February 9, 2010

Special opportunity framework

Following is a guest post from ninad kunder. I have been working with ninad and arpit on arbitrage deals for some time and we exchange notes and ideas. In the post below ninad has explained the framework we follow for an arbitrage or a special situation.

In addition, I have upoaded a template which I use to track such opportunities (look for file – arbitrage delisting template).

My friend Rohit had in his earlier posts detailed out the Elantas Beck opportunity and the various milestones associated with the special situation opportunity.

The objective of this post, taking the example of Elantas Beck, is to list down the framework (in our limited intelligence :) for managing a special situation opportunity and the thought process associated with it.
Before I run thru the framework and the thought process, let me just run thru a brief background about Elantas Beck.

About Elantas Beck
Elantas Beck is the subsidiary of Altana AG which is a specialty chemical major based out of Germany with operations spread across the world. Altana historically had a pharma business and a specialty chemical business. The company divested its pharma business and transformed itself into its current form.

Altana has four key divisions
2) BYK

Elantas beck India is a 88% owned subsidiary of Altana and is aligned to the Elantas division globally. The other divisions at present have a marginal presence in the Indian market.

Process Framework
In any delisting opportunity and the same framework can broadly be applied across other special opportunities, there are 3 risk points in the transaction
1) Time Risk
2) Price Risk
3) Deal Risk

Let me address each of these risks with respect to the Elantas opportunity.

1) Time Risk
In any arbitrage opportunity even though the deal might go thru and at the price that we had defined, there could always be time delay involved in the deal which will shave off potential returns. This is especially true in the Indian context when there are court approvals required in certain special situation opportunities like mergers.
In the Elantas beck deal time risk was eliminated by constantly monitoring the milestones achieved in the deal. The entry point was timed only post the shareholder approval and once the company had filed with the BSE for the delisting process.

2) Price Risk - There were 2-3 ways to handle price risk in this transaction. This of course would be different for every transaction.

a) Valuation - As Rohit pointed out step 1 was to ascertain the fundamentals of the company and Rohit & Arpit (They are good at this :-)) arrived at a fair value of Rs 600 for the Elantas stock.

b) Ability / Inclination of the parent company -The interesting point is that the largest shareholder of Altana is taking Altana private and Elantas was the only listed subsidiary in the world. Market cap of elantas was 360 crores. So the parent would have had to cough up about 40-50 crores to do the delisting. It wouldn’t have been a big amount considering their balance sheet and 15-20% more wouldn’t have been difficult to stretch. Also having run their global balance sheet and other communication, it was clear that India was a high focus area for Altana and the other divisions were waiting to enter the country.

c) Expectation of market participants - When the delisting was announced ICICI emerging star had about 2.25% stake of the 11.5% public holding. They exited at around the 460-470 mark post the delisting announcement. So market participants who bought that 2.25% holding, at that price clearly bought it with an intent to tender it at a higher price in the delisting process.
Factoring in all the above variables Rs 600 was a reasonable estimate that was arrived for the delisting price.

3) Deal Risk - which brings us to the most imp variable in this transaction. We saw a high deal risk because of the dispersed nature of shareholding and out of the 8 lac outstanding shares there were 2 lac shares in the physical form. Though the current SEBI amendment has allowed physical holders to tender in the delisting process, we saw not too many shares getting tendered on this front.

Factoring in a high deal risk we defined 2 clear exit points which ever came earlier.
1) Price point - 520-525 levels (my comment: take advantage of the 10-15% pop in the prices)
2) Time point - Exit midway thru the book building process.

The call was clear not to wait till the reverse book building process closes and take whatever money was available on the table and not live with the deal risk. There is of course the behavioral angle to the transaction where the dopamine kicks in when one is actually in the thick of action and tends to not necessarily follow what was defined at the start of the transaction :-).


Anonymous said...

Rohit - One more delisting opportunity announced yesterday - Dunlop india.


shankar_1979 said...

Hi Rohit,
I am a regular follower of your blog. My question is about the valuation template file - valuationtemplatevNIIT2009.xls.
1. Can you please tell me where one can extract the raw data to start with?
2. Many of the numbers like RONW, OPM% etc are not matching that found in MoneyControl. Is this expected?

Rohit Chauhan said...

Hi prashant
thanks for letting me know. i will look into it


Rohit Chauhan said...

Hi shankar
i take the numbers from the annual report. some difference can be expected due to error on my part or the way these ratios have been calculated. if the difference is too much ..then makes sense to look at the annual report ..rather than moneycontrol or any website


Anonymous said...

I want to thank all of you for making things so clear and putting it in xls form for all readers.

Quick question - isn't this sort of framework something which can be reused for say an m&a or other kinds of arb oppty?


Rathin Shah said...

Hi all,

I think Money-control and other websites use standalone numbers (sourced from Religare Technova Database). As a result some annual report numbers vs. website figures will vary.

sorry in-case you all are already aware of this.


Rohit Chauhan said...

Hi anon2
yes, this framework can be used for other opportunities too ..but the exact questions and triggers will vary

Rohit Chauhan said...

Hi rathin
i think thats very useful information. i have seen the difference in the past and it mainly due to the fact that none of the websites use consolidated numbers due to which the data is all wrong for many companies
i think the best option is to always refer to the annual report directly

Raj said...

Thanks for the very interesting post. Very information. Do you guys have something similar for merger arbitrage like what are the stages involved in the process that are publicly available of course. It would be great if you could share something on that.