For the sake of case study, Please assume that today the date is 06/11/2020
Case Study
Jullundur Motor Agency ( Delhi) is engaged predominantly in trading and distribution of automobile parts, accessories and petroleum products primarily in India.
On 4/11/2020 , the Board of directors gave approval to buyback 74,50,000 equity shares @ 36/- per share (being 24.98 % of total paid capital). The Promoter and Promoter Group have expressed their intention to not participate in the Buyback.
The result of Postal Ballot (voting by shareholders) is awaited on 15 December 2020. Along with Shareholders approval , record date and other dates will be finalised. The expected completion timeline would be in the early days of January 2021.
Now from our case study on NTPC Buyback, we know that buyback sometimes leaves out arbitrage opportunities for minority shareholders. Let us first revise what does the law states in this matter.
Law States
There is a special provision in law (Sebi Buyback Regulations,2018) for the small shareholder ( i.e who holds less than 2 lac worth shares according to the close price as on the record dates). The provision states that the company needs to take approval:
A)Either 15% of the total shares proposed to be buyback
B) Or the number of securities entitled by them (small shareholders) as per their shareholding.
whichever is higher.
This results in buyback situations profit or loss decided by the small shareholder viewpoint. Such laws results in special situations created with favourable odds.
Back to Case Assessment
Shareholding of The company:
A) Small Shareholders (holding less than 2 lakh worth of shares) – 88.72 lakhs
B) General Shareholding – 86.9 Lakhs. Since promoters are not participating in the buyback their shares are excluded.
Total shares available for buyback (Small + General) =88.72 + 86.9 =1.82 crore
Small Shareholder:
As per law, small shareholders will get:
A) Either, their normal entitlement which is (Small shareholders/Total Shareholders * Shares to be bought back) ((0.8872/1.82) *0.745 ) = 36.31 lakh shares.
B) Or, 15% of 88.72 lakh shares to be bought back. It comes out to be 13.3 lakh shares.
whichever is higher, so 36.31 lakh shares are reserved for the small shareholders in the buyback and 38.19 lakh shares (74.5-36.31) are reserved for large ones.
Case Analysis:
We will analyse the case on the basis of acceptance ratio. What is acceptance ratio?
Acceptance ratio for minority = Shares reserved for minority/total shareholding of minority that wants to participate in buyback.
In our case Acceptance ratio for minority shareholders = 36.32/88.72 = 41%
Since the numerator in the above calculations is fixed, calculated as per law, however the denominator part is unknown and we have done the above calculations assuming all minority and majority shareholders will participate in the buyback. However, based on our limited live experience and knowledge this is rarely the case.
Case Assessment:
In order to assess the case we need to make judgement/assumptions regarding two parameters:
- The denominator for minority shareholders
- Post buyback price
Post Buyback Price: You may have different views regarding the same, we would love to hear them. We need to make a probable guess of the same using some tools.
- Pre buyback announcement price was around 25-26
- Current EPS of the company is 4.5 and the PE of the company is around which is the lowest in previous two years. Assuming all things remaining same, the EPS of the company will increase to 6.5 after buyback. If we assume the PE to remain same the price comes around 25-27.
- PB , book value at the time of buyback is around 175 cr and market cap near 75 cr from which price to book roughly comes out to be 0.4. After buyback the 27 cr will be used for buyback and 148-150cr will be left in the books. If we assume the PB to remain same 0.4 book value market cap comes out at 60cr. Which the price comes in the range of 25-27.
- From past 1 year Price pre buyback has fluctuated mainly in the range of 18-23.
Being conservative we will assume the post buyback price to be in the range of 24-27 after buyback. Let us go back to make further cases for the buyback (Adjusting the acceptance ratio by changing the number of minority shareholders who will participate in the buyback).
Assessing Cases: Now we will assess cases with different acceptance ratio and try to pick the more probable case. In each case, we will assume that we will buy 100 shares.
Case 1: If acceptance ratio is 40% (approx) as thought (Though this is rare as some shareholders never tender their shares)
Current Market Price: 31
Price post buyback from above 24.
Total Cash Outflow = 31 * 100 = Rs 3,100 (ignoring brokerage and other expenses)
Since 40% is the acceptance ratio, then Expected Acceptance = no of our shares bought back * Buyback price announced by company( Rs36)
No of shares bought back = Shares we own * Acceptance ratio = 100 * 0.4 = 40 shares.
Expected Acceptance = 40 * 36 = 1,440
Cash Inflow = Expected Acceptance + (Shares left * Post buyback price)
=1,440 + (60 * 24)
= 2,880
We know we have taken an extreme case rarely do all the shareholders tender their shares.
Case 2: Acceptance ratio is thought to be 60%
We will buy again 100 shares.
Cash Outflow: 100*31 = 3,100
Expected Acceptance: 60*36 = 2,160
Cash Inflow: 2,160 + (40*24)
= 3,100
Acceptance Ratio of 60% seems to be priced in by the market or is the breakeven point(Cash outflow – Cash Inflow) assuming post buyback price of Rs 24.
Case 3: Acceptance ratio is thought to be 75%
We will buy again 100 shares.
Cash Outflow: 100*31 = 3,100
Expected Acceptance: 60*75 = 2,700
Cash Inflow: 2,700 + (25*24)
= 3,300
Here we make a pre tax return of 6.5%. Since most of the buyback on an average our completed on 2-3 months, it gives a good margins of safety. However, 75% acceptance ratio has very minute probability based on our limited past experience (Bayes odds).
Case Assessment from The Point of View of Large Shareholder:
As on 30 September,2020 Out of the total shareholding of company , around 39% belongs to promoter and rest 61% belongs to public. Out of 61% public shareholding approx 50% belongs to 5600 small shareholders. Rest 50% belongs to large shareholders whose holding is worth more than 2 lakhs ( out of which 80 percent hold by the 8 shareholders).
If the distribution is so much skewed, there is very less possibility that large shareholders won’t tender their shares. This will further reduce our chances of making a profit as a large shareholder, unless some large shareholders are not interested.
Conclusion:
Now all matters is the risk/reward ratio. If @ around 30%-40% acceptance ratio we would have good return, and our thinking would have suggested that this is likely, then we may have considered this situation investable. At current price this does not make a good candidate for investment. Our thinking based on acceptance ratio is based on bayes odds (or the odds of similar situations) in the past.
Two main variables determine in this thinking model the success or failure of this kind of buyback special situation:
- Post buyback price
- Acceptance ratio
We have used this model. We may be wrong. This is ongoing live case study. However, we would Love to learn and get your views on this situation or this type of thinking model, with its flaws too.
Further, we would love to hear your views on how we may further improve our odds of each situation, as situations are similar from past but not exactly similar. We are using bayes odds, but we would love to know situations where despite being very high acceptance ratio priced in the market, still the odds were good or where such kind of models fail.
May we all learn together.
Lets use it as an ongoing case study to learn together. It will be updated in future on what happened or what we could have done.
Please consult us or some other Investment advisor for detailed advice regarding the same. This is in no way an investment advice or buy/sell recommendation. It is just a sample case study of a situation which we may do. It involves its own risk (In terms of allocation or loss). We may change our mind before you may know (Or sell). So please if you want to do such situations, please consult us or any investment advisor.It is just a case study for future learning. We may be wrong and make mistakes. It is ongoing.
Argha Investment Advisers 