# Indo Asian Fusegear

This text is taken from my blog

On 23rd July French company Legrand announced that it would buy Indo Asian Fusegears 's Switch gear business for a sum of 600Crs. The break up of the deal is as follows:

1). Amount to be paid for Switchgear Business : 495 Crs

2). Amount to be paid as non compete fee : 35 Crs

3). Amount to be paid as non compete fee to promoters : 35 Crs

4). Amount to be paid to promoters for Indo Asian Marketing : 35crs

So this works out to 530 Crs to the company(shareholders) and 70 Crs to the promoters . The board of directors of Indo Asian Fusegear has already approved the sale, which is subject to regulatory approvals. Now lets do the math and see how much cash may eventually hit the company’s book.

Amount paid by legrand to company = 530 Crs

Tax to be paid to govt.(not sure about the %,assume worst case 30%) = - 159Crs

Total debt on companies books(as of Mar 2009 ) = -128Crs

Total cash on companies books(as of Mar 2009) = Rs 13.2Crs

Remaining Amount with company = 256 Crs or Rs 167/sh

The company is now available at a Marketcap of 225 Crs (Rs140).The above calculation has a few assumptions like,the debt is as of last years Balance sheet and there is a chance of it going up or down(most likely up). The same argument applies to the cash balance. I have also assumed the worst case Tax at 30% since i am not too sure about this one but there is a chance it can be between 20-30%. So as per my calculations at the current price the market seems to be valuing the company at a 10% discount to its expected cash on books and completely disregarding the remaining business of Indo Asian. Lets take a brief look at the various segments of the company & its financial performance till date to understand why this may be the case.

Indo Asian Fusegear operates in the following business segments:

1). Switchgear : This was the segment that was sold to Legrand for the above mentioned amount.This includes MCBs, HRC Fuses, Feeder Pillars, RCCBs, Distribution Boards, Switches etc. This division had Revenue of 206Crs & Profit of about 31 crs in Fy 2008-09(need latest Annual report for latest figures).

2). Lighting : This includes Compact Fluorescent Lamps, Fluorescent TubeLights and Luminaires etc. This division had Revenue of 28Crs & Loss of about 2.5crs.

3). Cable and Wires: This includes Wires and Cables etc. This division had Revenue of 26.7Crs & Loss of about 2.25crs.

As its obvious from above, the Switchgear business was the key revenue & profit contributer for Indo Asian a trend visible all the way from 2006-10. The Lighting business was profitable till 2008 & went into losses last year.The Cable & Wires division didn’t figure in Annual Reports till 2008 & looks like a new division & it is also loss making. The Lighting business is also very competitive as per the Annual report. Assuming the Lighting & Cable/wires divisions return to profitability in the near future, we can look at revenues of about 60Crs & profit of about 4-6 Crs(Assumption based on 2008 profits they could very well continue making losses too). Further the management plans to pursue opportunities in the areas of advance lighting systems (LEDs), products for energy management & conservation. This could be the key to its future prospects as getting into Advanced Lighting systems will require the company to make acquisitions or incur Capex all of which will require a good proportion of the cash it will get from the deal. The Management has also said they will consider a special dividend from the proceeds of the sale.

Risks

1.First of all, a lot of the figures used in the calculations above especially the balance sheet items are from FY 2008-09 as that is the latest available. The main unknown is the total debt on the company’s books. If it turns out to be significantly higher than 128Crs the cash & hence valuation of company reduces.

2.There is uncertainty regarding the prospects of the remaining divisions as to their latest performance. They are mostly loss making going by last year’s performance.

3.The management doesn’t score very high on corporate governance as per my understanding from the annual report. One of the concerns i found was a lot of Related Party Transactions with the relatives & family members of the promoters. Also the management hasn’t paid any dividend till date which implies they may not quite be shareholder friendly.

4.The management hasn’t shown anything to write home about w.r.t capital allocation so far. There is a chance that they may pay a small amount as dividend or do a share repurchase & invest the bulk of the cash into new businesses which could lead to value destruction if it doesn’t work out.

Conclusion

The market is Valuing Indo Asian Fusegear at more than 10%+ discount to its expected cash reserve post the deal. The key here is simply how the company will utilize the cash, will they pay a huge dividend or invest the bulk of it or use a part of it for share repurchase .So a lot of unknowns & uncertainty about the possibilities have resulted in the current valuation. I personally would prefer a share repurchase over dividend as this would avoid the unnecessary dividend distribution tax of about 16-17%. Although the management has already committed to paying a special dividend & also to get into the advance lighting systems business but the proportion of cash for the same is unknown.It would be good if the company also repurchases some stock with a part of the money which is the best possible use of the cash given their capital allocation record. So a high Uncertainty but not necessarily a high risk special situation,would be interesting to see how it turns out. I am sure i would have missed some finer/obvious details, hence i invite views.

Sid,

Nice, well-argued thoughts. But looks like a open and shut case to me.I haven’t analysed special situations before. Let me try to think through logically:

1). The residual business is poor and does not add anything in possible upsides. Proper utilisation of the Cash on BS -odds are rather stacked against - poor track record on the existing business, corporate governance record, diversification to competitive LED segment may again be value destructive, quantum of special dividend being high is questionable.

2.So Cash on BS exceeding Mcap is the only “mispriced” logic, though its a significant one.

3). But because of 1) market does not seem overly enthused. Infact there has been a steady cooloff since beginning Aug when it touched Rs.160 (~ near the cash/per share)

4). To my untrained eye, it seems the best period to take advantage of the mispricing is over. If one had modest targets of 50-60%, one could have made that in a short period of 1 month by buying around announcement day Jul 23 (Rs.108)

http://in.finance.yahoo.com/q/hp?s=INDOASIFU.NS&g=d&a=06&b=4&c=2010&d=07&e=18&f=2010

My take is Special situations are not for those with laden foot. I guess you need to be both nimble and sure-footed with your calculator:)

One thing that I only get in FTSE and the US markets are LEAP. These are long dated one year or more options. On of the best way to play for special situations is to use deep out of the money long duration options.

I usually use special situation strategies in the US because price discovery is more efficient there. One company, is currently being investigated for fraud. Now the company is not bankrupt and is trading well below its cash value. Now this is what I call an asymmetric trade. What you do is buy out of the money calls of 12 month duration on the company’s stock and wait and watch. Even if the fraud charges are proved to be right, that means a management change and no more.