Divide and Conquer !!

Value Unlocking by Spin-offs….

One plus one is rarely two in the investing world . That shouldn’t come as a surprise for seasoned stalwarts of schizophrenic markets. Sum of parts  larger than whole – is the gaining wisdom in the whimsical world of finance.  Spinoffs in much of the  cases miraculously magnify the valuation so as to yield juicy returns for investors.

As savvy investors know , value unlocking in listed space  needs a catalyst . Corporate actions such as buy-back , open offer , delisting , mergers and demergers act as the required catalysts for rerating in mispriced stocks . Of all these , the most profitable one by historic data is the catalyst in the form of demerger . Spinoffs and subsequent listing of demerged entities have generated handsome returns for investors .

For the parent company , rationale for demerger can be many and can well be beyond the limited objective of value unlocking . Needs such as strategic sale , differing funding profile , sharper focus , promoter’s funding needs  etc could be some of those drivers  . Take the case of Crompton Greaves which is in the process of demerging its consumers business . This demerger is primarily driven by the promoter’s ( Avantha Group) need for raising funds for its power and infra ventures vide its plan to exit from its consumers business . Or take the case of Polaris which demerged and listed  its product business “Intellect” recently in the market . The funding and return profile between IT services and IT product businesses are vastly different . While Polaris’s IT services business is in a mature phase throwing cash year on year with stable growth , its product business is in investment phase with significant needs for regular cash infusion . This mis-match in return and funding profile underscored the need for demerger in the case of Polaris.

Irrespective of the underlying rationale for demergers , historic data over past few years shows that the demergers in majority of  the cases  , resulted in sizable rerating for both parent and off-shoot units  . As per one of the studies , of the top 11 demerged companies by market capitalization , almost 60%+ of them have delivered “2x – 7x” returns over the event cycle . Intellect design ( from Polaris) , Orient Cement ( from Orient Paper) , NRB Industrial bearings (from NRB) , Marico Kaya ( from Marico) , Star Ferro ( from Century Ply) , Gulf Lube ( from Gulf Oil) are some of the stellar performers that created significant value creation from demergers.

Interestingly , demergers define much of  the deft portfolio strategies that value investors rely for cash management during market tops . When value is scarce during market tops , value investors vote for special situation based arbitrage opportunities to eke out the extra returns while conserving the cash at the same time for the rainy day    . In Buffett’s parlance it is called “work-outs” . Demergers tops the work-outs during market highs with its attractive arbitrage returns profile .  The added kicker in demerger based arbitrage strategy  is that the inefficiency in the price discovery process of the demerged company ( mis-pricing during the listing process )  can many times morph the resultant company into a deep value opportunity for value investors  . Understandably , nothing is seen in the  horizon that can  dent the dazzle in the demerger themes  for times to come !.

Market Musings

Wobble while waiting… 

The wait is long and not over yet for the earnings to show up on the ground . The ongoing earning season offers no comfort either for a quick turnaround  . As the market waits for the earnings to catch up  , its vulnerability to shocks have risen manifold . Tax tantrums on MAT (for FIIs) ,  pains in rains and political grid-locks have only worsened such risks . Given the elevated level to which the valuation has vaulted  over last year , global gyrations if any can wreck a wobble during this protracted wait . Markets have ample  reasons  for such gyrations in the coming months . Impending fed rate hike cycle , potential Greek exit , hard landing in china or any reversal in crude story etc could trigger such global gyrations. Not to forget the risks from reversal in Rupee’s one way run so far . Surging FII inflows have so far kept the rupee on a robust wicket , defying the fundamentals that warranted weaker one . It is a familiar fact that the Indian currency has appreciated significantly on a trade weighted basis , impacting the export competitiveness .Fickle FII flows  on  delayed earning    cycle  is  a  serious  threat  to  Rupee in the coming months . If tapering traction in FII flows over last few weeks is anything to go by , it could be a rocky ride for rupee in the near term .

For investors , it is a classical early stage scuffle between valuation that has gone up on hopes and earnings that is yet to catch up on ground . This tussle is a typical of what  happens in early stage of every economic recovery cycle .  Nothing to get nervous about , but to welcome it as a window for deployment ( nibbling) during this dull phase . It is a typical pattern  of “long-term gains at the cost of short-term pains”  in such stage of the cycle . Since markets never adjust in orderly fashion , the ride will have its nerve wrenching moments . Seasoned investors understand these nuances and will welcome such a  fiery ride for distress prices , instead of fretting about temporary portfolio losses during these volatile times . Of course , one needs to have a cushion of cash to capitalize on such wild swings . Portfolio managers and investors who have conserved cash will come out as winners from this wobble-in-the-wait   . Risk to such a cautious call is that if there is any  sudden surge in FII sentiment (hence liquidity) , it  could trigger a sharp rally defying the weak medium-term  fundamentals . While this is unlikely given the lull earnings season and the impending fed tightening   , it can’t be completely ruled out .  Interesting times ahead .

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