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Adventures of a risk arbitrageur

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  • 1. Adventures of a Risk Arbitrageur
  • 2. Trade # 1
  • 3. Trade # 2
  • 4. Trade # 3
  • 5. From Nirma’s Annual Report of FY1997-98
  • 6. Trade # 4
  • 7. Trade # 5
  • 8. Trade # 6
  • 9. A Special situation is one in which a particular development is counted upon toyield a satisfactoryprofit even thoughthe general market does not advance.
  • 10. Buffett’s Case on ArcataCorporation
  • 11. 28 Sept, 1981: KKR agrees to buy Arcata printing and forest productsbusiness and a contingent claim.10,700 acres of Arcata timberland acquired by govt. in 1978.
  • 12. Arcata Timberland
  • 13. $97.9 mil compensation over manyinstallments deemed inadequate; plus co got 6% simple interest- claimed more, compounded Value of the stock = value of the business (less debt) + the value of contingent claim
  • 14. KKR offered Arcata’sshareholders $37 plus two-thirds of contingent claim if materialized.
  • 15. How did HEAnalyse this situation
  • 16. How likely is it that KKR will go through with this transaction?Deal subject to “satisfactory financing”Given KKR’s credentials, low probability of deal failure
  • 17. What will happen if the deal with KKR fell through?Other buyer likely to emerge
  • 18. What is the Redwood Claim worth?Somewhere between zero and “a whole lot.” Why did Mr. Buffett not value this claim?
  • 19. Started buying at $33.50. offer pricewas $37 plus two-thirds of the claim. Started buying on 30 September.Payment expected by next January.Heads I win a little, tails I win a lotNot counting the value of contingent claim, expected return = 40% p.a. annualized.
  • 20. Financing glitches appear. (“Shit Happens”)The stockholders’ meeting was postponed again, to April.Such news usually treated bythe arbitrageur community as bad bad news.
  • 21. Stock declines, Mr. Buffett buys more.On March 12 KKR revises offer,first cutting it to $33.50, then two days later raising it to $35.00.
  • 22. March 15: Arcata Board Rejects KKR bid and accepts rival bid of $37.50 plus 50% of contingent claim.Stockholders approved deal, $37.50 paid on June 4.
  • 23. BRK received $24.6 mil versus its cost of $229 mil.average holding period close to 6 months. Annualized return came to 15%return excluding any value for the redwood claim.
  • 24. What about the contingent claim?The trial judge appointed two commissions: One to look at the timber’s value
  • 25. The other to consider the interest rate question.January 1987: Timber valued at $275.7 mil compoundinterest @14% p.a. awarded! Wow!
  • 26. August 1987 the judge upheld these awards Total value of claim = $600 mil. Government appealed. In 1988, claim settled for $519 million.BRK received an additional $29.48per share, or about $19.3 million.
  • 27. Risk Arbitrage Teaches Probabilistic Thinking
  • 28. Risk Arb: Pursuit of profits from an announced corporate event such as sale of the company, merger,recapitalization, reorganization, liquidation, self-tender, etc.
  • 29. In most cases the arbitrageur expects to profit regardless of the behavior of the stockmarket. The major risk he usually faces instead is that the announced event won’t happen.
  • 30. To evaluate arbitrage situations you must answer four questions:1. How likely is it that the promised event will indeed occur?
  • 31. 2. How long will your money be tied up?
  • 32. 3. What chance is there that something still better will transpire - a competing takeover bid, for example?
  • 33. 4. What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?
  • 34. Annexure to 3rd Edition of Security Analysis
  • 35. Trade # 7
  • 36. The commercial vehicle business ofEicher Motors Limited along with the related components and designservices businesses will be transferredto the joint venture company which is a step-down unlisted subsidiary of EML on slump sale going concern basis at a value of Rs202 crores
  • 37. Volvo will contribute Rs 1,082 crores in cash and will also transfer its Indian truck distribution and service network to the joint venture. In lieu of cashand the service and distribution network, Volvo willbe allotted 45.6% equity shares in the joint venture. EML will consequently hold the balance 54.4%equity and thus the joint venture will be a subsidiary of EML and its financials will be consolidated with the financials of Eicher Motors.
  • 38. Volvo will also buy 8.1% equity stake in EicherMotors Limited from the promoters of Eicher Motors Limited at a consideration of 157 crores whichequates to Rs.691 per share. Now taking into account it’s direct and indirect holding, Volvo’s economic ownership of the joint venture will be 50%.
  • 39. The joint venture will have exclusive distributionrights in India for all present and future Volvo truck products. All future Volvo group truck projects in India will be routed through this joint venture subject of course to agreement on the terms and conditions.
  • 40. EML and promoters have also entered into aseparate non-compete agreement with the joint venture for not getting into trucks and busesbusiness in India. Volvo shall pay a non-compete consideration of Rs.39.4 crores each to Eicher Motors and to the promoters.
  • 41. Post-closing Eicher Motors will receive aconsideration of 202 crores from the joint ventureand it will be debt-free. In addition there will be the39.4 crores of non-compete fees which will come in.So both put together this will be around 240 crores.
  • 42. “Eicher Goodearth (promoter of EML) intends to propose to the EML board to consider a buyback of shares from the public shareholders in the same proportion as the promoters have sold to Volvo. Sothe promoters have sold 8.1% out of 58.2% stake andthat equates to around 13% of the promoter holding.So we are recommending to the EML Board to do the same to the public shareholders and at the same price of Rs.691.”
  • 43. Buy 100 shares at 225 Tender 13 shares at 691Effective cost of 87 shares = 13,517 or Rs 155 per share.
  • 44. Capital Structure Arbitrage Exploiting relative valuation gapsbetween different securities which form part of the same capital structure.
  • 45. Network 18 PCCPS1 pccps = 1 stock + 1 warrant + 1 preferred = 1/2 stockBuy Spot Sell in Futures Create cheaply! Trade # 8 Market neutral returns of 23% in 3 months
  • 46. http://fundooprofessor.wordpress.com/2011/03/01/ ben-graham-framework-36/
  • 47. Example Capital Structure Arb: ISPAT INDUSTRIES
  • 48. http://fundooprofessor.wordpress.com/2011/02/19/ bfbv-examination-question/
  • 49. http://fundooprofessor.files.wordpress.com/2011/02/ ispat_pa_22122010.pdf
  • 50. Subsequent Developments
  • 51. 24 Feb 2012
  • 52. 3 Sept 2012 13 Sept 2012
  • 53. EXAMPLECONVERTIBLES ARB TATA STEEL CCPS Trade # 9
  • 54. 26.8 x 6 = 160.80 which is 12% cheaper than Tisco Stock
  • 55. Current Discount is 12%
  • 56. Rs 2 per share dividendon Rs 26 dividend yield (tax free) = 7.7%
  • 57. Update as on 29 October 2012
  • 58. EXAMPLE CONVERTIBLES ARB TATA MOTORS DVRSlides from a presentation made on 13 october, 2011 Trade # 10
  • 59. DVR enjoys 1/10th the voting right ofEquity but gets 5% extradividend rights. Discount of 46%
  • 60. Post Split Equity shares = 269 cr shares @ 186 ≅ Rs 50,000 cr.Post Split DVR = 48 cr DVRs @ Rs 101 ≅ Rs 4,800 cr. (Almost $1 billion) Discount of Rs 85 per DVR x 48 cr DVRs = Rs 4,100 cr.
  • 61. http://breport.myiris.com/ICICISL/TATENGLC_20110530.pdf Why No Mention of “DVR”? Price is before stock split
  • 62. Why don’t they switch?
  • 63. Why the discount?
  • 64. Is corporate 28% discount governance atPantaloons betterthan at the house of Tatas?
  • 65. Month Promoter Stake in DVRJun 2011 9%Mar 2011 19%Dec 2010 19%Sept 2010 36% Is there a technicalJun 2010 36% reason for theMar 2010 53%Dec 2009 57% discount?Sep 2009 80%Jun 2009 84%Mar 2009 84%Dec 2008 84%
  • 66. 1,500 Class B = 1 Class A (Economic Rights) 10,000 Class B = 1 Class A (Voting Rights) 74x1,500 =111,000 No Discount in Class B
  • 67. Why do TataMotors Futures trade at a discount to spot?
  • 68. Update as of29 Oct 2012
  • 69. 1500:1
  • 70. Thank You