‘I don’t know’

Ask any analyst, market commentator, investor or your friend on the future direction of the market and they will have a wide variety of views ranging from totally pessimistic to wildly optmisitic. Most will also have very plausible reasons to back up their viewpoints.

In reality, I doubt anyone can consistently time the market (and there is enough evidence to back it up). True some people can get it right sometimes, but I personally have never tried it as I know for sure that I will not get it right.

My approach to this question is ‘I don’t know’. I am not sure what will happen in the future. However that does not mean being blind to the present situation and doing nothing about. On the contrary I have some crude approaches to resolving this problem.

For individual stocks I typically maintain a valuation band (and not a price band). For example, if I think a business has very strong competitive advantage and will do very well, I tend to accord it higher valuations. As a specific case I can cite marico. Marico as a business was valued at a PE of around 10-12 in 2003, when I looked at it for the first time. I conservatively valued it at 20-22 at that time. Since then marico has done very well and may have improved its competitive position. As a result I have bumped up my valuation band to 25-27. The advantage I see in this approach is that I do not fixate on the price. Price is a function of the current earnings and the PE ratio, which in turn would depend on a variety of condition. By looking at a valuation band, I can assess the company’s competitive position and decide whether the current price looks overvalued or not.

Ofcourse the above approach is not perfect. A better approach would be to do a complete DCF analysis from scratch without any assumptions. However it is very time consuming and may not be feasible for me every time.

For the broader market, I have an even cruder method. I track the earnings growth, dividend yield and ROE of the market as a whole. I tend to treat a market PE of 20 as trigger to start investigating as to why the market should not be considered to be overvalued. A PE of 20 does not necessarily indicate an overvalued market. This number has to be seen in context of the other numbers I spoke of earlier. But at this point, I start analysing further and also look at reducing my holdings.

All of the above is hardly scientific and may appear as very crude. However I try not to be too smart in selling. I try to follow buffett’s advice (paraphrased) ‘Buy at such an attractive price, that selling becomes an easy decision’

In the end, my approach is to accept that I don’t know the future of the market and need to manage my emotions (greed at present!!). So a mechanical approach although sub-optimal works well for me.

As an aside, Mr market is current in complete euphoria with the kind of oversubscription for RPL and sun TV IPOs.

Great time for businesses to raise capital from the market !!

‘I don’t know’

Ask any analyst, market commentator, investor or your friend on the future direction of the market and they will have a wide variety of views ranging from totally pessimistic to wildly optmisitic. Most will also have very plausible reasons to back up their viewpoints.

In reality, I doubt anyone can consistently time the market (and there is enough evidence to back it up). True some people can get it right sometimes, but I personally have never tried it as I know for sure that I will not get it right.

My approach to this question is ‘I don’t know’. I am not sure what will happen in the future. However that does not mean being blind to the present situation and doing nothing about. On the contrary I have some crude approaches to resolving this problem.

For individual stocks I typically maintain a valuation band (and not a price band). For example, if I think a business has very strong competitive advantage and will do very well, I tend to accord it higher valuations. As a specific case I can cite marico. Marico as a business was valued at a PE of around 10-12 in 2003, when I looked at it for the first time. I conservatively valued it at 20-22 at that time. Since then marico has done very well and may have improved its competitive position. As a result I have bumped up my valuation band to 25-27. The advantage I see in this approach is that I do not fixate on the price. Price is a function of the current earnings and the PE ratio, which in turn would depend on a variety of condition. By looking at a valuation band, I can assess the company’s competitive position and decide whether the current price looks overvalued or not.

Ofcourse the above approach is not perfect. A better approach would be to do a complete DCF analysis from scratch without any assumptions. However it is very time consuming and may not be feasible for me every time.

For the broader market, I have an even cruder method. I track the earnings growth, dividend yield and ROE of the market as a whole. I tend to treat a market PE of 20 as trigger to start investigating as to why the market should not be considered to be overvalued. A PE of 20 does not necessarily indicate an overvalued market. This number has to be seen in context of the other numbers I spoke of earlier. But at this point, I start analysing further and also look at reducing my holdings.

All of the above is hardly scientific and may appear as very crude. However I try not to be too smart in selling. I try to follow buffett’s advice (paraphrased) ‘Buy at such an attractive price, that selling becomes an easy decision’

In the end, my approach is to accept that I don’t know the future of the market and need to manage my emotions (greed at present!!). So a mechanical approach although sub-optimal works well for me.

As an aside, Mr market is current in complete euphoria with the kind of oversubscription for RPL and sun TV IPOs.

Great time for businesses to raise capital from the market !!

Oil and gas industry - Refineries

This is a complex industry with some of the largest public companies in india. It would be difficult to cover the entire industry in detail in a single post. I would however try to cover the critical components of the industry and try to explore one of the subsets of the industry in this post

The industry can be roughly be split into 3-4 groups

Refining companies – This would include standalone refining companies like RPL, MRPL.chennai petroleum etc and other vertically integrated companies like IOC, HPCL and BPCL which have their own refineries. Refineries are capital intensive businesses with high economies of scale, low differentiation in the product and competitive advantage being mainly with the low cost producer. In addition refineries are cyclical in nature with their margins driven by the price of crude

Marketing companies – There are no stand-alone marketing companies in india. Most of the companies like IOC, BPCL HPCL and now reliance are a combination of marketing companies (through retail outlets) and refineries supplying the marketing companies.

Marketing companies have more pricing power, some level of branding and less cyclical in nature. However in india as the retail price is controlled by the government, companies having the marketing division (HPCL, BPCL, IOC) etc do not have control on their pricing and typically have to bear losses which at best is mitigated through oil bonds.

Gas – These include companies like GAIL, Gujarat gas, Indraprastha gas etc. This is one the fastest growing sub-sectors in the oil and gas industry. With India trying to reduce its reliance on oil, there is a lot of focus on switching to the gas fuel.

In addition pricing for gas is not tightly controlled by the government. As a result most of the companies have fair amount of pricing power. As the industry is characteristed by entry barriers in the form of pipelines and licenses in specific markets. At the national level the market has been controlled by GAIL. However the government has opened the sector to compeitition and the common access guidelines provide access to the national gas pipelines controlled by GAIL.

The sector is however growing rapidly with a lot growth coming from industrial consumers and some cities switiching to CNG for vehicles.

Lubricants – These are some standalone lube companies like castrol. However for most of the companies this is an additional product which is produced and supplied through the same supply chain (Petrol pumps) or through retail outlets.

This sector is characterised by high competition with the industry growth dependent on the growth of the automotive sector. The last 2-3 years have been better in terms of the growth. However the sector characterised by poor pricing.

In the rest of the post I would cover the refining sector. I will cover the other sectors in future posts.

Porter’s 5 factor Industry analysis for refining companies

Entry barriers

The industry has moderate barriers characterised by economies of scale. Larger refineries with latest technologies which can process varying types of crude tend to have higher GRM (gross refining margins). For ex: the new RPL refinery is to have the latest technology with the capability to process heavy and sour crude oil(HSCO) and as a result could have margins as high as 10 $ per barrel.

Rivalry Determinant

The rivalry in the industry has been low till now as the industry was tighlty regulated by the government. The level competition would increase in the future, with reliance and other MNC becoming more aggressive

Supplier power

Supplier power is high as the net margins are strongly dependent on the price of the crude. Due to crude price volatility and supply risks, a lot of the indian companies are integrating backwards into E&P activities

Buyer power

Not too critical for most companies as refining operations are a part of the complete supply chain, with the refining operations supplying the product to the marketing company. However in case of standalone companies (which may no longer apply) long term contracts have to be signed with the marketing companies. The margins in such cases are dependent on such long term contracts.

Substititute product

Although gas , solar power etc exist as substitiutes , none of them are big enough to impact the demand of the petroleum products.


Company details

The key companies in this sector are MRPL, Kochi refineries, RPL (IPO), Chennai petroleum and Bongaigaon Refinery. Most these companies have benifitted with the high crude prices and are currently operating a high capacity utilisations. A few thoughts on these companies are below

RPL – the major points are coevered in this article. In addition, the pricing of the IPO at 60 would be on the higher side and as suggested in the article would account for the positives of the project being priced in. As an aside, considering the good deal which reliance is getting , I would like to look at RIL (it seems after all the demergers, the cross holding creation has started again in the new companies).

In addition, chevron has picked a stake too.

MRPL – The company has been turned around in the last 2 years and has now become profitable. It is now running at high capacity utilisation 119% (10 mmt capacity) . The financial numbers are much better now (see here) and the company has turned around after receiving capital from the parent (ONGC). The company is now valued at a PE of 9. Considering that the petroleum prices are at a high and any further expansion of earnings would come with further increase in refinery capacity, I think the company is fairly valued ( most of refinery companies are experiencing a cyclical high in terms of earnings).

Bongaigaon Refinery – This is a small refinery (2.1 MMT) with majority holder being IOC. It is running at fairly high capacity utilisation (100% +). The company is valued at a normalised PE of around 10 (based on average of last 5 years of earnings). Again the last year’s earnings seem to be at a cyclical high (GRM – gross refining margins were almost at 10 dollars last) and this year there has been a 50% drop in profits. Also further expansion will come only through capacity expansion, so the earnings / Free cash flows could be subdued for some time. However among all the refinery companies, this one is worth further analysis.

Oil and gas industry - Refineries

This is a complex industry with some of the largest public companies in india. It would be difficult to cover the entire industry in detail in a single post. I would however try to cover the critical components of the industry and try to explore one of the subsets of the industry in this post

The industry can be roughly be split into 3-4 groups

Refining companies – This would include standalone refining companies like RPL, MRPL.chennai petroleum etc and other vertically integrated companies like IOC, HPCL and BPCL which have their own refineries. Refineries are capital intensive businesses with high economies of scale, low differentiation in the product and competitive advantage being mainly with the low cost producer. In addition refineries are cyclical in nature with their margins driven by the price of crude

Marketing companies – There are no stand-alone marketing companies in india. Most of the companies like IOC, BPCL HPCL and now reliance are a combination of marketing companies (through retail outlets) and refineries supplying the marketing companies.

Marketing companies have more pricing power, some level of branding and less cyclical in nature. However in india as the retail price is controlled by the government, companies having the marketing division (HPCL, BPCL, IOC) etc do not have control on their pricing and typically have to bear losses which at best is mitigated through oil bonds.

Gas – These include companies like GAIL, Gujarat gas, Indraprastha gas etc. This is one the fastest growing sub-sectors in the oil and gas industry. With India trying to reduce its reliance on oil, there is a lot of focus on switching to the gas fuel.

In addition pricing for gas is not tightly controlled by the government. As a result most of the companies have fair amount of pricing power. As the industry is characteristed by entry barriers in the form of pipelines and licenses in specific markets. At the national level the market has been controlled by GAIL. However the government has opened the sector to compeitition and the common access guidelines provide access to the national gas pipelines controlled by GAIL.

The sector is however growing rapidly with a lot growth coming from industrial consumers and some cities switiching to CNG for vehicles.

Lubricants – These are some standalone lube companies like castrol. However for most of the companies this is an additional product which is produced and supplied through the same supply chain (Petrol pumps) or through retail outlets.

This sector is characterised by high competition with the industry growth dependent on the growth of the automotive sector. The last 2-3 years have been better in terms of the growth. However the sector characterised by poor pricing.

In the rest of the post I would cover the refining sector. I will cover the other sectors in future posts.

Porter’s 5 factor Industry analysis for refining companies

Entry barriers

The industry has moderate barriers characterised by economies of scale. Larger refineries with latest technologies which can process varying types of crude tend to have higher GRM (gross refining margins). For ex: the new RPL refinery is to have the latest technology with the capability to process heavy and sour crude oil(HSCO) and as a result could have margins as high as 10 $ per barrel.

Rivalry Determinant

The rivalry in the industry has been low till now as the industry was tighlty regulated by the government. The level competition would increase in the future, with reliance and other MNC becoming more aggressive

Supplier power

Supplier power is high as the net margins are strongly dependent on the price of the crude. Due to crude price volatility and supply risks, a lot of the indian companies are integrating backwards into E&P activities

Buyer power

Not too critical for most companies as refining operations are a part of the complete supply chain, with the refining operations supplying the product to the marketing company. However in case of standalone companies (which may no longer apply) long term contracts have to be signed with the marketing companies. The margins in such cases are dependent on such long term contracts.

Substititute product

Although gas , solar power etc exist as substitiutes , none of them are big enough to impact the demand of the petroleum products.


Company details

The key companies in this sector are MRPL, Kochi refineries, RPL (IPO), Chennai petroleum and Bongaigaon Refinery. Most these companies have benifitted with the high crude prices and are currently operating a high capacity utilisations. A few thoughts on these companies are below

RPL – the major points are coevered in this article. In addition, the pricing of the IPO at 60 would be on the higher side and as suggested in the article would account for the positives of the project being priced in. As an aside, considering the good deal which reliance is getting , I would like to look at RIL (it seems after all the demergers, the cross holding creation has started again in the new companies).

In addition, chevron has picked a stake too.

MRPL – The company has been turned around in the last 2 years and has now become profitable. It is now running at high capacity utilisation 119% (10 mmt capacity) . The financial numbers are much better now (see here) and the company has turned around after receiving capital from the parent (ONGC). The company is now valued at a PE of 9. Considering that the petroleum prices are at a high and any further expansion of earnings would come with further increase in refinery capacity, I think the company is fairly valued ( most of refinery companies are experiencing a cyclical high in terms of earnings).

Bongaigaon Refinery – This is a small refinery (2.1 MMT) with majority holder being IOC. It is running at fairly high capacity utilisation (100% +). The company is valued at a normalised PE of around 10 (based on average of last 5 years of earnings). Again the last year’s earnings seem to be at a cyclical high (GRM – gross refining margins were almost at 10 dollars last) and this year there has been a 50% drop in profits. Also further expansion will come only through capacity expansion, so the earnings / Free cash flows could be subdued for some time. However among all the refinery companies, this one is worth further analysis.

Companies/ industry with falling pricing

There are industries with stable pricing power like FMCG companies (to a certain extent), cylical pricing power like cement, steel and other commodity companies which depends on the demand and supply conditions and then there are companies which have a business model where the price is always dropping. A few industries, which come to mind are the computer industry (Dell, HP etc), semiconductor industry, memory (moser baer) and even electronics.

These industries are not even like airlines where there is a certain cyclicality of pricing. In the above industries, there is a relentless race to the bottom. Its almost a given. A PC now is around half the price of a PC in 2000 (maybe lesser), but it is 5 times or more powerful. So you have a scenario where the product keeps getting better and the price keeps falling.

So even when the revenue is increasing, the margins and profits may be shrinking. So what does it mean for an investor?

1. To be competitive all participants in the industry must constantly spend huge sums on new technologoies, equipments and other cost reduction options. So effectively the earnings are overstated for these companies, as depreciation is way to lower than the obsolence in the industry.


2. Due to poor pricing power, any drop in the demand has a severe impact in margins (see samsung results here). Companies like Intel which have a monopoly in the processor business have also taken huge hits when the demand has dropped.


3. Sudden shifts in technology can destory the exisiting product lines and put the company at risk. Even small shifts can hurt these companies badly (nokia got hurt and lost market share when the preference moved to clamshell phones in 2004/2005.)

In the end I would value these companies at low multiples if I can forsee the future of the company and figure out that the company would do well for quite some time.

As an example, look at Moser baer. This company has grown a lot, but at the same time operates in a falling price environment and needs constant investment into capital equipment. As result the company has had to add capital to the business. I am not sure if this business would really have any free cash flow.

Companies/ industry with falling pricing

There are industries with stable pricing power like FMCG companies (to a certain extent), cylical pricing power like cement, steel and other commodity companies which depends on the demand and supply conditions and then there are companies which have a business model where the price is always dropping. A few industries, which come to mind are the computer industry (Dell, HP etc), semiconductor industry, memory (moser baer) and even electronics.

These industries are not even like airlines where there is a certain cyclicality of pricing. In the above industries, there is a relentless race to the bottom. Its almost a given. A PC now is around half the price of a PC in 2000 (maybe lesser), but it is 5 times or more powerful. So you have a scenario where the product keeps getting better and the price keeps falling.

So even when the revenue is increasing, the margins and profits may be shrinking. So what does it mean for an investor?

1. To be competitive all participants in the industry must constantly spend huge sums on new technologoies, equipments and other cost reduction options. So effectively the earnings are overstated for these companies, as depreciation is way to lower than the obsolence in the industry.


2. Due to poor pricing power, any drop in the demand has a severe impact in margins (see samsung results here). Companies like Intel which have a monopoly in the processor business have also taken huge hits when the demand has dropped.


3. Sudden shifts in technology can destory the exisiting product lines and put the company at risk. Even small shifts can hurt these companies badly (nokia got hurt and lost market share when the preference moved to clamshell phones in 2004/2005.)

In the end I would value these companies at low multiples if I can forsee the future of the company and figure out that the company would do well for quite some time.

As an example, look at Moser baer. This company has grown a lot, but at the same time operates in a falling price environment and needs constant investment into capital equipment. As result the company has had to add capital to the business. I am not sure if this business would really have any free cash flow.

A good idea carried too far

1991-1992: Harshad mehta boom
Story: Liberalisation

1994 – IPO boom

1999-2000: IT stock boom

2003 - ? : The india story .

‘India will grow at above average rates ( > 6 %) for the next few years and more. India has the requisite demographics, savings rate and the right condition for growth’

The underlying idea behind each boom was true and maybe sound. But typically the idea got carried too far. I am reminded of this quote from benjamin graham (paraphrased)

‘ It is not the bad idea which does you in, it is the good idea carried too far’

So you have a boom in the stock market, the commodities market, gold market, real estate market. Read somewhere that property in mumbai is more expensive than manhattan !!

Maybe it is ‘different’ this time …who knows ?

I am reminded of the following statement from warren buffett

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large dosesof effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities - that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.

-- warren buffett , letter to shareholders 2000

So maybe there are people who are smart to know when the market will turn. I don’t think I can do that. Better to hold back or if the froth in the market increases, start selling.

another indicator of the bull market - in any party or evening out with friends and family, i keep hearing of the fantastic real estate, IPO or stock tips which should not be missed. prefer to keep my mouth shut in such groups. Who wants to listen to a party pooper ! surprising bit is that no one talked about stocks in 2002-2003 .

A good idea carried too far

1991-1992: Harshad mehta boom
Story: Liberalisation

1994 – IPO boom

1999-2000: IT stock boom

2003 - ? : The india story .

‘India will grow at above average rates ( > 6 %) for the next few years and more. India has the requisite demographics, savings rate and the right condition for growth’

The underlying idea behind each boom was true and maybe sound. But typically the idea got carried too far. I am reminded of this quote from benjamin graham (paraphrased)

‘ It is not the bad idea which does you in, it is the good idea carried too far’

So you have a boom in the stock market, the commodities market, gold market, real estate market. Read somewhere that property in mumbai is more expensive than manhattan !!

Maybe it is ‘different’ this time …who knows ?

I am reminded of the following statement from warren buffett

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large dosesof effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities - that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.

-- warren buffett , letter to shareholders 2000

So maybe there are people who are smart to know when the market will turn. I don’t think I can do that. Better to hold back or if the froth in the market increases, start selling.

another indicator of the bull market - in any party or evening out with friends and family, i keep hearing of the fantastic real estate, IPO or stock tips which should not be missed. prefer to keep my mouth shut in such groups. Who wants to listen to a party pooper ! surprising bit is that no one talked about stocks in 2002-2003 .

Follow up on the Infomedia ltd arbitrage

I had a look at the AR of infomedia to figure out what could be the downside risk to the arbitrage opportunity I discussed in my previous post


Following are my observations/ conclusion from what I read in the AR

• Infomedia is a fairly profitable company with a networth of 155 cr and a cash and equivalents of 126 cr.


• The company has a Return on capital in excess of 30 % (invested capital net of cash, net profit excluding exceptional items)


• The company is a zero debt company and is does not have a very capital intensive business.


• The net profit growth in mid to high single digits (7-9%).


• The publishing/ printing industry is growing at a moderate rate ( 8-13 % on avg - see macmillan performance which has a similar business as Infomedia)


• A fair valuation would be around 16-20 times free cash flow. Currently the free cash flow seems to be around 7-8 Rs / share. I would at best value the company at 160-180 Rs/share. So at 210 the company seems to fairly valued. Defintely not a long term buy at the current prices

So if I put the price after the buyback at around 180-190, the annualised return seems to be around 30%. Ofcourse the post-buyback price is just a guess on my part.

I still need to find how tendering of the shares is done? Does the company send some documents to the investor and is the investor supposed to fill up some papers to tender his shares? If anyone knows how the process works, please let me know or leave a comment.

Follow up on the Infomedia ltd arbitrage

I had a look at the AR of infomedia to figure out what could be the downside risk to the arbitrage opportunity I discussed in my previous post


Following are my observations/ conclusion from what I read in the AR

• Infomedia is a fairly profitable company with a networth of 155 cr and a cash and equivalents of 126 cr.


• The company has a Return on capital in excess of 30 % (invested capital net of cash, net profit excluding exceptional items)


• The company is a zero debt company and is does not have a very capital intensive business.


• The net profit growth in mid to high single digits (7-9%).


• The publishing/ printing industry is growing at a moderate rate ( 8-13 % on avg - see macmillan performance which has a similar business as Infomedia)


• A fair valuation would be around 16-20 times free cash flow. Currently the free cash flow seems to be around 7-8 Rs / share. I would at best value the company at 160-180 Rs/share. So at 210 the company seems to fairly valued. Defintely not a long term buy at the current prices

So if I put the price after the buyback at around 180-190, the annualised return seems to be around 30%. Ofcourse the post-buyback price is just a guess on my part.

I still need to find how tendering of the shares is done? Does the company send some documents to the investor and is the investor supposed to fill up some papers to tender his shares? If anyone knows how the process works, please let me know or leave a comment.

Arbitrage opportunities

With the market at current levels, I am not finding too many long term opportunities. Maybe my criteria is too stringent. But for my long term holdings I am not too keen to relax them.

In addition there aren’t too many graham type value stocks either. That kind of leaves out only aribtrage opportunities. Although I have not done much on it in the past, I have started looking at this area of investment opportunity actively. Atleast looking at arbitrage opportunites would keep me busy till I find a long term opportunity and hopefully prevent me from doing something foolish (which I may still end up doing)

There two opportunities which have come up. One was point out by amit in the comments. I also found reference to it on the icicidirect website ( see here )

The first company is infomedia india ltd. This is a buyback offer from the company.

1. The salient features of the scheme are as under:


2. The company shall buy back equity shares representing 14% of its paid-up equity capital. The buyback shall be across the board.


3. The consideration for buy back shall be Rs 245 per equity share.


4. Shareholders holding less than 50 equity shares per ledger folio / Client ID will have the option to tender their entire holdings over and above 14% of their shares at Rs 245 per share.


5. The shares so bought back shall be cancelled.


6. The scheme as envisaged will not affect the shareholding pattern of the company materially.


7. The scheme is subject to such approvals as may be required including that of the stock exchanges, Bombay High Court, shareholders and creditors.

The buyback is at 245 Rs per share. The current price is 210 per share. So technically there is 16 % return. Let me take you through my thought process on the above offer

ICICI ventures is the major shareholder with the shareholding at around 72 %. So the free float for the stock is 28%, which is 50 % of the open offer. So there is good probability of 50% of the tendered stock being accepted (maybe more).

I have found this excel arbitrage evaluator . So based on this evaluator, the following needs to be estimated further

1. Probability of the buyback not happening – looks low at less than 5 %


2. Closing price after buyback – This is a key variable to figure. As there is a likelhood of 50% or more of the stock being accepted, there rest will have to be sold after the buyback offer. Now one can choose to hold the stock, but that would require more analysis.


3. Duration of the scheme – looks like 1.5 to 2 months.

I can see a best case return of 40-50 % (annualised, net of expenses) in the above case. The key issue to figure out the downside and whether it can be mitigated by holding the stock for long term(more on that in future posts)

In addition to above, I am looking at two more of the following

1. EDS bid for Mphasis ( see here ) : No opportunity here, as the offer is at the almost the current market price. But I would like to see if EDS would up its offer (unlikely that the current price will get a lot of response)


2. Micro inks : I have just been emailed the AR for the company. I am now looking at this company as both a long term opportunity or a possible arbitrage opportunity in the future (if there is a possibility of a buy back or reverse book building by a german co – don’t have much info on it though)

Disclaimer – I am not recommending any stocks / aribtrage on my blog. Even if I am excited or find something interesting, I may not invest any money into it if it does not add up.

Arbitrage opportunities

With the market at current levels, I am not finding too many long term opportunities. Maybe my criteria is too stringent. But for my long term holdings I am not too keen to relax them.

In addition there aren’t too many graham type value stocks either. That kind of leaves out only aribtrage opportunities. Although I have not done much on it in the past, I have started looking at this area of investment opportunity actively. Atleast looking at arbitrage opportunites would keep me busy till I find a long term opportunity and hopefully prevent me from doing something foolish (which I may still end up doing)

There two opportunities which have come up. One was point out by amit in the comments. I also found reference to it on the icicidirect website ( see here )

The first company is infomedia india ltd. This is a buyback offer from the company.

1. The salient features of the scheme are as under:


2. The company shall buy back equity shares representing 14% of its paid-up equity capital. The buyback shall be across the board.


3. The consideration for buy back shall be Rs 245 per equity share.


4. Shareholders holding less than 50 equity shares per ledger folio / Client ID will have the option to tender their entire holdings over and above 14% of their shares at Rs 245 per share.


5. The shares so bought back shall be cancelled.


6. The scheme as envisaged will not affect the shareholding pattern of the company materially.


7. The scheme is subject to such approvals as may be required including that of the stock exchanges, Bombay High Court, shareholders and creditors.

The buyback is at 245 Rs per share. The current price is 210 per share. So technically there is 16 % return. Let me take you through my thought process on the above offer

ICICI ventures is the major shareholder with the shareholding at around 72 %. So the free float for the stock is 28%, which is 50 % of the open offer. So there is good probability of 50% of the tendered stock being accepted (maybe more).

I have found this excel arbitrage evaluator . So based on this evaluator, the following needs to be estimated further

1. Probability of the buyback not happening – looks low at less than 5 %


2. Closing price after buyback – This is a key variable to figure. As there is a likelhood of 50% or more of the stock being accepted, there rest will have to be sold after the buyback offer. Now one can choose to hold the stock, but that would require more analysis.


3. Duration of the scheme – looks like 1.5 to 2 months.

I can see a best case return of 40-50 % (annualised, net of expenses) in the above case. The key issue to figure out the downside and whether it can be mitigated by holding the stock for long term(more on that in future posts)

In addition to above, I am looking at two more of the following

1. EDS bid for Mphasis ( see here ) : No opportunity here, as the offer is at the almost the current market price. But I would like to see if EDS would up its offer (unlikely that the current price will get a lot of response)


2. Micro inks : I have just been emailed the AR for the company. I am now looking at this company as both a long term opportunity or a possible arbitrage opportunity in the future (if there is a possibility of a buy back or reverse book building by a german co – don’t have much info on it though)

Disclaimer – I am not recommending any stocks / aribtrage on my blog. Even if I am excited or find something interesting, I may not invest any money into it if it does not add up.

Comparing apples and oranges

Is it that software stocks are undervalued relative to the market? Will they outperform going forward? In our view, the risk-return matrix of investing in software stocks currently is equally poised.
On a relative basis, assuming a 15% CAGR growth in earnings of the BSE Sensex companies, the benchmark index is trading at a price to earnings multiple of around 14 times FY08 earnings. As compared to the same, the top five software majors, on an average, are trading at 19 times our estimated FY08 earnings. This is a 28% premium to the benchmark index. Considering the fact that earnings growth of the top three software companies i.e. Infosys, Wipro and TCS is likely to around 25% CAGR in the next three years (66% higher than Sensex earnings growth), we believe that the premium is justified

From: BSE IT: Has it tracked fundamentals

Question: Company A has a PE of 10, expected growth of 10 % for next 10 years and a ROE of 5 %. Company B has a PE of 15, expected growth of 8 % for the same period and an ROE of 20 %. Which company is cheap?

IT companies have a return on capital which is far in excess of 25%. However the key point in justifying the current valuations would be whether this level of growth and ROE hold? and that is where issues such as competivitive advantage of the indian IT service companies, their ability to contain costs, rupee – dollar rates etc comes in. So basically the answer to the question posed in the above article is not as obvious as the writer is suggesting (at least to me)

I typically avoid reading broker reports and their recommendations. The analysis is typically very shallow, incomplete
and hardly covers any of the key aspects in valuing the company. And worse is the tendency to compare apples and oranges, which in this case is to compare BSE sensex (which includes banks, commodity companies etc ) with an IT services company.

Answer to my question: Company A is a value destroyer and would need capital to grow at 10 % for next 10 years. So I would not pay more than 4-5 PE for the company.

Comparing apples and oranges

Is it that software stocks are undervalued relative to the market? Will they outperform going forward? In our view, the risk-return matrix of investing in software stocks currently is equally poised.
On a relative basis, assuming a 15% CAGR growth in earnings of the BSE Sensex companies, the benchmark index is trading at a price to earnings multiple of around 14 times FY08 earnings. As compared to the same, the top five software majors, on an average, are trading at 19 times our estimated FY08 earnings. This is a 28% premium to the benchmark index. Considering the fact that earnings growth of the top three software companies i.e. Infosys, Wipro and TCS is likely to around 25% CAGR in the next three years (66% higher than Sensex earnings growth), we believe that the premium is justified

From: BSE IT: Has it tracked fundamentals

Question: Company A has a PE of 10, expected growth of 10 % for next 10 years and a ROE of 5 %. Company B has a PE of 15, expected growth of 8 % for the same period and an ROE of 20 %. Which company is cheap?

IT companies have a return on capital which is far in excess of 25%. However the key point in justifying the current valuations would be whether this level of growth and ROE hold? and that is where issues such as competivitive advantage of the indian IT service companies, their ability to contain costs, rupee – dollar rates etc comes in. So basically the answer to the question posed in the above article is not as obvious as the writer is suggesting (at least to me)

I typically avoid reading broker reports and their recommendations. The analysis is typically very shallow, incomplete
and hardly covers any of the key aspects in valuing the company. And worse is the tendency to compare apples and oranges, which in this case is to compare BSE sensex (which includes banks, commodity companies etc ) with an IT services company.

Answer to my question: Company A is a value destroyer and would need capital to grow at 10 % for next 10 years. So I would not pay more than 4-5 PE for the company.

Learning Arbitrage

I have a conceptual understanding of arbitrage and have started looking at it actively. The first time I looked at it seriously was before the reliance de-merger. However I was not too confident of the opportunity and as a result did not commit much capital to it.

I just came across these two posts by prof. Bakshi which talks of two such arbitrage opportunities

http://fundooprofessor.blogspot.com/2006/04/nothing-ventured-something-gained.html

http://fundooprofessor.blogspot.com/2006/04/creating-free-warrants-case-of-jsw.html


I think Prof bakshi has explained the two situations in a fair amount of detail and anyone wanting to learn about arbitrage opportunities should read these two posts.

I am looking for some books on arbitrage and till date have found a bit of an explaination on it in warren buffett’s letters to shareholders and in Benjamin graham’s books – ‘The intelligent investor’ and ‘Security analysis’. However I am still looking for some books which covers this topic in detail, especially risk arbitrage, M&A arbitrage etc.

If anyone of you know a good book on it please leave me a comment. I would really appreciate it.

Learning Arbitrage

I have a conceptual understanding of arbitrage and have started looking at it actively. The first time I looked at it seriously was before the reliance de-merger. However I was not too confident of the opportunity and as a result did not commit much capital to it.

I just came across these two posts by prof. Bakshi which talks of two such arbitrage opportunities

http://fundooprofessor.blogspot.com/2006/04/nothing-ventured-something-gained.html

http://fundooprofessor.blogspot.com/2006/04/creating-free-warrants-case-of-jsw.html


I think Prof bakshi has explained the two situations in a fair amount of detail and anyone wanting to learn about arbitrage opportunities should read these two posts.

I am looking for some books on arbitrage and till date have found a bit of an explaination on it in warren buffett’s letters to shareholders and in Benjamin graham’s books – ‘The intelligent investor’ and ‘Security analysis’. However I am still looking for some books which covers this topic in detail, especially risk arbitrage, M&A arbitrage etc.

If anyone of you know a good book on it please leave me a comment. I would really appreciate it.