AuthorRohit Chauhan

Follow up on the Infomedia ltd arbitrage

By Rohit Chauhan
In Arbitrage, Company analysis, Investment ideas, Uncategorized
April 8, 2006
2 Min read
3 comments
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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.

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Arbitrage opportunities

By Rohit Chauhan
In Arbitrage, Uncategorized
April 4, 2006
4 Min read
7 comments
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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.

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Comparing apples and oranges

By Rohit Chauhan
In General thoughts, Uncategorized
April 3, 2006
2 Min read
6 comments
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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.

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Learning Arbitrage

By Rohit Chauhan
In Arbitrage, Uncategorized
April 2, 2006
1 Min read
Add comment
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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.

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Notes from Columbia Business School trip’s meeting with Warren buffett

By Rohit Chauhan
In Uncategorized, Warren buffett
March 29, 2006
2 Min read
3 comments
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I always make it a point to read the transcripts/ notes of these meetings. A lot of it is the same stuff, but I am always able to find a few gems of wisdom in buffett’s replies to the Q&A. Some of the interesting comments are below

Link : http://investoblog.blogspot.com/

Question 3: What do you read?Everything. Annual reports, 10-K’s, 10-Q’s, biographies, history. When he’s in airplanes, he’ll read the instructions on the seat backs. Two books he recommended specifically are Poor Charlie’s Almanack and Personal History, Kate Graham’s bio. He rarely ever reads fiction, feels like it would be taking up time he could be reading about business. He reads five newspapers a day, and plays bridge twelve hours a week.


Question 4: Please share your thoughts on your position in Remy International and the auto parts industry in general.“Boy, I thought airlines were tough.” They took the position in Remy three years ago.When your big customers are teetering on the brink of bankruptcy, it’s tough to get price increases. You can’t survive as a high-cost producer in this industry. You can’t pass through costs like you could in the old times.


Question 5: What investment lessons have you learned?He keeps making mistakes. Predicting the future is hard, and it will keep being hard. As long as his mistakes are in his analysis, that’s okay. When you buy a stock, you need to be able to get out a yellow legal pad and write down, in one page why it is cheap. For example, “I am buying the Coca Cola company for $14b for x, y, and z reasons and I think it is worth far, far more than that.”



He finds the game fun and always has. If you like it, keep practicing. It’s hugely important to buy stocks on your own. By doing that, you learn in a way that you can’t from reading books. Temperament and emotions are hugely important, and you need to experience that first-hand.

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Common errors in DCF models

By Rohit Chauhan
In Investment process, Uncategorized
March 29, 2006
2 Min read
6 comments
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Found this great article from Michael Mauboussin, Chief Investment Strategist of Legg Mason Capital Management (LMCM). It is a 12 page article on the common errors investors commit in using the DCF (Discounted cash flow) model.

Personally my approach to valuation (which is not original and mainly developed from reading) is to create a DCF model for three scenarios. I extend the current business condition and create an as-is scenario. So the assumption is that the current growth rates, margins, competitive situation etc will continue as is. The second scenario is an optimistic scenario where in I try to calculate the intrinsic value using the most optimisitic assumptions for growth rates, margins, competitive intensity etc. The third scenario is the pessimistic scenario with poor growth rates, high competitive intensity etc.

I try to associate probability against each scenario and try to calculate the expected value.

So expected value is = intrinsic value (as is) * probability for ‘as is’ + instrinsic value (optimistic scenario)* probability for optimisitic scenario + intrinsic value (pesimistic scenario) * probability for pessimistic scenario.

I also cross check the above expected value with ratio based valuations.

The above approach forces me to think harder on all my assumptions. Also when the annual results are declared for any company I have invested in, I go back to my excel spreadsheet and relook at the numbers, assumptions etc and calculate the new intrinsic value again. This gives me an idea on whether I should sell, buy more or hold.

I am not able to post my valuation / analysis spreadsheet on the blog. If any one is interested, please e-mail me on rohitc99@indiatimes.com

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The warren buffett of India

By Rohit Chauhan
In Notable value investors, Uncategorized
March 28, 2006
2 Min read
4 comments
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Chandrakant sampat is rightly called the warren buffett of india. See his profile here

I just read this interview with him where he has given his thoughts on the market. It’s a must read

A few excerpts from the interview

A few months back, I was looking at a table of 100 Indian companies ranked by return on capital employed (RoCE). At some point, these stocks were quoting at eight-year lows, which is strange. Look at Siemens. It did an eight-year low and now it’s quoting at Rs 5,000. Tata Steel was down at Rs 40-50 and now, after adjusting for bonus, it’s Rs 700-800. Of this set of companies, if investors pick up something quoting at a 10-year low, it appreciates 10 times.
Pick up good companies with good managements when their share prices are at an eight-year or 10-year low. Alternatively, if you still want to do something, buy good companies that are 40 per cent lower than their 52-week high. I will buy only those companies that…

• Are in a business that even fools can understand
• Have very little debt
• Have free cash flows
• Don’t have much capital expenditure, which is nothing but deferred cost

So, the companies you say are growing, are they really growing? The answer is ‘no’. They have to keep all deferred costs aside, they can’t declare hefty dividends, as the future costs. So, that’s another lesson — buy stocks that have minimal capital expenditure.

I have put a few more articles and interviews with chandrakant sampat below

Indiainfoline interview

Businessline interview

Rediff interview

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portfolio construction – Size of a bet

By Rohit Chauhan
In Investment process, Portfolio management, Uncategorized
March 27, 2006
3 Min read
5 comments
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My earlier tendency when adding a stock to my portfolio was to allocate an arbitrary amount of money to it. The actual bet or the size of the position was initially a fixed amount of money and later it became a fixed percentage of the portfolio (around 5 % usually).

However later I read several articles and charlie munger’s thoughts on investing and have modified my approach. After I have identifed a stock and am willing to commit money to it, I try to evaluate how confident I am about the stock. I try to quantify this confidence level in terms of the margin of safety, which is the discount at which the stock is selling from the intrinsic value of the stock. So if the intrinsic value of the stock (as calculated by me) is 100, and if the stock is selling at 60, then the discount is 40%. So higher the discount or margin of safety, higher my confidence.

In addition, I try to calculate the odds on the stock too. I use the following formulae to calculate the odds

Intrinsic value (under most optimisitic assumptions of growth, profit margins etc) – current price / (current price – intrinsic value (under most pessimistic conditions)

So my cut off in terms of odds is 3:1 and I typically look at stocks selling at a discount of 40% to intrinsic value. The above may seem to be very stringent criteria in terms of selecting stocks, especially under current market conditions. But this criteria has served me well, as I am able to build a huge margin of safety in my purchases. Ofcourse I am using the above criteria for my long term holdings.

My bet or size of the position is generally 2% or 5 % and a max of 10% if my level of confidence is very high. However I am not into portfolio balancing. So if my best idea has done well and is now say 20% of my portfolio and I think is still undervalued, I let it run and remain in the portfolio. The only time I would sell would be if the fundamentals of the company deteriorate or the company becomes highly over valued.


Side note : Just read that capital account convertibility may be introduced in india. That could have major implications for all of us as investors as it is possible that we may be allowed to invest out of india. I think currently we can do that with a limit of 25000 usd, but it is with restrictions. Lets see what kind of freedom the capital account convertibility brings in. I am however optimistic and excited about it.

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An investment idea (In process)

By Rohit Chauhan
In Investment ideas, Uncategorized
March 23, 2006
3 Min read
6 comments
A

I generally run a simple screen in icici direct to list all the companies selling below a PE of 12. Why a below 12? Well, there is a certain logic behind it and I will expand on it in another post.

So with the market at 10,000+ levels, the list has become fairly short with quite a few banks and commodity companies. I analysed a two companies (one looks interesting, the other one does not) and here are my thoughts on the first one (micro inks) which looks promising enough for further analysis.

Micro inks

As the name suggests, this is a 900+ cr company with the main business in inks. It is a kind of an Indian multinational with around 57% turnover coming from overseas (US accounting for almost 34%) and is fairly vertically integrated.

The company has done well in the last 5 years with CAGR growth of 20% in revenue and average net margins of 8-10%. See P&L here

The company has a fairly conservative balance sheet with a low Debt to equity of 0.3. The ROE has been erratic but at a respectable 10% plus for a few years. Other Financial ratios look like Net margins, Operating margins have increased and are at healthy 10%+ and around 15-18 % for OPM. Account recievables are almost at 100 days, which is not healthy and a figure which needs to be watched closely. It is mainly at this level due to the type of marketing setup the company has (distributors, resellers etc)

The company has expanded its international operations through equity funding and moderate amounts of debt. This has a lower risk (for the company atleast) although the ROE is depressed now. Most of the investments seem to be in Subsidiaries and JV’s.

The company is valued at around 11 times last year PE. This year however has not been as good with profits declining due to raw material cost pressures. However the company still sells below 12-13 forward PE (Full year results are not yet in).

The numbers look fine (I need to read the annual report), but there some issues which I need to think through further

– How will the international strategy play out for microinks. Will the company be able to expand profitably in the international markets?
– What is the capital structure plan for the company. Will future expansion happen through equity (more dilution?)/ Debt or internal accruals?
– Competitior analysis

I have still not made up my mind on the above company, and will add to my analysis further as I read up on the company.I have done the basic checks on the company and nothing seems to be wrong on the face of it. In my case, it means that i will now be investing more time in understanding the industry dynamics, competitor analysis and try to understand the future economics of the company (mostly the soft stuff).

So typically i go through the annual report and the numbers as the first step and try to see if there is something off in terms of the numbers like high debt, excessive valuations or any other issues. If the investment idea passes the basic checks, i get into more detailed analysis which takes a few weeks for me.

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To invest or not to invest ?

By Rohit Chauhan
In Investment process, Uncategorized
March 21, 2006
2 Min read
2 comments
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I was looking at one of my first few posts

Market now offering 10:1 odds

And

Investing based on odds …Does it work ?

And saw that back in 2004, the market odds were 10:1

So what are current odds?

With a PE ratio of around 19, the current odds are around 1.4:1 . These odds are based on the last 6 years data. Its very easy to calculate the odds. Just export the nifty PE data from the their website here. The odds are basically the number of days the nifty closed at a PE of more than 19 to the total number of days.

Now the above calculation is very simplistic and one can argue, backward looking. So if you believe the earnings will continue to grow rapidly, interest rates would remain at the current level and the ROE of the indian industry would remain at the current level (around 24%) or increase, then maybe the odds are better. But frankly the margin of safety does not exist. In may 2004, the odds were 10:1 and the expected returns much higher. That’s not necessarily the case now.

The above does not mean that there no investment opportunities out there. Its just that there is no low hanging fruit now. Back in 2003 or 2004, just putting money into the index was good enough. Any PE or valuation screen was throwing up a huge number of stocks. But now, I am not finding too many companies. I am currently looking at Micro inks and Asahi glass and would be posting my analysis soon.

update 21st : saw this update on moneycontrol – With the Sensex touching 11K today, analysts told Moneycontrol that the benchmark is fairly priced at current levels and apart from fundamentals, liquidity is trying to find value in Sensex stocks.

see this table in the article for the valuation of the top sensex stocks

what is magical about 11k ? read this speech by warren buffett at wharton (question 3) where he talks of valuation in terms of band. So it may be possible to say that 10-11k is fairly valued with a certain set of assumptions. But giving a precise number is trying to bring a level of mathematical certainty to something (valuation in this case) where it may not be possible to do so

Do read this speech by warren buffett. I learnt a lot from it

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