Adventures of a Risk    Arbitrageur
Trade # 1
Trade # 2
Trade # 3
From Nirma’s Annual Report of FY1997-98
Trade # 4
Trade # 5
Trade # 6
A Special situation is one in which a     particular   development is  counted upon toyield a satisfactoryprofit even thoug...
Buffett’s Case on  ArcataCorporation
28 Sept, 1981: KKR agrees to buy             Arcata  printing and forest productsbusiness and a contingent claim.10,700 ac...
Arcata Timberland
$97.9 mil compensation over manyinstallments deemed inadequate; plus  co got 6% simple interest- claimed          more, co...
KKR offered Arcata’sshareholders $37 plus two-thirds of contingent claim if        materialized.
How did HEAnalyse this situation
How likely is it that KKR will   go through with this        transaction?Deal subject to “satisfactory         financing”Gi...
What will happen if the deal  with KKR fell through?Other buyer likely to emerge
What is the Redwood Claim worth?Somewhere between zero and “a whole lot.” Why did Mr. Buffett not value this claim?
Started buying at $33.50. offer pricewas $37 plus two-thirds of the claim. Started buying on 30 September.Payment expected...
Financing glitches appear.       (“Shit Happens”)The stockholders’ meeting was  postponed again, to April.Such news usuall...
Stock declines, Mr. Buffett         buys more.On March 12 KKR revises offer,first cutting it to $33.50, then  two days late...
March 15: Arcata Board Rejects KKR bid and accepts rival bid of  $37.50 plus 50% of contingent              claim.Stockhol...
BRK received $24.6 mil versus its       cost of $229 mil.average holding period close to 6            months.  Annualized ...
What about the contingent          claim?The trial judge appointed two         commissions: One to look at the timber’s   ...
The other to consider the   interest rate question.January 1987: Timber valued   at $275.7 mil compoundinterest @14% p.a. ...
August 1987 the judge upheld         these awards Total value of claim = $600 mil. Government appealed. In 1988, claim set...
Risk Arbitrage Teaches Probabilistic Thinking
Risk Arb: Pursuit of profits from an announced corporate    event such as sale of the        company, merger,recapitalizati...
In most cases the arbitrageur expects to profit regardless of   the behavior of the stockmarket. The major risk he usually ...
To evaluate arbitrage situations you    must answer four questions:1.    How likely is it that the     promised event will...
2. How long will your money be            tied up?
3. What chance is there that   something still better will     transpire - a competing   takeover bid, for example?
4.     What will happen if the      event does not take place     because of anti-trust action,        financing glitches, ...
Annexure to 3rd Edition of Security Analysis
Trade # 7
The commercial vehicle business ofEicher Motors Limited along with the    related components and designservices businesses...
Volvo will contribute Rs 1,082 crores in cash and will    also transfer its Indian truck distribution and service network ...
Volvo will also buy 8.1% equity stake in EicherMotors Limited from the promoters of Eicher Motors   Limited at a considera...
The joint venture will have exclusive distributionrights in India for all present and future Volvo truck  products. All fu...
EML and promoters have also entered into aseparate non-compete agreement with the joint  venture for not getting into truc...
Post-closing Eicher Motors will receive aconsideration of 202 crores from the joint ventureand it will be debt-free. In ad...
“Eicher Goodearth (promoter of EML) intends to propose to the EML board to consider a buyback of  shares from the public s...
Buy 100 shares at 225             Tender 13 shares at 691Effective cost of 87 shares = 13,517 or Rs 155 per               ...
Capital Structure Arbitrage Exploiting relative valuation gapsbetween different securities which  form part of the same ca...
Network 18 PCCPS1 pccps = 1 stock + 1 warrant + 1 preferred                               =                           1/2 ...
http://fundooprofessor.wordpress.com/2011/03/01/           ben-graham-framework-36/
Example Capital Structure Arb:     ISPAT INDUSTRIES
http://fundooprofessor.wordpress.com/2011/02/19/           bfbv-examination-question/
http://fundooprofessor.files.wordpress.com/2011/02/              ispat_pa_22122010.pdf
Subsequent Developments
24 Feb 2012
3 Sept 2012   13 Sept 2012
EXAMPLECONVERTIBLES ARB   TATA STEEL       CCPS     Trade # 9
26.8 x 6 = 160.80 which is 12% cheaper than Tisco Stock
Current Discount is 12%
Rs 2 per share dividendon Rs 26 dividend yield (tax free) = 7.7%
Update as on 29 October 2012
EXAMPLE    CONVERTIBLES ARB    TATA MOTORS DVRSlides from a presentation made on 13 october, 2011                   Trade ...
DVR enjoys   1/10th the voting right ofEquity but gets    5% extradividend rights.  Discount of     46%
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 ...
http://breport.myiris.com/ICICISL/TATENGLC_20110530.pdf   Why No Mention of “DVR”?     Price is before stock split
Why don’t they  switch?
Why the discount?
Is corporate                    28% discount  governance atPantaloons betterthan at the house     of Tatas?
Month      Promoter Stake in DVRJun 2011            9%Mar 2011            19%Dec 2010            19%Sept 2010           36...
1,500 Class B = 1 Class A (Economic Rights) 10,000 Class B = 1 Class A (Voting Rights)           74x1,500 =111,000        ...
Why do TataMotors Futures  trade at a discount to    spot?
Update as of29 Oct 2012
1500:1
Thank You
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
Adventures of a risk arbitrageur
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Adventures of a risk arbitrageur

  1. 1. Adventures of a Risk Arbitrageur
  2. 2. Trade # 1
  3. 3. Trade # 2
  4. 4. Trade # 3
  5. 5. From Nirma’s Annual Report of FY1997-98
  6. 6. Trade # 4
  7. 7. Trade # 5
  8. 8. Trade # 6
  9. 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. 10. Buffett’s Case on ArcataCorporation
  11. 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. 12. Arcata Timberland
  13. 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. 14. KKR offered Arcata’sshareholders $37 plus two-thirds of contingent claim if materialized.
  15. 15. How did HEAnalyse this situation
  16. 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. 17. What will happen if the deal with KKR fell through?Other buyer likely to emerge
  18. 18. What is the Redwood Claim worth?Somewhere between zero and “a whole lot.” Why did Mr. Buffett not value this claim?
  19. 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. 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. 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. 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. 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. 24. What about the contingent claim?The trial judge appointed two commissions: One to look at the timber’s value
  25. 25. The other to consider the interest rate question.January 1987: Timber valued at $275.7 mil compoundinterest @14% p.a. awarded! Wow!
  26. 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. 27. Risk Arbitrage Teaches Probabilistic Thinking
  28. 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. 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. 30. To evaluate arbitrage situations you must answer four questions:1. How likely is it that the promised event will indeed occur?
  31. 31. 2. How long will your money be tied up?
  32. 32. 3. What chance is there that something still better will transpire - a competing takeover bid, for example?
  33. 33. 4. What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?
  34. 34. Annexure to 3rd Edition of Security Analysis
  35. 35. Trade # 7
  36. 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. 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. 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. 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. 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. 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. 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. 43. Buy 100 shares at 225 Tender 13 shares at 691Effective cost of 87 shares = 13,517 or Rs 155 per share.
  44. 44. Capital Structure Arbitrage Exploiting relative valuation gapsbetween different securities which form part of the same capital structure.
  45. 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. 46. http://fundooprofessor.wordpress.com/2011/03/01/ ben-graham-framework-36/
  47. 47. Example Capital Structure Arb: ISPAT INDUSTRIES
  48. 48. http://fundooprofessor.wordpress.com/2011/02/19/ bfbv-examination-question/
  49. 49. http://fundooprofessor.files.wordpress.com/2011/02/ ispat_pa_22122010.pdf
  50. 50. Subsequent Developments
  51. 51. 24 Feb 2012
  52. 52. 3 Sept 2012 13 Sept 2012
  53. 53. EXAMPLECONVERTIBLES ARB TATA STEEL CCPS Trade # 9
  54. 54. 26.8 x 6 = 160.80 which is 12% cheaper than Tisco Stock
  55. 55. Current Discount is 12%
  56. 56. Rs 2 per share dividendon Rs 26 dividend yield (tax free) = 7.7%
  57. 57. Update as on 29 October 2012
  58. 58. EXAMPLE CONVERTIBLES ARB TATA MOTORS DVRSlides from a presentation made on 13 october, 2011 Trade # 10
  59. 59. DVR enjoys 1/10th the voting right ofEquity but gets 5% extradividend rights. Discount of 46%
  60. 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. 61. http://breport.myiris.com/ICICISL/TATENGLC_20110530.pdf Why No Mention of “DVR”? Price is before stock split
  62. 62. Why don’t they switch?
  63. 63. Why the discount?
  64. 64. Is corporate 28% discount governance atPantaloons betterthan at the house of Tatas?
  65. 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. 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. 67. Why do TataMotors Futures trade at a discount to spot?
  68. 68. Update as of29 Oct 2012
  69. 69. 1500:1
  70. 70. Thank You

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