Sanjay bakshi

Talk on Persuasion Tactics

Sat, 24 Oct 2009 07:00:55 +0530

I was recently invited by India’s Ministry of Finance to make a presentation to delegates from seventeen third-world nations who had come to India for a training program. The presentation on “Persuasion Tactics” can be downloaded from here.

The Chart that worries me

Sun, 2 Aug 2009 16:44:38 +0530

I track three ratios very closely. These are Nifty’s Price/Earnings (P/E), Price/Book (P/B), and Dividend Yield.

Each of these ratios compares Nifty’s price level, which is observable, with fundamental factors which may or may not be observable.

While dividends are observable, earnings and book values are mere estimates made by accountants and managements. And lately both of these groups of people have been very aggressive.

Given that presently there is plenty of funny accounting going on in Indian companies (e.g. non provision of interest on convertible debt, aggressive accounting for impairment of assets, non recognition of forex losses on “hedging” activities etc.), I feel it’s much safer to rely upon objectively measured dividends, instead of subjectively estimated earnings and book values. The chart below shows Nifty’s dividend yield since 1999 till date.

Over the last ten years, Nifty’s dividend yield has ranged from a low of 0.82% to a high of 3.18%.

Now let’s look at what’s happened to Nifty’s returns in the past at different ranges of dividend yields. My colleague Ravi checked this out and his results are given in the chart below.

Ravi split the range of Nifty’s dividend yield into ten buckets (the bucket with the lowest yield is when Nifty has been most expensive and vice versa) making sure there were enough data points in each bucket. He then measured Nifty’s return over the next three years for each bucket. The results are highly symmetrical - i.e. the lower the dividend yield , the lower the three-year forward returns, and the higher the dividend yield, the higher the three-year forward returns.

For example, on days - there were 368 such days since Jan 1999- when Nifty was in the cheapest bucket (dividend yield ranging from 2.11% to 3.18%), a blind strategy of simply buying Nifty would have produced a three-year forward average return of positive 185%. Not bad at all!

This average return would, however collapse to a negative 32% if you had bought Nifty on days when it was in the most expensive bucket (dividend yield ranging from 0.82% to 1%). There were 57 such days since 1999.

Nifty’s current dividend yield is 1.11% and its presently in bucket # 2. Another 11% rise in Nifty from present levels of 4,636, with no corresponding change in dividends will push it into the most expensive bucket # 1.

Unless corporate earnings (and dividends) rose without a corresponding rise in stock prices, dividend yield will remain near historically low levels and if history is any guide, it’s warning us to be wary about investing in large cap stocks at current prices.

When you dig a hole too deep...

Wed, 29 Apr 2009 09:16:01 +0530

If you start small by booking some fake revenues...

....eventually you will have to book much larger fake revenues to maintain the growth rate implied by your stock price and the hole you’ve started to dig will become deeper...

... and then to prevent your receivables from going out of line with your revenues, you’ll have to show you received money which is really not there from people who are really not there. And then your accounts will show that your bank has lots of money which is really not there and the hole you are digging will become deeper and deeper...

....and if you claim you have money in the bank which is really not there, you’ll have to invent interest income which is really not there and the hole will get even deeper...

... and then if you are earning so much interest income which is really not there, you’ll have to show that you are paying taxes on that income that is really not there and the hole will become even more deep...

And then a day will come when the hole will sooooo deep that you won’t be able to get out of it... And then what?

Is Satyam a Sinking Ship or a Racing Car?

Thu, 23 Apr 2009 20:48:33 +0530

Mr. Anand Mahindra said this to Satyamites recently: "I don't believe that [Satyam] is a sinking ship. It is not a racing car yet. We will make it one."

If you think Mr. Mahindra is right, then you can create Satyam shares at a discount to his cost price of Rs 58. Here's how: Buy 100 shares @ 47, tender them in Mr. Mahindra's offer @ 58. About 40% of the shares are likely to be accepted (L&T can’t tender, and many investors who have much higher cost basis won’t tender). The remaining 60 shares will have an effective cost of about Rs 40 because the profit on shares tendered can be thought of as a reduction in the cost of the returned shares. This calculation ignores trading costs and taxes.

So, you can get into Satyam at a cost lower than that of Mr. Mahindra - all thanks to his very tender offer.

Keep in mind, however, that getting in cheaper than Mr. Mahindra will cause regret, should the stock sink below Rs 40 after the tender offer instead of vrooming like a Formula 1 racing car.

While Mr. Mahindra has all the incentives to make Satyam appear as a racing car and not a sinking ship, it’s a good idea to remember the words of the Captain of a ship who famously said: “In all my experience, I’ve never been in an accident of any sort worth speaking about. I have seen but one vessel in distress in all my years at sea. I never saw a wreck and have never been wrecked nor was I ever in any predicament that threatened to end in disaster of any sort.”

Those famous words were uttered in 1907 by one E.J. Smith, Captain, RMS Titanic...

:-)

Case on Eicher Motors

Mon, 13 Apr 2009 21:39:26 +0530

Volvo, the second largest producer of heavy trucks in the world, is optimistic about India...

“The Indian market for heavy trucks is the fourth largest in the world and it is strategically highly important for the Volvo Group. Projections indicate continued very strong growth. Major investments in improved infrastructure and stricter rules for truck weights will strongly drive demand for heavy trucks, which makes the market particularly attractive for the Volvo Group.” - Leif Johansson, CEO, Volvo Group

You can acquire an option on Volvo India’s rapidly growing truck business, plus an equity interest in India’s third largest truck manufacturer for nothing. This note will tell you how.

Eicher Motors is India’s third largest producer of trucks having a market share of 27% in light and medium-heavy trucks. This company recently entered the growing heavy vehicle segment (more than 16 tons) in India and is now the third largest player in that segment. The company is also a manufacturer of bus and motorcycles as well as components, mainly for gearboxes and axles. The company also has an engineering services division.
For the year ended March 31, 2008, Eicher Motors reported earnings of $13 million on revenues of $533 million.

Volvo India and Eicher Motors are now coming together in a joint venture.

Under the terms of the JV agreement, Eicher Motors will transfer its entire truck, bus, and components businesses, as well as the engineering services business to the JV company to be called “VE Commercial Vehicles Limited” (The “V” is for “Volvo” and “E” for “Eicher”). Surplus cash on Eicher Motor’s balance sheet amounting to $54 million which is invested in bonds and the motorcycle business will not be transferred to the JV.

For this sale, Eicher Motors will receive cash of $50 million, of which $42 million will be paid by the JV company for the transfer of various businesses to it and the balance $8 million will come from Volvo as non-compete fee.

In turn, Volvo will transfer its India truck dealer and service network business valued at $75 million, together with cash of $275 million to the JV company in return for a 45.6% stake in that company.

The balance 54.4% will be held by Eicher Motors. $350 million for a 45.6% stake translates into a $767 million value for the JV company.

Eicher Motor’s 54.4% stake in the JV company is thus valued at $417 million. Eicher Motors’ current market cap is only $116 million.

There are two additional aspects of this deal which need attention. First, in addition to the cash injected by Volvo in the JV company, Volvo will also buy an 8.1% stake in Eicher Motors from its controlling stockholder at a price of Rs 691 per share. Eicher Motors stock is currently trading at Rs 200 per share.

This acquisition will give Volvo a combined stake of 50% in the JV company which will enable it to consolidate its financial results with that of the ultimate patent company in Sweden.

The second aspect of the deal shows that minority shareholders of Eicher Motors are being treated fairly because they are being offered an exit for the same proportion of shares as the controlling stockholders, at an identical price of Rs 691.

Here is how that has been structured. When the controlling stockholders of Eicher Motors sell their 8.1% stake in the company to Volvo out of the total 58.2% that they have at present, they would end up selling 13.15% of their stake at Rs 691. In order to give the same deal to the company’s minority stockholders, Eicher Motors will offer to buy back from every minority stockholder, 13.15% of his or her holding at the same price i.e. Rs 691.

The proposed investment operation involves buying shares of Eicher Motors from the market at Rs 200, tendering 13% of the holdings at Rs 691 and be left with the remaining 87% shares at an effective cost of Rs 126 per share. We think that this is the correct way to think about this operation i.e. to treat the profit on the sale of tendered shares as a reduction in the cost of the non-tendered shares.

At Rs 126 effective cost to us, Eicher Motors will be a ridiculously low-priced bargain stock. Post buyback, the company will have 24.4 million shares. At that cost price, we will end up buying at a total company value of $64 million. What do we get in return for this investment?

We get a debt-free business at Rs 126 per share in possession of the following assets: (1) cash of approximately $75 million (Rs 147 per share); (2) ownership stake in a JV valued at $417 million ; and (3) a motorcycle business (minor).

Its important to note that net cash on the balance sheet of Eicher Motors alone exceeds the market cap so one is not paying anything for the remaining assets on its balance sheet. Moreover, its also important to note that this is not like a dotcom company which was debt-free but the business was bleeding and the cash on the balance sheet was a mirage.

Indeed Eicher Motors basic business of making and selling trucks is consistently profitable and cash generative causing the balance sheet to be so strong.

This opportunity has arisen because of an irrational market which has brought down the stock price of Eicher Motors from Rs 500 per share in early 2008 to Rs 200 at present (see chart).

At its current price of Rs 200 per share, Eicher Motor’s stock is not only a fantastic cash bargain, it is also comes with a free equity interest in India’s third largest truck manufacturer and one is also getting a free option on the rapidly growing business of Volvo’s truck business in India.

This option is likely to be very valuable over time because Volvo has retained all of the capital-intensive side of the business of making trucks with itself while only transferring sales operations and service network to the JV.

Volvo’s Truck sales in 2007 were $116 million on which the distribution related profit was $4 million or about 3.7% of revenues. The JV company is getting, in effect, about 4% of Volvo India’s truck revenues as additional profits. These profits will grow in line with Volvo’s volume growth, driven by India’s growth, and also by additional investments made by Volvo in India.

The JV company will not have to make any additional investment to benefit from this growth. All of the incremental capital investment, marketing, and advertising costs will be borne by Volvo and the JV will simply get 4% of Volvo’s truck revenues as incremental profits. This is a very high-quality, and growing, earning stream — one, which we are getting for free.

This investment operation is subject to certain regulatory risks. For example, the buyback proposal has to be approved by SEBI, India’s securities market regulator. Moreover, Volvo has to spin off its India truck dealer and service network business into the JV company which needs approvals from two state courts. We expect these approvals to come in the next 5 months.

MY SUBSEQUENT COMMENTS:

Today was the first day on which the returned shares (about 85%) in the buyback listed. By now the situation had completely changed (deterioration of fundamentals) and it was decided to liquidate. So, here is what roughly happened: 100 shares bought at Rs 200, 15 tendered at 691, balance 85 sold at 190. Average exit price per share: Rs 265. Profit: Rs 65 per share or 32.5% in 6 months.

Social Psychology at its Best

Thu, 19 Mar 2009 10:06:36 +0530

I loved watching this presentation by Dan Ariely of MIT, also author of “Predictably Irrational” which is a book I loved reading.

Here is another one of Dan’s very good presentations.

Swirl Opens An Ice Cream Parlour at GMR Airport!

Wed, 14 Jan 2009 07:44:02 +0530

GMR made a very “important” announcement on the BSE yesterday. See following link:

http://tinyurl.com/a689kj

Spread over an area of 6 sq. mts, the parlours will “sell, cool, thick and creamy Smoothies blended with real fruit, natural juices and enhancers for health-conscious people.” In addition, airport visitors at the Rajiv Gandhi International Airport at Hyderabad will now be able to enjoy Soft Serve (in a cone, cup, or pie), Cappuccino swirls, Thunderstorm swirls, Fruit fusion swirls, and Dry fruit swirls.

GMR has a current market cap of about $2.7 billion.

What's Wrong with this Idea?

Sun, 19 Oct 2008 00:15:49 +0530

Morgan Stanley Growth Fund (MSGF) is a closed-ended mutual fund whose units sell in the market at a discount to their Net Asset Value (NAV). On Friday, 17 October, 2008, MSGF had an NAV of Rs 33.41 per unit. On the same day, the fund’s closing price on the National Stock Exchange was Rs 30.85 per unit. The difference of Rs 2.56 per unit represents a 7.6% discount to the NAV. Put differently, if you bought the units from the market and could immediately redeem them at NAV, then you could capture a return of 8.3% instantly.

While you can’t lock in this return instantly, you might be able to earn that 8.3% return over the next 4 months. It so happens that MSGF is supposed to be liquidated on or before February 17, 2009 which is 4 months away.

Here is another interesting fact. The fund’s NAV is highly correlated to the Nifty Index on which futures are traded actively on the National Stock Exchange.

So here is the trade. You can buy MSGF units from the market and simultaneously short the Nifty on a money-equal basis. This will protect from a further decline in Nifty, and, therefore, in the fund’s NAV from the date of purchase to the date of redemption.

When the fund liquidates you will get the NAV at which time you can cover your short position in Nifty futures. Regardless of where Nifty goes, you should be able to earn a return of 8.3% over a period of 4 months, which translates into an annualized pre-tax return of 24.9% before costs. And you may also be able to leverage this trade because of the hedge.

Here is another good news. Its quite possible that MSGF will be open-ended before 4 months are over. The fund has filed an application with SEBI, India’s securities market regulator to approve this conversion. If the conversion happens early, your annualized return may be that much higher.

Now what’s the catch? What’s wrong with this idea? How can I end up regretting that I invested in this idea? What could make this idea wrong?

I asked these questions from my BFBV class students recently, and we came up with some interesting answers. I will post them on this blog soon.

BFBV Newsletter # 3: A Chain is only as strong as its weakest link. Or Is it?

Mon, 13 Oct 2008 15:52:21 +0530

This can be downloaded from here.