap of 380 crs with zero debt.The investment book is currently worth close to 230 crs (out of which 110 crs is held in Reliance Industries stock). So, the investment book is akin to a poor undiversified mutual fund. I will give it a 60% discount to its NAV. Thus, one can realise only 90 crs from this investment book.

So, the Pan Masala division and the real estate divison is available at a price of 290 crs (380-90). Pan Masala Division has not been doing well for quite some time. Profits are on a decline and have a look at the receiavbales; just going through the roof.Infact, the management has been selling investments to support the working capital requirements. Pan Masala Division has done around 35 crs avergae EBITDA for the last 3-4 yrs. Even if, one gives it a multiple of 5, the Pan Masala division might be valued at 175 crs.

So, one is effectively paying 115
(290-175)crs for the real estate division. The book value of the land in the books is only 13 crs. The land might be under valued in the books in all probability, but 115 crs is still a big sum for it.

Will give this demerger a miss. Unless I have not counted something or there is some great value in the subsidiaries, which I am not aware.

Rohit Chauhan said...

hi ankur

I think the company has around 500 odd crores of cash and equivalents (investments).

300 odd crore investments
loans/ advances - 175 crores
cash - 25 crs

recievables seem to be around 18 crs. I have taken these numbers from 2007 report from icici direct. I do not have the AR for the company, so if you have access to the AR, then you must be right.

although pan masala is a declining business, it is a cash generater and should carry a higher multiple

However all of the above are theorotical calculations. the management is not investor friendly and has allocated capital badly. As a result the pan masala and real estate division may get low multiple as you say.