A Lesson In Open Offer – The ABB Example

Promoters of ABB have offered to buy 48.51 million shares, or 22.89%, in the firm from shareholders at Rs 900, an 8.8% premium to current market price (CMP) of Rs 826.

The offer by ABB Asea Brown Boveri and ABB (Switzerland) will launch on July 8 and will close on July 27, HSBC Securities and Capital Markets said. ABB Asea Brown Boveri and its unit ABB Norden Holding together hold 52.11% in ABB.

Calculation:

Is there any arbitrage available or should one buy taking open offer into consideration?

ABB current price = Rs 826 e.g. 100 shares are bought.

Currently, ABB holds 52.11% and it has offered to buy 22.89% more which would take their stake to 75% in India unit. So it makes a 47.8% probability that our shares would get tendered in open offer.

So if one buys 100 shares, approximately 48 would go into open offer and he will get payout @ Rs 900 a share.

Net Profit on tendered shares = (Rs 900 - Rs 826) X 48 = Rs 74 X 48 = Rs 3,552.
Net Profit = 4.3% on total capital invested, decent returns for holding period of around 2.5 months!

What History Teaches Us:

Ranbaxy shareholders were given a similar open offer which was way above its market price at that time and it was at Rs 737 a share from Daiichi Sankyo of Japan while shares were ruling at Rs 550 at time of announcement. The stock has never risen to those levels now almost 2 years have passed, those who bought in anticipation of open offer got payout for small number of shares and larger part of holdings is still stuck.

Why Foreign Companies Give Open Offers?

They are investing in businesses and not at all interested in small short term gains, they think of 5-10 years in advance minimum and bet on future of the economy which a common retail investor doesn`t do.

In case of ABB, the open offer price looks really stretched as the company is already trading at a P/E multiple of 62 and at Rs 900 it would go beyond 67 which is not at all cheap by any stretch of imagination.

ABB has reported an average decline of 34.5% in profits for the past four quarters ended December 2009. The performance has taken a further sharp blow in the March 2010 quarter, with profits falling by 92%. The company`s financial performance has been disappointing mainly due to its exit from a key business segment, delays in some of the projects and fluctuation in input prices.

Company imports nearly 40% of its raw material requirement and is exposed to a large foreign exchange risk; it has to follow an active hedging policy which may be lacking so far. Recent rupee appreciation may hurt financials more.

The probability of giving shares in open offer may go down also as public holding currently stands at less than 15%, which means that the company would have to convince the institutional investors, who hold a total of around 33%, to respond to the offer.

Looking at company prospects in immediate future and history of similar open offer it looks wise to take profits at current market price or have small exposure as stock may fall after the event is over. Even an 8% drop from current levels would take the investor into losses if one buys from the viewpoint of open offer now. If parent doesn`t have intentions of de-listing,profit for the investor is not guaranteed by any open offer.

IPL Model

After the emergence of the Indian Premier League, BCCI secretary Niranjan Shah had grandly announced: "Indian cricket is now worth a billion dollars every year." So where is all this money to come from and where will it go? What’s the ‘business model’ of the IPL? Is there any way the franchisees who have bid millions of dollars a year can make money?

To get a fix on the answers to these questions, let's start from the source of the river of moolah. The IPL - read BCCI - has four major sources of revenue. The first is the sale of media rights for the matches, which will fetch the board $1 billion over a 10-year period. The second includes things like title sponsorship of the tournament, licensed merchandise and so on. Put together, these form what the IPL calls "central revenues".

From the sale of media rights, IPL will keep 20% for itself, give out 8% as prize money for the tournament and distribute the remaining 72% evenly between the 8 franchisees. These proportions are valid till 2012, after which IPL’s share goes up in two stages by 2018, with the shares of both prize money and franchisees declining.

The second stream - other central revenues - will be shared between IPL, franchisees and prize money in the ratio 40:54:6 up to 2017 after which IPL’s share will increase to 50%, the franchisees’ share will drop to 45% and the remaining 5% will go for prize money. The third major source is, of course, the amounts bid by the franchisees. The fourth stream comes from the revenues generated by the franchisee rights, of which 20% will be given to IPL.

From the franchisees’ perspective, while the share in central revenues will be a given, they can raise money on their own by a variety of means. These include selling advertising space in the stadia for home matches, licensing products for their team like T-shirts, getting sponsorship for the team uniform, advertising on tickets and so on, apart from the gate money. As already mentioned, 20% of all of this will then go to IPL.

What do the players make? Apart from the annual fee contracted with the franchisee, they get a daily allowance of $100 through the IPL season, which lasts about a month-and-a-half. The total amount spent on player fees for an IPL team cannot be less than $3.3 million each year and is actually expected to be significantly higher. In other words, players will earn about Rs 80 lakh or more per season on average, though the amount would vary from one member of the team to another.

Players could also get bonuses from the team owners and perhaps even the prize money that the team wins by virtue of where it finishes in the tournament. But it is for each franchisee to decide whether these payments are made to the players or not.

Even in the case of the annual fee negotiated between a player and the franchisee, not all of the negotiated amount may actually go into the player’s pocket.

This is because the IPL is reaching two different kinds of agreements with players when it gets them on board. Under one arrangement — called the "firm agreement", the IPL commits a certain fee to the player. If a franchisee bids more for that player in the auction between franchisees for different players, the IPL gets to keep the excess. Under the other - the "basic agreement" – the player gets whatever is bid for him. Not surprisingly, most players so far have opted for the "basic agreement".

Now that we have the broad structure of the flow of money in place, how does this translate into actual numbers? The bottomline, acknowledge BCCI officials as well as franchisees, will depend on whether the IPL as a concept takes off and captures audiences.

As things stand, the expenses committed by franchisees are more than what they are certain to receive as income from IPL or from sale of their own rights. The UB Group, which acquired the Bangalore franchise, says the idea was to use it as a vehicle to promote its brands. "We are not looking at making money. But revenues will be in excess of costs," said Vijay Rekhi, president of United Spirits, the spirits company of the UB Group.

Some franchisees said that if everything goes according to plan, they will break even and perhaps even start making some money after about three years.

Sources say IPL is guaranteeing $7 million per franchisee from central revenues. But what will come from the local level is anybody’s guess. Even with the right to market just about everything connected with their teams, the industry is not expecting to raise more than $2 million per franchisee each year. BCCI expects the franchisees to earn $1.5 million from gate money in every IPL match, but insiders say the figure is "exaggerated" and that the franchisee will be fortunate to get $1.5 million from 7 home matches at home. In fact, highly charged India-Pakistan one-day matches make around $3 to $4million.

However, based on IPL’s calculation, tickets will have to be sold for Rs 750 to Rs 1,000 per match for gate money to be of the estimated levels. Will the fans pay that much? Apparently, there is also a suggestion from IPL that franchisees could have some "business class" tickets for Rs 10,000 each. Again, will there be takers for such expensive tickets? There are franchisees who are planning to sell tickets for Rs 200 to Rs 300 to keep them within the reach of the middle class, without which making the IPL a success would be difficult. But then, they cannot expect huge revenue from the gate money.

Assuming the gate money is around $2 million for all seven home matches, this means the franchisee in the first year can look forward to total income of about $10 million after paying 20% of local revenues to IPL.

Against this, the franchisee will have to spend at least $8 million. To this must be added the bid amount divided by 10. For Mumbai or Bangalore, that means another $11 million. Even if it’s lower for others, the franchisee's expenditure will be anything from 1.5 to 2 times of what his income is, at least in the first year.

What can change in this equation to make the business financially rewarding for the franchisee? If local revenues really rise, things could get better. It all boils down to whether the IPL teams can make their cities identify with them. That’s the billion dollar question.

Reference : Times Of India article

The Golden Ratio

The three great bull markets of the Twentieth Century are dramatically reflected in a chart of the Dow/Gold ratio, which is simply the quotient of the Dow Jones Industrial Average divided by the gold price in US Dollars. It is basically the price of the leading index of paper claims on productive assets, divided by the dollar price of an ounce of gold.

When the ratio is high, as it is in a boom, equities are expensive and gold is cheap.
When the ratio is low, as it is in a bust, equities are cheap and gold is dear.

Today, the Dow/Gold ratio is at its highest level ever. We believe this signifies the financial world is on the cusp of a huge inflection point, similar to that of the two prior peaks.

Just as at those prior peaks, financial assets are grossly overvalued, and gold is grossly undervalued.

Just as those prior valuation extremes resolved themselves through dramatic reversals in both the numerator and the denominator of the Dow/Gold ratio, so will today’s, and soon.

The key to understanding the Dow/Gold ratio and what it portends lies in isolating the principal factors that affect the numerator (equity prices) and the denominator (the price of gold).

At every peak, we find the same phenomena:

- Overvaluation of equities
- Over-ownership of equities
- Excessive liquidity
- Excessive credit

At every trough, we find their opposites.

And at each extreme, we find a background of breakdown in the global monetary system:

- Collapse of gold exchange standard (1929 -1934)
- Collapse of Bretton Woods standard (1961 -1971)
- Collapse of floating rate standard (pending)

Earthquake Theory For Stock Market Movements

The earthquake science working for markets is an opinion as old as the butterfly effect and the study on Sun cycles influencing markets. Earthquake do not cause market behaviour, but large-scale events in the stock market adhere to distinct patterns which can be witnessed in seismic activity. Economists should borrow the earthquake math from scientists who model natural disasters, the power curve mathematics.

The reason that economists are uncomfortable with power laws is that “unlike the bell curve they are not based on any assumptions about how markets or people work. They are simply curves that fit the data”.

The Power Law
The power law cannot predict when catastrophes happen, but only how often they will occur. An earthquake that is twice as big will be four times as rare. The power law school of thought is not working on the timing problem as they are convinced that power law is not about predicting time, it is just a recurring pattern in nature, which is an unexplainable rule.
Something can’t be understood so it is better to focus on things at hand rather than interpreting the science behind the law of nature. Power law is believed to allow policy-makers to set regulations that better shore up the financial world against extreme events.

Time Decay In Earthquakes
Probability of a disastrous economic fluctuation seems to be fairly independent of time period. Time independence could be an illusion and an idea which could assist physicists to ignore time. Many scientists have talked about the same earthquake science but from a time dependence aspect. Seismologists are now talking about recurrent time and use elapsed time to calculate earthquake probabilities. Elapsed time is now believed to influence future earthquake events. There is an effort to understand seismic cycles and improve earthquake maps. The researchers say that time dependent models are intuitively appealing.

Though this is an idea in the right direction, it has ground to cover before the scientific community reaches time fractals. We have talked about time decay on prior occasions. This time we are illustrating the time decay in earthquakes. Haiti was in the top destructive earthquakes of all time and has been extensively studied by the US geological survey. We pulled out the minute by minute data from 23 January to 29 January and isolated the time between shocks across the region. The plotted chart was an exponential curve again, suggesting the time (number of days) between shocks was proportionally spread even when smaller time was studied. We get a similar plot when we study earthquake date from 1575 and similar time patterns are seen when we study nuclear tests or any other social and natural activity.

How can time exhibit the same exponential order when the order is believed to be everywhere else? We can either see fractals and patterns all around us, in everything, or accept that time is indeed what gives every living entity, anything which ages, this distinct pattern. Everything from earthquakes, to volcanoes, to cotton prices, to human behaviour and even to the Sun is patterned by time. “When” remains a more important aspect than how often can earthquakes repeat, a crisis occur, a stock rise, or an asset outperform. The focus on “when” can assist us more even if we don’t have a perfect answer. Time is perfect, our interpretation of it can never be.

We started the year attempting to time relative performance. We asked early January, if it was time for Grasim to outperform Nifty? Grasim was at the bottom of numeric rankings on 29 December 2009 and now it is at the top of list. What does this mean? This means that end of December Grasim was ready to outperform Nifty and it did. Long Grasim, short Nifty delivered 13 per cent in January. Now that Grasim has hit a top in rankings, a performance reversal should not be far away, when it starts to underperform Nifty.

The anticipated breakdown we have been talking on markets also happened. Metals, small cap and capital goods are ready to underperform the market. Tata Motors and M&M also seem overstretched in performance and should not sustain outperformance against Nifty for long. HDFC’s performance cycles continue to suggest that there is more catch up for the stock against Nifty; the stock should outperform the benchmark. If everything is cyclical like time suggests, research solutions of tomorrow might just simplify things.


via the smart investor