Shanthi Gears/Shanti Gears

This is a special situation - there is an open offer for Shanthi Gears at 81/share. Details in this link:

http://www.bseindia.com/xml-data/corpfiling/AttachLive/Shanthi_Gears_Ltd1_130712.pdf

The investment operation involves buying shares from the market (tomorrow and the days that follow, below 81/share), say at 66.3 (as this would likely be locked on UC of 5%) and getting out at around 80/share or more making around 21% in 4-5 days. Looks like a fairly protected bet with decent returns.

Thoughts?

Hi Rohit,

Looks like a good trade if you can buy the shares; it’s likely that the big fish would flood buy orders in the pre-market session.

Interestingly, NSE says the delivery % since 15th July is “-”. Volumes have been spiking since 6 July.

More than 10% returns have been achieved since the note in a few weeks (i.e., about 70% annualized). Although adequate, returns have been lower and have taken a lot more time than expected at the time of the note. So, in order to internalize the learning fully, following four questions (as suggested by Buffett to evaluate arbitrage situations) are important to understand:

1). How likely is it that the promised event will indeed occur? The open offer was/is very likely to go through given the status of the acquirer and nature of the deal (an exit price of 81/share offered an adequate upside). As such, there was a high likelihood of daily traded share price going up as we approached the dates for open/end of the open offer.

2). How long will your money be tied up? I was expecting more than adequate returns to come in a matter of days, however, more realistic assumption would have been 8-9 weeks. However, any extension in the dates (unknown and unknowable) would have increased the duration for which money would have been tied up. But even if the process were to take 3-6 months, the expected annualized returns more than justified a buy.

3). What chance is there that something still better will transpire - a competing takeover bid, for example? Almost zero. The acquirer had acquired the promoters’ stake (44.1%) and it didn’t make sense for public (~37%) or DII (~17%) or FII (2%) to come up with a counter offer. If another acquirer came into picture, it would have only made the situation better (but this was almost a zero probability event)

4). What will happen if the event does not take place because of anti-trust action, financing glitches, etc.? The likelihood of the open offer not going through was/is almost zero. The probability of daily share price going up and touching the open offer price with time was high. In case there was price volatility, it was important to stick along till the open offer went through.

The stock was at 66-67 odd levels for quite a few days post the announcement (not to forget the run up from 50-51 levels to 67 in a matter of days, before the announcement was made). Recently, the stock started its upward journey again and has provided high returns on annualized basis even to those who got in at 66/67 levels. In all, a good experience in terms of learning and returns.

The offer will close in a few days and might offer upside to investors who get in now. However, not sure if the stock will continue to be at these levels post the completion of the process.

Best,

Rohit

Just to add, the biggest risk in such situations is that the announced event will not take place. Although the probability of the event not taking place was almost zero, the operation involved purchasing the shares from the market and selling them in the market, hence benefiting from price appreciation and not, purchasing the shares from the market and tendering them in the open offer, which would have been a different operation as follows:

)- Purchase at about 67/share

)- Tender the shares in open offer. The offer was to acquire 26% of the share capital at 81/share. The acquirer had acquired 44% of the share capital from the promoter, The acquirer would have about 70% in the company if the open offer went through successfully

)- Assuming ~4-5% of the share capital will not be tendered. If the rest ~52% tender, it would mean that for every two shares that are tendered, one will go through

)- Say, I acquired 100 shares at 67/share, and 50 shares went through at 81/share, I would still be left with 50 shares at 53/share. Would this have been a comfortable situation? There were three factors to consider:

a. As per the open offer document, the volume-weighted average market priceof the shares for a period of sixty tradingdays immediately preceding the date of the PAas traded on the NSE was51/share. All else the same, there was a good chance that stock price would come down to 51/share or below post the process was complete

b. FY12 EPS of 3.44 and a price of 53/share would mean a P/E of 15.4; if one considers Q1FY13 results, LTM P/E would be 17.6. This wasn’t comforting, especially given the not so great return ratios and lower valuation for comparable/better companies

c. The facts mentioned above implied that for the shares not accepted in the open offer, it would be best to sell them in the market. Assuming a complete exit of the remaining shares at 72/share, the total returns in the process would be 14.2%. While higher than the returns in previous case, the returns would have diminished with time, with a possibility of no exit for a few days (say because of lower circuit). As such, the option of purchase and sale in the market was preferred

Rohit,

This is a case where the deal is announced. Do you also invest in potential deal ideas ( West Coast Paper) etc ? If yes, what metrics do you use to analyse the potential ?

Regards