ambuja-acc-holcim make tripartite

Ambuja Cements is in the news for its supposed restructuring what it calls heading towards a more efficient capital structure. The company is entering into a share purchase-and-swap transaction with its majority shareholders resulting in merger of Holcim India Private Ltd. into Ambuja Cements.

As per the details of the scheme, Ambuja will purchase 24% of shares of Holcim for a cash consideration of Rs. 35 b; it will cancel 9.76% of its own shares held by Holcim; it will issue 584.44 m of its shares to Holderind Investments Ltd.; and by virtue of the scheme it will own 50.01% of ACC. 

The current shareholding of Ambuja is: Holderind (40.79%), Holcim (9.76%), minority (49.45%). Ambuja also has certain options, warrants and rights which are exercisable for the purpose of the scheme. Since Holcim is fully owned by Holderind, it gets 50.55% of Ambuja. Holcim also owns 50.01% of ACC. Holderind is part of Holcim, Switzerland.

The story goes forward: Out of Holcim's total of 5,690 m shares, 1,365 m shares are being purchased by Ambuja at a price of Rs.25.63 per share; and in exchange for the balance 4,325 m shares, Ambuja will issue 584.44 m of its own shares to Holderind. 

Post merger, Holderind will own 1,214 m shares in Ambuja resulting 61.12% of the fully diluted shareholding because of options, warrants and rights being exercised. The balance 38.88% will be left for the minority shareholders. 

The merger scheme required valuation of both Ambuja and ACC separately and as per the valuation made by the professional accountants the share swap is 7.4 and the implied price per share is Rs.189.66 for Ambuja and Rs.1249.02 for ACC. 

To evaluate how the scheme impacts both the majority and minority shareholders, let's first have a look at the implied market values: Holcim of Rs.146 b representing its ownership in Ambuja and ACC; Ambuja of Rs.293 b; and ACC of Rs.235 b. The implied valuations are not too far off current market-cap of Ambuja (Rs.275 b) and ACC (Rs.201 b). 

For the majority and minority shareholders, it would first appear that the difference in value is heavily tilted in favor of the majority. To see how, all that is to be done is to find out their value before and after the merger. 

The market value of Ambuja should go up post transaction from Rs.293 b to Rs.375 b because of the net effect of the cash payout and gain of share in ACC. This increase in value of Rs.82 b is shared by the majority (Rs.81 b) and the minority (Rs.1 b). Now it sounds like the real merger, with the minority defeated.

However, if we look at what happens to Holderind as a firm, the equation would be different. Holdeind will give up about Rs.148 b of its value in Ambuja and Rs.117 b in ACC; in exchange, it  will get cash of Rs.35 b and value of about Rs.229 b in the restructured Ambuja. The minority will give up about Rs.145 b and get Rs.146 b after the merger. Consequently, the net effect of the merger scheme is shifting of about Rs.1 b of value from, in fact, Holderind to the minority shareholders. The deal is now through as the required minority has voted.

All this is subject to the valuations being fair which I doubt profoundly.

Finally, this is how the companies have rewarded their shareholders in the past:

This is the problem with the cyclical business.

marico acquisitions - boost or boast

The growth strategy

The path for Marico has been clear: growth through acquisitions. Since 2005, it has made 10-12 acquisitions covering India, Bangladesh, Egypt, South Africa, Malaysia, Singapore and Vietnam. 

In a highly competitive market categories that the firm operates, one of the two strategies should pay: Increase volumes or increase prices, or may be a fair combination of the two. Since there is a limit to increasing prices and volumes of the current products, what better way than increasing the product portfolio? So does the management think and hence, these acquisitions. 

Acquisitions are good if price paid for these is fair in comparison to the future cash flows. Although, there are some exceptions, one of the parties to the transaction would have an edge over the other. This means, the value gained by that party would be at the cost of the other. That is how mergers and acquisitions function in the corporate world. Of course, most of them fail to create any value.

The historical performance

In this respect Marico has not done badly so far. Over the last decade its revenue has grown at an impressive annual rate of 20%; its operating and net margins have remained steady; but, return on capital and return on equity have reduced from high levels to reasonable levels.

The primary reasons for lower return ratios are the acquisitions. Its first major acquisitions took place in 2011 which included:

1) Singapore based skin care solutions business Derma-Rx for Rs.1.44 b; 

2) The Ingwe brand (mainly Caivil and Black Chic brands in hair care) from South Africa based Guideline Trading Company. Surprisingly, no information about the consideration and fair value of assets acquired is disclosed in the annual report. 

3) The 85% equity in International Consumer Products Corporation (ICP), a Vietnamese FMCG company having brands such as X-Men, L’Ovite, Thuan Phat in cosmetics segment. Here too, no information about the consideration and fair value of assets acquired is disclosed in the annual report. Instead, the resulting goodwill (which is the excess of consideration over the fair value of net assets acquired) of Rs.2.21 b is disclosed.

If we have a look at the fixed assets note and the statement of cash flows it appears that Marico's total cost of acquisition in 2011 was about Rs.4.62 b.

The stock performance in the past:

Clearly, shareholders have been happy.

The restructuring in 2013

Marico has undergone significant restructuring:

1) The divestment of Kaya Skincare business into a new (being listed) entity, Marico Kaya Enterprises Limited. As a consideration, the shareholders of Marico have been issued 1 share of Marico Kaya each (face value Rs.10) for every 50 shares of Marico (face value Rs.1), fully paid up. Because of this, Kaya skincare, including the 2011 acquisition of Derma-Rx, will be out of Marico's operations. 

2) In May 2012, Marico acquired the (Halite) personal care business of Paras Pharmaceuticals Limited from Reckitt Benckiser for a consideration of Rs.7.45 b. This is effectively for Set Wet, Livon, Zatak, Eclipse, Recova and Dr Lips brands.

The investments and free cash flows

Marico has made net investments of about Rs.26.28 b including working capital in the last decade. A large portion of this, about Rs.15.32 b, has come in the last 3 years. Consequently, revenues and margins will undergo some change in the coming years as the new acquisitions start flowing into the business. 

These investments have been funded by both equity and debt. If fresh issues of shares is used to fund acquisitions, there will be potential problems: It results in dilution of earnings for the existing shareholders; especially when the price paid for acquisition is not a bargain, it results in lower value for the business.

For the first time in many years, Marico issued new shares (apart from its annual employee stock options) in May 2012. It issued 29,411,764 equity shares on a preferential allotment basis at Rs.170 per share to two foreign investors - Indivest Pte.Ltd., an affiliate of Government of Singapore Investment Corporation (GIC) and Baring India Private Equity Fund III Listed Investments Limited.

The acquisitions on a regular basis have made sure that the firm has never had any meaningful free cash flows in the last decade. Its poor payout ratio reflects this.

The future performance
Marico owns brands such as Parachute, Nihar, Saffola, Hair & Care, Revive, Mediker, Livon and Set-wet (in India) and Fiancée, HairCode, Camelia, Aromatic, Caivil, Hercules, Black Chic, Ingwe, Code 10, X-men, L’Ovite and Thuan Phat (international).

Whether Rs.7.45 b for Set Wet, Livon, Zatak, Eclipse, Recova and Dr Lips brands is a fair price, time will tell us. However, considering their collective current revenue of about Rs.1.50 b, it will take significant growth in revenue and operating margins, and a high return on capital to justify this acquisition. 

After these acquisitions, Marico's book capital has increased significantly because of which there will be pressure on return on capital in the coming years unless higher operating margins are sustained.

As per its latest quarter's report the company has a target revenue growth of 15-20% and operating margin of 14-15%. Well, if I take their word for it and estimate the value of equity of the firm on a going concern basis it falls short of its current market value. 

Nevertheless, we have a precedent of two foreign investors buying shares at a price of Rs.170 per share in May 2012. The stock has run up 18% since then. 

You can bet on Harsh Mariwala and the CEO if you wish to; after all, the past is some indicator of the future, if not the best one. But then, it is your call on revenues, margins, cash flows and the risk.

ongc is not a fair game

Exploration business

Brent crude is now at about $108 per barrel. In fact, it has remained higher than this level for much of the period. Oil exploration companies are treading good fortune, one might say. 

Despite that, 2013 annual report of ONGC says that its net realization on crude oil was $47.85, and it was $54.72 in 2012. For the first-half of 2014 it has been $42.56. This is not new, it has always been like that for ONGC. What is going on here? 

For any exploration business two biggest risks are explorable oil and oil price. The former depends upon several factors including technology and cost. As for the latter, the higher it goes the better it is. However, for ONGC it is not. Funny though, it is in a weird situation. 

The regulation

ONGC is forced to sell oil at discount to oil marketing companies, its customers. The discount is pretty large as we can already see. 

This is how it works: The government controls retail selling prices of high speed diesel, superior kerosene oil and liquefied petroleum gas. The reason appears to be simple; non-subsidized votes from the general public in exchange for subsidized petroleum products. Consequently, IOC, BPCL and HPCL sell for too low and incur losses (call it under-recoveries). The story gets interesting from now on. As mandated by the government more than 90% of these losses are to be borne by the government itself (about 55%), and upstream companies (ONGC, OIL and GAIL - about 35%). And more than 80% of the upstream share is charged to ONGC. The government does not reimburse in cash, it issues oil bonds to the oil marketing companies instead. ONGC and other upstream give discounts to them. 

Value destructive

Some thinking and analysis would tell us that this policy has had enormous impact on the business and shareholder value. The cornerstone of corporate finance has gone bonkers. In the last ten years, total subsidy borne by ONGC is about Rs.2,163 b; it's massive. That's the amount of revenue lost by the company. The bottom-line impact on ONGC is lower than this because it has to be pay VAT and statutory levies to the government. In 2013 the firm lost Rs.421 b and in 2012 it lost Rs.378 b on net basis; that is, cash loss after paying taxes. The minority public (including institutions) have lost about 30.77% (their stake) of this cash on account of poor regulation. 

Lack of substance

I just don't understand why the math had to be like this; it is ridiculous. If the public has to be supplied with cheaper products, why not just reimburse directly to the marketing companies? Just collect taxes, levies and dividends from the upstream, and give it to the marketing. Or better yet, stop this nonsense and go for market-driven policies where everyone gets what he or she deserves. Create employment, private partnership and growth, and make people work to afford goods and services, however expensive they might be in the market. If they cannot afford it, people should learn to live without it; a fair game.

The hapless minority

This is how I see it. The average return on equity (also return on capital) earned by the firm has been more than 26% over the last decade. If the subsidy cash was reinvested by ONGC in the business and earned say 25%, the current value of that cumulative reinvestment would have been staggering Rs.2,635 b; compare this to the current market value of equity of Rs.2,400 b. The government has destroyed the firm's equity value by about 50%. In other words, the minority would have been richer by 100% if only those policies were not adopted. Alas, it was not to be. 

The following shows how the minority has been taken on a ride by the majority shareholder (at March 2013).

This shows value lost by the firm at different levels of opportunity costs. Even the no-brainer 8% rate would have increased market value by Rs.1,534 b.

In fact, the government too could have done far better without regulation. Its share of value including all levies would be much higher. But then, politics is not business and finance.

The deregulation...the value creator

In 2013 both return on equity and capital reduced to less than 20% for the first time in the decade. No wonder the chairman is worried. The production levels (both oil and gas) have not moved much for a long time; fields have become old and mature.

For the firm to create value in future a few things have to take place: Increase reserves acreage; improve technology to reduce cost of production; hope for steady oil prices; and above all, pray for deregulation. The production targets require sustained reinvestment which would be impacted if the current policy continues.

We are informed that in June 2010 petrol prices were deregulated (I don't see it explicitly though) and diesel is on its way to be deregulated. All this is to bring down subsidies and fiscal deficit; the current hot topic.

When or whether it will happen is left only to guesswork. What we learn is that we don't learn. That should not stop us from guessing.

socialist democracy

The outsiders' view
He is usually low on the US and Europe, and high on Asia and commodities; that is his view. I don't track Jim Rogers. I am not particularly interested in commodities as such, because for me they are subject to pricing mechanics, not value mechanics; and that is my view.

Nevertheless, I found his recent comments about India quite interesting. Some of his thoughts:

Well, these are his thoughts and views. How much of these are really true, it is for anyone to ponder.

The fish school
The government has been from the school of giving the fish, rather than teaching to fish thought. Free food, subsidized food, subsidized products, in exchange for non-subsidized votes, probably. Wouldn't job creation be better? Wouldn't partnering with the private be better if the state cannot do it alone? Tough questions I guess, but, is India really catching up with the world, is it behaving right? Imagine a state owned listed company looting its minority public shareholders in the name of general public subsidy.

An option to delay...for how long...
I do see opportunities for improvement, if only some questions are addressed properly. We need to first check what India has shown in the past several years in terms of employment, per capita income, and real growth; how easy it is to do business, both for domestic and foreign firms; what kind of infrastructure is in place; how flexible or stringent are the rules regarding capital, currency and profits to move. These are to be assessed on a relative basis, both what it was before and what it is now, and also how it compares with other economies. If other economies are better placed it is easy to tell that business, money and growth will flow there.

The advantage India has is that it is difficult for the world to ignore it; it is tough to shrug off a billion-plus people, the potential for demand is immense; consequently, there is colossal opportunity for doing business. It is up to India now to capitalize on this, or fall behind.

At this stage, though, it is tough to tell whether India is a democracy, or a socialist; or a socialist democracy, I don't even know what it means.

Right now for investors it is like an option to delay worth a very low value. India needs do everything to increase that option value.

value of a business

The essence

The crux of the matter when it comes to investing is valuation. Unfortunately, value is often mistaken to be price, and vice versa. Just as investing itself is often confused with speculation. Understanding the difference is far too important for an investor. 

Speculation, especially calculated speculation, is not bad as long as one knows that one is speculating, not investing. Similarly, estimating the price is fine for an investor or speculator as long as he knows that he is chasing price, not value. 

The value

Let's come to value. The value of any cash flow generating asset is the present value of its cash flows over its life. Obviously you need to discount these cash flows at an appropriate rate to bring them to the present value. Thus, estimating value poses twin challenges: estimating cash flows and using the right discount rate. 

The value of a business is, accordingly, the present value of the cash flows it is going to generate over its life. If the life is considered finite, cash flows are estimated over that period. However, often, a business has infinite life. Consequently, cash flows have to be estimated over perpetuity. 

The cash flows

When this is the case, the cash flows period is split into more than one. First is to estimate when the business will reach the stable growth. It can be in 5, 10 or any other number of years. The period until stable growth is the growth period. Then cash flows are estimated during the growth period using an appropriate growth rate over this period. Lastly cash flows are estimated during the stable growth period considering the fact that business has become mature. The behavior of the business is different during the growth and the stable growth periods. Naturally, you expect decisions regarding investing, financing and dividends to be different too. The key to estimating cash flows then is to understand the behavior of the firm under different conditions. That is to know that revenues, margins, reinvestment and return on capital change as the firm's characteristics change. As the behavior of the firms changes, their value changes.

The discount rate

It is the easiest when cash flows are almost a certainty.  In this case, you just use the risk-free rate to bring them to the present value. Heck, cash flows are never certain. Using the right discount rate then becomes more challenging. 

The garbage in

It appears quite clear that once you input cash flows and discount rate, out comes the value. This is easily manipulated if the analyst is exposed to bias arising either due to his own emotions, or market-driven conditions. Therefore, it is imperative that caution is exercised before estimating cash flows and discount rate.

What is not value

Every other method used to calculate the so-called value is actually not value. That may appear surprising to many since value is used so much loosely in context by too many on too many occasions.

The most popular method used is the multiples-based method. Here, multiples such as price-earnings, price-book, price-sales, or enterprise value based multiples are used to estimate value. In reality, however, what the analyst is doing is to estimate the price, not value. Fundamentally, he is assuming that markets are overall correct all the time, but on individual stocks they are often wrong. Therefore, under-priced and over-priced stocks are selected for transaction purposes. Income-based valuation is nothing but a pricing method.

Asset-based methods use either book values which is nonsense, or market values which is again pricing. 

Liquidation value method is a valuation method if based on cash flows, discounted when required, or is a pricing method if you turn to the markets for clue.

Then there is option-pricing model used to value an asset, especially out-of-the-money, as an option. When estimating cash flows as they are is not easy, estimating inputs used for option-pricing seems rather too uncomfortable. The only way I see it is that since the downside risk is fixed, an option gives just that, an option to buy or sell, which should be used with caution. Let's not get attracted to the fancy stuff; let's concentrate on how comfortable we are with the cash flows, although they are probable.

The explicit

It is quite clear that the only way you can value an asset is based on the discounted cash flows. Every other method is useless if you are trying to estimate value. Pricing is fine if you know that you are trying to price for the short term. Prices change too quickly while value does not. Therefore, a prudent long term investor would want to value the stock rather than price it. 

It is amazing that so many professional analysts get it wrong. They seem to know nothing about the difference between value and price, or they seem to ignore it. The result is that their reports use models to estimate price, which is unfortunate because these reports are pitched to the potential buyers.

Now, if the buyers are unaware of the difference, they will fall prey to the pricing pitches, and will be exposed to lose money.

Get it right

You will be alright if you know what you are doing, and more importantly, if you know what you are not doing. Understanding the limitations and constraints is the key. Behave right!

was it right for blackberry

The scary ride

It is not clear whether not going private was a good decision for Blackberry, or was it not being able to sell the business to potential buyers. 

Last few years have been daunting for the smart phone maker whose technology was once considered disruptive. 

As revenues and profits started falling, market value has also taken a dive. The latest quarter ended August 2013 was extraordinary as the firm posted a gross loss. Does this mean it sold blackberry phones below cost, and did not have operating cash to cover its research & development, selling, general and admin expenses? Well, it looks like it.  

Dwindling market value

The consequence has been value destructive for the shareholders. 

From $47 b market cap in Sept-2009 it is worth, as appraised by markets, about $3.4 b now. As much as we hope that nobody bought any stock in the last four years we can't run away from reality. There must be a number of investors who believed the firm would grow its market share and stock price and put the money only to see it vanish. 

The good and the bad 

I am not sure what is in store for it now. Nevertheless, there are investors who have shown faith in its business model, or some of its assets.

The good news so far has been is that it has not been burning cash, yet. Depreciation and change in non-cash working capital have been positive cash flows for the firm compensating for the negative earnings. In fact, Blackberry would have increased its cash over the last year if it had postponed its capex. It has over $2 b of cash and no debt now which can help counter the storm for sometime, although, withering some ego. It also has software and patents apart from devices and network assets; these must be worth something.

However, there is plenty of bad news. Revenues and profits have been falling; market share is probably at its lowest point now; cash may not last for too long. Yet, the most important negative has been failing business model. There appears to be lack of a clear strategy going forward at least as available in the public domain so far. Moreover, capex cannot be postponed for long if Blackberry wants to continue doing what it does. In fact, it spent about $7.5 b in capex in the last four years; and we know what happened in those years. Reinvestment has to show growth and value, otherwise, it is meaningless and wasteful.

The uncertain bet

I am sure those who want to invest significantly in the firm have got a plan in place, and more importantly have faith in place. That $1 b investment in the form of debt securities with an option to convert into equity at $10 per share shows that faith. 

Whether it will fructify is something we have to wait and see. These are the challenging times for technology firms especially those into making smart phones and tablets. 

The option to sell the business in parts, a form of liquidation of assets, is apparently not on the cards. There is no full sale or part sale, there isn't going private, there isn't a strategy going forward. So what is it for the current and potential investors now?

It is tough to tell. But, here is what I reckon. Today, the market is willing to give just $1 b for its operating assets excluding cash. Is it too little or too high? Investment in Blackberry now is like a blind date, like you wouldn't know whether it is going to be a fairy or a witch. It is a bet which might pay off or may not. Blackberry's patents, like options, could pay off for the investors, or they may not. All this, however, is full of uncertainty. 

Uncertainty is what Blackberry is seeking today with its intention not to sell. Just for math, the stock price has to jump over 50% for the lenders to be even with the strike price for conversion. To make money it has to jump several fold though.

They must know better.....They must know something I don't. Wishful or nonsense?

reflections of the market

Short term or long term: Price and Value

We have discussed in the past about historical values of markets and made some analysis on key pointers. Well, it's about a year since and I see it apt to reflect on where it stands now. 

The factors that drive markets are the same as those drive individual firms, i.e. cash flows, growth and risk. Since risk has direct impact on cash flows and growth it becomes all the more important how we see risk both in terms of intuition and reason. In the long term markets catch up with the fundamentals of the firms. 

However, in the short term that is not the case. Markets move up and down based on the expectations of short-term price seekers. Often, there is irrationality embedded in these expectations. The game of short-term players and long-term investors always renders moot. In the battle of price and value as I see it, eventually value will have the triumph. This is based on the premise that price has to catch up with the fundamentals despite odds and delays.

The year so far

Let's come back to the market and its moods during the year. It started with 5937.65 and closed at 6299.15 yesterday; that is about 7.3% annualized, not very exciting. 

The Nifty was at 5285 by end of August 2013, though; that is about 19% in just two months. You can try the annualized yield, but, the point is such things happen in the short term. The expectations drive moods and consequently, the stock prices.

In the past ten months, the PE has moved from about 15 to 19. The fact that current values are far different from the all time high-low values lets us an opportunity to make decisions. Clearly, the buy time was end-August / beginning-Sept. 

The dividend yield has never been great for the index. This should be because either the firms are in high-growth phase, hence low payout ratios, or there is over-estimation of growth in price. In a growing economy like India, the tendency is to assume the former; however, this should be done with caution. We see firms investing in mediocre projects when they have a lot of cash. This happens primarily when their core business is generating excess cash, and the managers try to extend their smartness to the area they are not good at, just to fill their ego. Instead of increasing dividend payouts they go about empire building. This is not smart corporate finance. When firms reach their stable growth period it is far better to accept that reality and behave like mature firms.

The PB ratio has moved between 2.62 to 3.26. How far one can pay over the book value depends upon the type of business one is looking at. For a capital-intensive business the PB can vary significantly based on the expected earning power of operating assets. For a financial firm the PB is more closer to the book, though. Collectively for the index, it is better to visit history to check the prices it has traded at, albeit keeping in mind the level of interest rates . In Sept-2001 it was 1.92 and in Jan-2008 it was 6.55. A grand display of the vicious moods of Mr. Market.

The Diwali bonanza

Now, the Nifty is trading at 18.18 PE, 2.99 PB and 1.46% dividend yield. In the coming days, there will be a lot of coverage on hot stocks for the season, for the next year and for the next few years. All I can say is, be wary of these talks for these are often loose. Think about this default reasoning: If anyone is good at picking stocks that person would not appear on media and talk about it, rather would concentrate all resources on those stocks and get rich. As a corollary to this, because that person is appearing all over and trying to sell ideas there is reason for us to ignore it. One should try to recognize the bias involved in every proposition.

The basics

The suggestion is to stick to the basics. If you have time and are interested in business, finance and investing, set this activity as your business (full-time or part-time) and make all the efforts in understanding the business and its valuation. Try to understand the difference between price and value. Pick stocks on a selective basis whenever there is price-value mismatches. 

If you don't have time because you enjoy a different activity, there is plenty to cheer than fear. It is best to stick to long-term investing on a systematic basis in a diversified index, let's say, S&P-500 or S&P CNX Nifty. Such a program should be continued despite low or high index values, or adverse economic conditions, and should be carried out for a fairly long period of time. With this strategy you would have beaten a large number of so-called professionals managing money. The rest of the time you can concentrate on your favorite subject.

For both the strategies to work, one aspect is far more important. That is the ability to control emotions, not to get carried away by markets, media, week-end parties, relatives or friends. The fancy word is behavioral finance, but, one need not get there if one has discipline and right behavior.

We all need to cultivate such habits, and thus create our own good luck. 

Finally, the decision to buy an index or a stock should come from the expectations of cash flows, growth and risk. Bear in mind that expected inflation and interest rates influence value at any point in time. Therefore, none of the market ratios should be looked at in isolation.

Let's go back to work, rather than hear the media on hot stocks. Flap!