March 26, 2009

Getting cheated

I am mad ! very very mad. See this news item on novartis india.

Novartis AG has announced an open offer for Rs 351 per share with the aim of taking their shareholding to 90%. Although they have not stated any plans for delisting, I think once the shareholding reaches 90%, delisting norms could kick in and the rest of the shareholders will be forced to exit the company.

Why am I mad ? See my analysis of novartis
here. My conservative estimate of the intrinsic value is around 600-650 (company has a cash of almost 150 rs/ share). Look at it this way – Net of cash, the buy back offer is valuing the company at 800 crs. This is for a company making almost 100 Crs of profit on a capital base of around 30-40 Crs !!

Another view point – The buyback offer will cost the company around 440 Crs. The company has cash and equivalents of around 435 Crs as of december 2008. So the Parent company will be able to increase its holding to 90% without spending a penny from their pocket !!

Should I feel cheated ? May be not. I have known this modus operandi for some time. A lot of MNC’s have cheated their minority shareholders this way. The steps are as follows

- Allow the performance of the company to stagnate for a few years by avoiding product launches and anything else which enhances value
- Hold all the surplus cash during this time period.
- Wait for a bear market to drive your price down to very low levels.
- Announce an open offer at premium to current price, utilising the cash holding
- Try to mask this operation as a shareholder friendly operation by pointing out that the price is at premium to the current price (which is way below intrinsic value).

I have known and written the above earlier on my blog. I have however chosen to ignore my own advice though and would now be paying for it. At the current price, net of dividends, I have made modest returns. However that is not the point – The point is being treated fairly by the management of your company.

Another case -
Ingersoll rand : They have announced their intention of coming out with an open offer too. I am not holding my breath on that as they have tried a similar tatic in the past, but were not successful in completing the buyback.

Lesson for me : Management matters more than i would like to accept. A good business with bad management will translate to poor returns.

What next ?
I am going to wait and watch how this open offer will play out. However even if the minority shareholders reject it, don’t expect the management to change or mend their ways. They will continue to ignore the minority shareholder, give poor dividends and will continue to accumulate cash. The best startegy in such a case would be to exit the stock and deploy the capital somewhere else.

24 comments:

Somnath said...

This is very surprising and ironical to say the least! When I compare management practices of MNC's vis a vis Indian companies (for eg., the way they manage people processes etc) MNC's really do very well.

But I guess when it comes to shareholder interests, there doesn't seem to be much difference (whether it is an MNC or an indian company!).

Rohit - I agree with your thoughts on the management. It is as important a yardstick that one needs to consider as the financial numbers. There is no use to waste time on companies like this!

Anonymous said...

bosses ...u are expecting too much from MNCs. The minority shareholders in their own county is what is important to them . Please see what all tricks the MNCs play , in transfer pricing .
On another note , something more pernicious has come in today . Despite the objections of ICAI , AS 11 has been suspended . What happens to M2M of forex positions is frightening . All profits for 4QFY09 will be hugely inflated . Be on a trading mode only
thanks
rihan ahmad
09451145055

rbery said...

Hi Rohit,
I would disagree with you on your analysis of MNC managements. They manage their companies efficiently and are therefore huge cash generating machines. Since the price of Novartis India is now above the offer price maybe the announcement by the parent company helped bring attention to the huge cash on its books. Ingersoll Rand too cannot be faulted as the parent company returned cash to the Indian subsidiary when they divested their businesses globally. I have rarely seen Indian managements share this benefit with minority shareholders. Compared to managements like Satyam et. al. MNC companies have transparent accounting practices. I think we tend to ignore these positive facets.

Anonymous said...

Rohit - I exit Novartis yesterday after the news. My average price was 247. For some reasons, I never built full position.

Ingersoll Rand is another issue. very small position - still 20% up. Will exit next week.

Thanks
Prashant

Amit said...

Hi Rohit, its unfortunate that something like this is happening. But some MNCs have been extremely shareholder friendly. Take the case of Colgate - it has given out more than 90% of what it earned in the last 10 yrs (if we account for the taxes). Infact, it has even paid out a part of its paid-up capital (Rs 9 of the FV of 10) I want to know what are your thoughts on Colgate - to me it seems a bit on the pricey side (in terms of P/E). However, it has unmatched brand power, market share, good management and excellent returns on capital. Would you call it falling under the category of "fair price for a great company" instead of "great price for a fair company"? Would be great if you could comment or even better analyse it if you have the time.

Amit said...

By the way, I'm sorry if I have made the same comments 2-3 times - making comments on a blog for the first time so just realised that I have probably sent it twice

Ravishankar said...

I had earlier mentioned in one of your posts (maybe HTMT?) on management being the biggest driver of value (amongst other things). This is but one example though in my experience typically MNC's had done better but looks like birds of a feather flocking together

- Ravishankar

Rohit Chauhan said...

hi somnath
MNC's have good management practises and good business models. that shows up as good fundamental performance.
however several MNC parents give a rat's ass for the indian minority shareholder. they would like stiff the minority shareholder at the first opportunity and that is what they do several times.
Indian managements are equally bad. i think pedigree or country of origin does not define management quality ..their actions do

unfortunately on a handful of managements in india care about the minority holders

regards
rohit

Rohit Chauhan said...

Hi rihan
thats true ..and that is also the reason for their undervaluation.

Its a joke to put AR11 on hold. next we should also put rm cost, salary and depreciation on hold once these costs rise

regards
rohit

Rohit Chauhan said...

Hi rbery
i diasgree with your comment. you need to look at the operating history of novartis and its share price history to evaluate if the current price is fair.
one can always drive the price down or take advantage of a bear market to give an offer price higher than the current price ..but way below the instrinsic value.
what ingersoll rand did when they divested their global business was required to be done from their part. it was legally mandatory. MNCs dont break the rules ..they just play with the spirit of the law.
satyam is an extereme case of fraud ..but a lot MNC and indian management manage to steal from their shareholders without breaking the law

MNCs have clean practise and good business model. but poor governance ..and that translates in poor returns for us
regards
rohit

Rohit Chauhan said...

Hi amit
i am not implying all MNC managements are bad. its just that MNCs were considered as a group to be good on business practises and corporate governance. i dont think that is true for the group as a whole ..though some of the MNC like indian companies have good shareholder friendly managements

regards
rohit

Rohit Chauhan said...

Hi ravishankar
yes MNC managements have done better on average. they management the business well, but several have bad governance.

i am appreciating it now more and more.

regards
rohit

Anonymous said...

I also feel what Rohit is saying is correct. The MNCs are very good in executing operations and generating handsome revinues from their Indian operations. They have technologies, cash reserve for CAPEX from parents etc to agument profitability. But when matter comes to the Indian shareholders, they are really bad. They always work for their parent companies & neven give a damn about the Indian shareholders. So the situation is like pre-independence days, when britishers were working in India for England !

Warm Regards
Gcpradhan

mkd said...

Hi Rohit,

I agree with you that investors should be getting out of companies like these (MNC or no MNC), where the Management does not blink an eyelid before shortchaning the small investor.

However, in this case, are you suggesting that we should sell at current prices and get out.

Is it not possible for the small investors to collaborate and reject the open offer, so that Management is forced to increase the offer price.

Also, do you think that FIs will accept such an open offer?

Thanks,
mkd

Rohit Chauhan said...

Hi GCpradhan
i would like to believe the same, unfortunately indian managements are usually not better. i would 90% of company managements would not blink an eyelid before cheating - legally- their minority shareholders. a lot of these tatics come out during the bear markets.

our security laws and SEBI's attitude does not help the small investor either

regards
rohit

Rohit Chauhan said...

Hi mkd
it is quite possible that the FI's and minority shareholders will reject the offer. but look at it this way, do you think this management will change. they have a local subsidiary through which most of the new products are being launched.
i also read about other governance issues where novartis lent out a huge amount of money to a group company - at market rates - but nonetheless it was lent out.
the above incident is the last straw for me..life is too short and there are lot more other decent companies to invest ..rather than get irritated with this company

regards
rohit

Rohit Chauhan said...

Hi all
does anyone have an idea why the stock is selling @ 360+ levels when the open offer is capped at 351 ? not that i am complaining

regards
rohit

mkd said...

Hi Rohit,

It seems to be a given that this Open Offer is not going to get enough response to get 90% holding for the parent.

As per few other folks that I talked to, parent might come up with a revised offer at much higher price (500?). There seems to be precedent for this kind of behavior by other companies in the past.

In any case, if someone can forget about management for some time, here is a company with limited downside (cash reserves, relatively low valuation, decent dividend yield, stable operation and business) with potential upside of some percentage due to revised offer. Worst case scenario might be to get stuck with the stock in a range and a dividend yield similar to yield from bank savings.

Of course all that changes once the true intentions and management greed are factored in.

After the recent flurry of activity from various agencies, I wonder if something like this cannot be addressed by them. (Letter of law might be fine but spirit is not)

Kundan Kumar Lucky said...

Hi Rohit,

I am a little confused here. As I read in one of the letters from Buffett, this is supposed to enhance the shareholder's value (although not for the ones who exit). I quote from 1984 (page 4):

The companies in which we have our largest investments have all engaged in significant stock repurchases at times when wide discrepancies existed between price and value. As shareholders, we find this encouraging and rewarding for two important reasons - one that is obvious, and one that is subtle and not always understood. The obvious point involves basic arithmetic: major repurchases at prices well below per-share intrinsic business value immediately increase, in a highly significant way, that value...

Please clarify to me which is correct. Or am I missing something?

Regards
-Lucky

rajind said...

Siemens has this habit of selling profitable subsidaries to its parent and calling it 'creating/enhancing shareholder value'. The recent one is its sale of Siemens Info system to Siemens AG. It now looks like many MNCs are following a similar pattern.

Rohit Chauhan said...

Hi rajind
if that is happening, it is complete nonsense. i dont have the details, but it is typical rip off of minority shareholders by the MNCs
regards
rohit

Raji C said...

When Siemens India announced the sale of its profitable 'Simens Info Systems' to Siemens AG at Book Value in Dec 2008, I felt cheated. Just like you mentioned in your post. What added salt to my wounds was them calling it as 'enhancing shareholder value', when articles all over were hollering about how it weakens Simens India. But this was not the first time that Simens was doing it and so it didn't come as a bolt out of the blue for me. I thought that it was an isolated case of Siemens- the Siemens habit. From your article, I have started thinking that, may be, many MNCs have this agenda of playing with minority shareholders' interests through slightly different routes .

mkd said...

Seems like Swiss parent read your blog and revised the offer price to 450 :-)

Still, seems like they have just reduced their 'Margin of Cheating'

Rohit Chauhan said...

Hi mkd
nice comment !! margin of cheating :) couldnt have put it better myself