May 23, 2010

ABB buyback - An arbitrage opportunity ?

I recently received an email from pradeep about the ABB buyback offer (see deal announcement here). His question was – Does the buyback have an arbitrage opportunity? My response (With light editing to make it for better reading) is below

Dear Rohit,
How are you?

I wanted to know your opinion about ABB delisting. I have never done arbitrage but ABB has declared an open offer for 900 Rs and the shares, though jumped today to 830 Rs, still is at a 70 Rs discount to the offer price indicated by ABB.

I am not sure how one should think through this situation. I have invested some money today since the upside seems to be around 8% return in 2 months time. But I am wondering why the stock price did not end up at 880s level since the risk that ABB would withdraw the offer seems pretty low?

Is there any mistake in my thought process?

Hi pradeep

Good to hear from you. Thanks for passing this info. I had a look at the offer and below are my thoughts
- The offer is not really a delisting offer. ABB - the parent, holds around 51% of ABB India. This open offer is to buy around 23% of the shares to take their shareholding to 75%. The purpose seems to be increase control.
- the acquirer has stated in the offer document that they do not intend to delist the company.

See this link here :

Deal Math
Let’s look at the deal math:

If you buy 100 shares, you pay around 83000. With public holding at 49%, the acceptance ratio will be 50-100% depending on the tender levels.

For acceptance ratio we can look at the shareholding structure. On the ABB site, you can see that around 30% is held by institution and the rest by individuals. 10% is held by LIC.

The key to acceptance ratio is how the institutions will tender. If they don’t, then you get 100% acceptance and a 10% upside

If the some of the institutions tender then you have a ratio between 50-80%. Let’s take 70% for assumption sake - then 70 shares get accepted and you make 63000. Let’s assume the rest - 30 shares you sell in market at pre-deal rate of 700-720. The total value comes to around 83000-84000. I am not even assuming the market risk here.

Best case scenario - 10% gain
Likely scenario - 3-4% gain
And worst case - 6-7% loss

Overall the risk reward are not too attractive, atleast to hold till the tender date.

However you can adopt an alternative approach - Hold your shares for some time and exit when the price approaches 900 levels. That way you will get a decent gain and not face the downside risk. I have to caution you that this would however be a speculative option.

Additional thoughts (not part of the above email)
ABB is currently selling at around 40+ times earnings. It may be undervalued, though I find that very hard to believe. If you share my opinion, then buying the stock at 820-830 levels with the ‘hope’ of selling at a higher price before the buyback would be a speculative position without a valuation support to it. As a result I have given this deal a pass.


Navjot Kashyap said...

I will like to know your views on
1-Tide Water Oil Ltd.
2-JSW Steel Ltd.
Tide Water looks cheap with good growth in both topline and bottomline consistently over the years.Same for JSW.I am averse to steel due to its cyclic nature but this stock begs attention.

Ravi said...

Hi Rohit,

That was a simple but great post. I obviously overlooked the most simple element of only 50% of the public holding will be taken by the promoters to take their stakeholding to 75%. It is so easy to miss this simple but important element. What is your view on the arbitrage oppurtunity of the Bank of Rajasthan and ICICI bank merger? For every 4.72 shares of BOR we would get 1 ICICI share. Even though BOR ran up quiet a bit there is still that small arbitrage opportunity that exists. My understanding is that one should buy BOR and sell ICICI futures to make the profit. The board has approved the merger and the EGM is on jun 21st. The risk is time risk and the DIPP approval risk. What is your opinion on this? I know that the potential return now has dimnished due to runup of the stock but I want to learn more on the arbitrage that existed when BOR was trading below 140 when the news came and ICICI around 834. Hope to see your reply.

Once again thanks for this great posts.


Rohit Chauhan said...

hi navjot
havent looked at tide and will do so. I checked JSW sometime back and did not find it undervalued. dont know if the price has dropped a lot since then

Rohit Chauhan said...

hi ravi
i have heard of the BOR news. need to check on it. will do so and let you know

Navjot Kashyap said...

Ok.Thanks a lot.If its not a bother to you,see Spice Mobiles too.It has almost negligible debt,good sales and profits growth.PE around 9.I wish I had found it 6 mnths ago but still not much late.Mobiles business will keep flourishing for next 3-5yrs.Seems like a good bet.

CCGemini said...

Rohitji ...How does one know when a share has reached saturation point...

Rohit Chauhan said...

Hi navjot
i was discussing spice with a friend a few months back and was not convinced about the long term profitability of the cell phone biz and hence did not go ahead. it is definitely worth a look though


Rohit Chauhan said...

Hi CC gemini
i dont know what you mean by saturation point - fully valued ?
i value a stock at time of buying it and when it reach that value, i know it is near fair value