Some deals on the stock market seem too good to be true; and usually they are. One such is the Arrow Coated Products rights issue.
Anyway, just bare basics about the company. It is in the plastics/packaging industry and manufactures Water Soluble Films (WSF) along with a host of other plastics. They have been in business for about 17 years now. In the latest annual report, they have also hinted at moving into manufacturing credit cards and into IT for Aadhaar project (don’t ask!). Presumably, they have got quite a lot of patents and there is a lot of talk on monetizing these patents, but I don’t see any in the latest results. They paid dividends from 2004 till 2007 and haven’t paid any dividends from then till now. Anyway, here are the links to Annual reports 2010 and 2011 which should give you more than a fair background about the company.
Before getting into the numbers and the rights issue, one paragraph from the Annual report which gives an insight into the ‘conservativeness’ of the management –
So, the numbers of the business for the past 5 years look something like this (and mind you, there was a huge bull run in 2010-11 in the plastic packaging film industry due to better realizations).
They have been losing money for every unit they sold for the past 5 years. The return ratios are pathetic and less said about the EPS, the better.
All in all, a pathetic business. And yes, let me point you to the latest balance sheet before we jump into the rights issue.
Quite a lot of ESOPs for a 3.9 cr marketcap company. And yes, since earnings are negative all the time, there is no P/E ratio to compare. What we can do though is to do a EV/EBIT valuation to see how ‘invaluable’ this company is. I will not bother you with the detailed calculations, but EV/EBIT works out to 31. 31!! By any standard and especially for a commodity company, this stock is ridiculously overpriced.
So, what does the company do in the face of such wonderful results and magical stock price? Without any explanation or reasoning, they come up with a rights issue which looks too good to be true. (the board had approved a rights issue way back in 2009, and they are exercising it now). Here is the link to the announcement and here is the pdf document which details the rights issue.
In summary, it says this –
Our current market price per share is Rs. 7.32/-.
Let’s say if you decide to buy 100 shares from the market before 09/Feb/2012, you have to shell out –
a) 100 shares at CMP will cost you Rs. 732/-
b) Subscribe to our rights issue and we will give you another 100 shares at a ‘fantastic’ price of Rs. 10/- which will cost you Rs. 1000/- for 100 shares.
c) Now, don’t you worry that you are paying more for the rights than the current market price. We will also throw in a couple of detachable warrants, where the floor (as in, the minimum price) is Rs. 10/- for every 10 shares that we issue through the rights. Rs.10/- is just the minimum price – the max. price can be anything that a weird calculation points out in the next 18 months – so don’t worry, just give us the money.
That is, if you buy 100 shares from the market and subscribe to our rights issue, we will give you another 100 shares and throw in about 20 warrants for which the minimum value per warrant is Rs. 10/-.
Valuation: Looking at the stock chart for the past few years, I will be conservative and assume the warrants will be priced at Rs.10/- and nothing more. So, what are we paying and what are we getting?
(avg. price calculated as ((1+2-3)/200)
So, if I subscribe to this rights issue, in essence I am paying slightly more than the market price to acquire one share of Arrow Coated products. Not just this, I am buying into a severly ‘wonderful’ company with very ‘conservative’ management and with ‘great’ margins and ‘fantastic’ products. What’s more – there is ESOP dilution, there is Rights dilution and then a warrants payment inspite of the ‘invaluable’ profits that ACP generates. And yes, there are no dividends.
We all should buy into this rights issue, shouldn’t we? NOT. Bewakoof samjhe kya? Nonsense.
Of course, the company might turnaround amazingly and the warrants might quote at a much higher price than the floor price during the subsequent 18 months, in which case your acquisition price per share might be turn out to be much lesser. And then you can accuse me of being a fool for not subscribing to the rights issue.