Indian Stock markets: Special Situations–A Starter Post

Everyone talks about Equity Investing, Debt Investing, Mutual Fund Investing and of course, No investing. But what about investing in Special situations? What exactly are these special situations?

This is a starter post where I try to compile some basics about Special Situations (am trying to learn more on these situations with virtual money and will compile as and when I have some learnings).

Special situations are usually (and mostly) one-off opportunities in the stock market. These situations tend to exploit the arbitrage opportunity between the current market price is versus a specific target price. Special situations arise because of the following reasons (not exhaustive) –

a) Takeover (Acquisitions)

b) Share Buyback

c) Rights/Bonus/Warrants issue

d) De-listing

The most recent examples of Special Situations are

a) iGate’s takeover offer of Patni – iGate wanted to acquire a 63% stake in Patni Computer. Due to some SEBI regulations and provisions, iGate has made a 20% mandatory open offer to buy Patni’s shares at Rs. 503.50 (there is a also a regulation for the floor price as explained below). The current market price of Patni as of today is Rs. 463. The Rs. 50 difference between the offer price and the current market price is due to certain risks as explained below.

and

b) Siemens AG International’s increase of stake in Siemens India – Siemens AG International wants to delist Siemens India. Delisting is a process where a particular stock will no longer trade in the market. Siemens International currently holds 55.18% in Siemens India and wants to increase its stake to 75% (increase of 19.82%). Siemens India was trading at Rs. 727/- per share before this deal was announced. However, the open offer to increase the stake was for Rs. 930/- per share. The current market price of Siemens India is Rs. 848 (again, the Rs. 100 difference is due to various risks outlined below).

Before we discuss risks, how does (for example) an acquirer determine the price? Well, the offer price doesn’t have any ceiling and the acquirer can offer as much money it thinks the target company is worth. However, there is a regulation for the floor price.

The price at which the tender offer must be made cannot be less than the maximum of two prices. Two of these prices pertain to the past. The minimum tender offer price has to be more than the maximum of:

i) the average stock price during 26 weeks before the announcement of the  acquisition and

ii) the average stock price during 2 weeks before the announcement of the  acquisition;

We move on to risks. For example, inspite of knowing the offer price is Rs. 503/- per share in case of Patni and Rs. 930/- in case of Siemens, why are the current prices of Patni and Siemens Rs. 463/ (a discount of Rs. 40) and Rs. 848 (a discount of Rs. 80/-) respectively.

Here, we take the help of Rohit Chauhan (and Ninad Kunder)’s explanation (I have modified their post slightly to make it more generic, instead of a specific example on which their post was based on) –

In any delisting opportunity, 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 –

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.

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 – Ascertain the fundamentals of the company and evaluate the fair (intrinsic value) of the company.

b) Ability / Inclination of the parent/acquiring company – How keen are the parents/acquiring company keen on completing increasing the stake/acquisition. (We can typically look at their Management’s history and get a pulse of their intentions vs action)

c) Expectation of market participants – What is the general opinion of the market participants. Specifically, can we look at any FIIs/MFs action on this stock/opportunity.

3) Deal Risk

Which brings us to the most imp variable in this transaction. Will this deal go through? How concentrated is the shareholding structure to make this deal a success? (a dispersed shareholding structure will lead to difficulties in securing a consensus)? What percentage would tender their offers? etc are some of the questions that need to be asked in Deal risk.

Prof. Sanjay Bakshi does talk about setting aside certain percentage of portfolio towards these Special Situations. In fact, he goes on to say (I can’t find the right post on his blog) that we need to be more aggressive in allocating funds to this portfolio when the market is overpriced, and value opportunities are few and far in between (times like now, I guess). Of course, we need to take into account the skill difference before being very aggressive on this portfolio 🙂 .

For investors who would like to take part in Special Situation opportunities, but can’t due to various other time commitments, there are Special Situation mutual funds that you might want to look at. Specifically,

a) Fidelity India Special Situations Fund

b) Birla Special Situations Fund

c) HSBC Unique Opportunities Fund and

d) ICICI Prudential Discovery Fund

The returns on these funds might not look very attractive during a bull market (where index and equity diversified funds might pound them), these might churn out better returns during the peak of the bull market and the bear markets than other funds (Of course, the usual disclaimer applies. Please do your own research before investing in any of these funds).

Update: As usual, Prof. Sanjay Bakshi explains different situations even more clearly (and this was way back in 1999) – Enjoy – https://www.ppfas.com/media/articles/sanjay-bakshi/special-situations.pdf

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