These guys were also known as Brescon Corporate Advisors till a few months ago (just in case you’d like to check on brokerage reports of the past – if there are any).

I will evaluate this special situation combining the principles/questions outlined by the Prof in this post (which, needless to say, is a must read for anyone who wants to do risk arb and the complexity is getting complexier and complexier 🙂 ) along with the analysis I had done for Tata Sponge Iron/Tinplate company in my previous post.

This open offer was brought to my notice by my friend Ashish Kila today morning. Also, at today’s closing CMP, there is no trade that can be done in this open offer on a profitable basis. This post is only for analysis (which reminds me, I need to come up with a mindmap kind of thing for open offers after the Prof’s complete post on the risk arb problem).

Anyway, Nusarwar Merchants Pvt. Ltd. (NMPL) has come up with an open offer to buy 26% of Brescon at a price of Rs. 123/-. Today’s current CMP is Rs. 113/-. The genesis of this offer was a 33.75% buyout from certain sellers (looks like a part of the promoter group, also called ‘persons acting in concert’ in the latest AR) in Brescon on 29/Sep/2012 and hence this open offer is a triggered offer. Here’s the link to the open offer.

Let’s go through the Prof’s questions to analyze this then (and given that all regulatory approvals are through and the chances of any regulatory surprises are close to nil, the relevant template would be template #2).

a) **What’s the expected return of this operation?**

Ans. The current CMP is Rs. 113/-. The offer price is Rs. 123/-. Payment would be done by Dec 25th, 2012 according to the schedule (2 months from current date). Since 33.75% has been acquired, theoretically, 66.25% can tender. Theoretical acceptance ratio would be 26/66.25 = 39.24% (approx to 39%). Let’s say I buy 100 shares and I expect the price after the open offer closes to be Rs. 100/-.

Investment = Rs. 113 * 100 = Rs,11,300/-

39 shares would be accepted at Rs.123/-. 39*123 = Rs. 4797 (Rs. 390/- would be the gain, on which 30% marginal tax would be applied since STT wouldn’t be applicable while tendering, but I’ll ignore this for now)

Remaining 61 shares would be sold at Rs.100/-. 61*100 = Rs. 6100/-.(a loss of Rs.793/- can be used to offset short term capital gains, if any)

Total return = 6100+4797 = Rs. 10897/-

That is, Investment > Total return, resulting in a loss, assuming a theoretical acceptance ratio.

b) **Should you look at fundamentals of the target company? Why or why not?**

We should certainly look at the fundamentals of the company since there is a chance that we can acquire shares of a good company at a very low cost. However, in case of Brescon, after looking at the fundamentals over the last 2-3 years and this slump sale arrangement (where they sold Brescon Corporate advisory business to their own subsidiary company on a slump sale basis citing some convoluted logic, read Item No. 3 on Page 6 of that arrangement for starters), I am not too comfortable in acquiring shares of this company for the long term.

c) **What is the likely acceptance ratio i.e. how many of your shares are likely to get accepted under the offer (theoretical vs. practical) and what key factors will govern that ratio?**

The theoretical acceptance ratio is 39% as stated in a). The practical acceptance ratio might be different. Given that only one part of the promoter group has sold out, the remaining promoter group has approx. 24% of the shareholding. Since this looks like a voluntary sellout by one part of the promoter group, the rest of the promoter group may not participate in the open offer. However, the chances of the promoter participating is non-zero. The retail shareholding is close to 20%. On a historical basis, not all retail investors have tendered for various reasons. Let’s assume 5% brain dead investors then. Let’s look at the two different scenarios then (am assuming the rest will tender)** –**

S.No |
Scenario |
Acceptance ratio |
Possibility |
Probability |

1 | Promoter group doesn’t tender; 5% brain dead investors | 71% | Highly likely | 70% |

2 | Promoter group tenders; 5% brain dead investors | 43% | Probably not | 30% |

A few calculations summarized in the table below –

No of shares |
100 |

CMP |
113 |

Offer Price |
123 |

Investment |
11300 |

Price post open offer |
100 |

Gain if | |

Acceptance ratio 71% |
333 |

Acceptance ratio 43% |
-311 |

Expected value per share based on probabilities above |
1.40 |

Gain% on expected value on an annualized basis |
7.50% |

Therefore, we’ll have a gain of 7.5% on an annualized basis without considering the effect of taxes, service tax, cess etc. This is poorer than the return if we invest the same money in a liquid plus mutual fund for 2 months. Hence, this opportunity is a pass.

d) **How can you use the “inversion” (invert, always invert) trick to estimate market’s assessment of the acceptance ratio?**

Ans. Let’s assume that the market cost of capital is 12%. That is, 2% for 2 months of money.

CMP is Rs. 113/-. At the end of 2 months, at the market cost of capital, the money should have been Rs.115.26. We can find the market’s expected acceptance ratio by

Rs. 115.26 = Offer price * Accepted shares + Remaining shares * Resultant share price after open offer.

Plugging in the values,

Rs. 115.26 = 123*x+(1-x)*100 and solving for x, we get an acceptance ratio of 66.34%. That is, the market is pricing to almost close to the best case scenario (refer table above) where the rest of the promoter group doesn’t tender and there are 5% brain dead investors. This is clearly very optimistic and hence the chances of a substantial upside is close to nil.

e) **Should you borrow money to do this operation? Should you have done it in Template 1? Why or why not?**

Ans. With the expected value of 7.5% p.a, and being a retail investor, I cannot borrow at less than 12%, if not more. This clearly is a losing operation for me. Hence, I wouldn’t borrow for executing this operation.

__Segways:__

a) There is certainly a price at which this operation can deliver a lot of value. Between now and 11 December 2012, if the market price of Brescon falls below say Rs. 100/-, this operation will have a quite a bit of value. It is not profitable just right now.

b) I have not considered the scalper syndrome scenario where you buy at Rs. 113/- and say if the market shoots up and if the price goes to Rs.118/- by end of next week, you can make some returns in quick time. However, then I would be speculating than evaluating.

* Disclosure*: No position in this open offer. This post is only for analysis and not for investment purposes.

#1 by Achin on October 27, 2012 - 12:22 PM

Can I request something on value unlocking. Possible examples – Cinemax (already happened), Genus Infra (planned)

#2 by

hjkon October 30, 2012 - 3:04 AMDid you mean segues instead of segways

#3 by

Balajion November 4, 2012 - 11:45 PMHi Kiran,

Would appreciate if could share your view on the Gujarat Gas open offer. Will be really helpful if you could pull up the right numbers give your analysis. It is trading at about Rs. 299 and the offer is for Rs. 314.17. I see a potential of 5% returns in just about 2 months. Here is the link to the announcement.

http://www.moneycontrol.com/livefeed_pdf/Oct2012/Gujarat_Gas_Company_Ltd2_041012.pdf

Thanks & Regards,

Balaji.

#4 by

Kuntalon December 7, 2012 - 6:45 PMHello Kiran,

Like to read your analysis of the special situations.

Do you think the demerger and the complex consolidations in the Zuari Global (or Zuari Group) makes Zuari Global a ‘special situation’ providing buying opportunity?

Reference to the report from HDFC Sec at: http://www.hdfcsec.com/Research/ResearchDetails.aspx?report_id=2989371

Regards

kuntal