Recently, an Open Offer was announced for KHIL at a price of Rs.135/-. The current market price is Rs.126/-. Bottomline, there is a 8% upside opportunity if all risks and numbers match up. This post tries to dig in to the numbers and risks. This is currently an academic exercise in that I don’t have a position (and I had discussed this with another investor, S, who may have a position already). I may/may not build it in the future.
Do go through this offer document before reading further. Summary being, Clearwater Capital (and Partners) (who are based out of Cyprus&Singapore) had approx. 23% stake in KHIL previously. KHIL had issued FCCBs worth $18 million in 2007 to fund their expansion plans (Mumbai Orchid and all that). Anyway, the conversion price back then (at the height of bull market) was set to Rs.225/-. After sanity prevailed, the conversion price was reset to Rs. 135/- in June 2010. Now, KHIL over the past 6 months or so has been converting FCCBs into equity at Rs.135/- (check various annoucements). Clearwater with a complete FCCB conversion will now hold approx. 33% of KHIL’s diluted equity. Once the percentage holding crossed 25%, Open Offer rules were triggered and ClearWater now has issued an announcement that they would like to buy 26% of the diluted equity at a price of Rs.135/-.
The first and foremost analysis in cases of Open Offer would be the subject of shareholding pattern.
Q2 results would indicate that the promoters hold around 65.63% and public holds the rest (34.37%). A little more digging would indicate that out of the Public holding of 34.37%, around 26.11% constitute Foreign holdings (and of this, 23% is held by Clearwater Capital). A pictorial representation would be better.
(there seems to be some weird calculation for Promoter holding of 65.63% (ClearWater partners has 24.5% holding. So, (57.6+(26.11-24.5)+.09+4.09) will give us 65%, but we will let that be).
After the FCCB conversion into equity, the number of additional shares would be 3463694 (bringing the total diluted equity of KHIL to be 19093394. Now re-calculating the percentage of shareholding on this diluted equity, we would arrive at a Promoter+Clearwater holding to about 83-85% (Promoter holding will be around 51% and Clearwater will have 32%).
Clearwater has declared an offer for 26% stake, which indicates that there will be a 100% acceptance (since public shareholding is less than 26% and assuming most of the promoter side won’t tender). Since there would be 100% acceptance and a 8% upside still available, should we go out and buy KHIL now?
Not so soon.
There are three risks that one needs to consider in an open offer – time risk, price risk, deal risk.
Time risk – This is probably the first time (atleast to my knowledge) that an Open Offer has been triggered due to FCCB conversion to equity. There might be a lot of to and fro regarding certain details, some court approvals needed and maybe some SEBI approvals too. It might take 2 months or it might take 10 months. The carrying cost (of remaining invested in this opportunity) is greater than the opportunity cost in this market and that too, for a 8% return.
Price risk – Rs.135/- seems to be capped in my opinion. Clearwater has converted most of its FCCB into equity at this price and I doubt if they would revise this price to something more (especially because the majority voting power will still rest with promoters at 51% even after the FCCB conversion). What is the downside? If the public doesn’t tender its shares at Rs.135/- and demands a higher price (and Clearwater is not ready to pay up extra), the open offer will fail and the price might decline to Rs. 90 levels.
Deal risk – The Open Offer has been triggered and is not voluntary. Can Clearwater back out of this Open Offer? Well, they can sell their positions to below 25%, but the probability is very low (they would not have converted at Rs.135/- otherwise). From a KHIL promoter standpoint, given its last 5 year revenues vis-a-vis interest payments, they would have heaved a sigh of relief that Clearwater decided to convert to equity. I don’t think they will do any keeda. Deal risk at this point remains at a minimum (again, since this is the first time in my knowledge that Open Offer got triggered due to FCCB conversion, I am not too sure how far the court/SEBI can put the spanner in the works).
So, net-net, 8% looks decent if we have definite timelines for completion of this deal (or atleast a hint). From my perspective, my hurdle rate in such special situation cases usually is 15%. So for now, it is a pass especially given the opportunity costs.
Another thought experiment to consider – should I tender the shares at all? Think about it. $18mn bonds get converted to equity. So, no interest payments to be made. Around 3-4 cr interest savings, which will bump up the profit. Equity share dilution is around 22%. Let’s say my investment price is around Rs.135/-. At that price, at what multiple would I be acquiring KHIL in FY13 figures? Is that cheap? Should I tender?