Friday, May 16, 2008

SEBI Eliminates Gimmickry in Buybacks

In December 2007, I wrote about a stock buyback announcement made by Mastek (MAST@IN). See "The Mystery Behind Mastek's Buyback."

In that post, I had written:

"Why did the company give a maximum price of Rs 750 per share for its buyback, even though the current market price is Rs 280 per share? Indeed, adjusted for stock splits and bonus issues, this company has not seen its stock price hit Rs 750 in the last seven years."

That post attracted many comments some of which dealt with the possible gimmickry in buyback announcements when buybacks are to be conducted thru open market purchases.

Fast forward to today when Mastek published an important notice in The Financial Express (page 11, New Delhi edition dated may 16, 2008). The company disclosed that SEBI has directed it to:

1. place orders for buying back shares from the market "at least once a week at market related prices during the periods when the market price is lower than the maximum buy-back price such that the amount of buy-back is exhausted expeditiously"; and

2. not to close the buyback without completing it except under exceptional circumstances, with prior approval of SEBI.


That will put a stop to some of the gimmickry.

Good work SEBI.

Wednesday, May 07, 2008

Bongy's Mating Dance with IOC

Bongaigaon Refinery (BRPL@IN) whom I fondly call Bongy, has been engaged with Indian Oil (IOC@IN) since November 2006.

On November 29, 2006, Bongy announced her intention to get married to IOC. As per the terms of the marriage, the stockholders of Bongy were to get 4 shares of IOC for every 37 shares they were holding on the record date. They are still waiting for the marriage to take place...

Marriage is a very serious business in India. There is lots of planning to do, arrangements to make. And so, since that date in November of 2006, Bongy is still waiting to mate with IOC because her parents, and those of IOC, have yet to give their assent. Interestingly, both Bongy and IOC have the same parents, so I guess, this is going to be an incestuous marriage, which is even more complicated than an Indian arranged marriage:-)

A long engagement period has made Bongy quite restless, as you can see from the chart below (click on it to get a better view):

Since 37 shares of Bongy are to be exchanged with 4 shares of IOC, Bongy should sell for 4/37th or 10.81% of IOC. The red line in the chart above depicts this steadfast relationship.

The red line is the marital bed from which Bongy must not wander too far away.

But its hard to keep Bongy waiting for her groom. She likes to wander away from the marital bed to return only occasionally. The blue line in the chart depicts Bongy's behavior since she got engaged- since then, her life has been volatile, and eventful.

Bongy's mischievous behavior presents opportunities to opportunists like me - arbitrageurs who bet on the outcome of marital events.

For instance, in early March of 2007, when Bongy was found to be somewhere under the marital bed, and not on it, people like me could either think of this as an opportunity to buy OIL cheaply thru Bongy, or we could simply buy Bongy and short IOC in the hope that Bongy will ultimately return to her marital bed, at which time, happy with the outcome, we would reverse our trades.

Then, sometime in June of 2007, Bongy decided to rise above the marital bed (see chart above), and she rose, and rose. Now why would Bongy do something like that? Could she justify her behavior? I asked her and she told me she can explain anything.

She said take a look at my assets, my productive capacity, my ability to generate cash, and compare them with my market value. She said, on a stand-alone basis, that is, if I call off this marriage, I am worth a lot more than the measly 10.81% of IOC. I checked this out, I compared her with other similar girls like Chennai Petro (MRL@IN), and I could not agree more with Bongy. She could indeed explain everything.

But a marriage is a contract we Indians take very seriously. Once Bongy had agreed to merge into IOC, it was not going to be easy for her to walk away. At least that's what some arbitrageurs must have bet, when in November 2007, they could effectively go long IOC at 534, and simultaneously go short Bongy at 98. This trade would have enabled a shrewd arbitrageur, to create Bongy shares thru IOC at a cost of Rs 57 and immediately sell them in the futures market at 98. Of course, this smart arbitrageur (not me) would have to carry forward his positions until March 24, 2o08 because on that date Bongy closed at 46.55 and IOC closed at 432.80. Bongy was now close to 10.81% of IOC, where she belonged. Grudgingly, she had returned to her marital bed. The arb could now reverse his trades and derive pleasure not only from his profits, but also from his successful enforcement of Indian traditions.

But Bongy is hardly traditional. Soon after her momentary visit to the marital bed, she decided to move away again (see chart). She now trades at 13.3% of IOC instead of 10.81%.

How long will it be before she returns to where she belongs?

Indian Overseas Bank Tries its Hand in The Alchemy of Finance

I was amused today while reading a story in the Business Standard titled, "Indian Overseas Bank cashes in on Realty."

The paper reports that the Bank plans to "sell" some of its real estate to a "special purpose vehicle (SPV)."

The sale, at current market price, will produce a "profit" for the bank because the real estate is valued in its books at cost which is much below its current market value. This "profit" will increase the bank's capital adequacy ratio. Moreover, the bank will then lease the real estate back from the special purpose vehicle!

There is no mention of the SPV paying cash to the Bank for the acquisition of the real estate assets.

In other words, without actually selling the real estate (in economic, not legal terms), the bank will magically increase its capital adequacy!


A simple revaluation of real estate wouldn't have worked. So, we now have this new attempt at financial alchemy. Reminds me of John Galbraith's words:

"The world of finance hails the invention of wheel over and over again, often in a slightly more unstable version. All financial innovation involves, in one form or another, the creation of debt, secured in greater or lesser adequacy by real assets."

Tuesday, May 06, 2008

How Weak is this Oily Chain?

Today's Finanical Express carries an interesting column by Vikram Mehta, Chairman of the Shell Group in India.

The following passage caught my eye:

"Success in the exploration and production of oil & gas requires a company to overcome three interlocking sets of probabilities. The probability that a given geologic structure contains hydrocarbons [let's call this Event A]; the probability that hydrocarbons will be located [lets call this Event B], and the probability that once located, the find can be commercially exploited [let's call this Event C]."

Vikram's statement has vast practical implications for security analysts.

The market value of an asset is the present value of its expected future cash flows. Cash flows from an oil exploration company can be derived only out of hydrocarbons which can be commercially exploited. And for that to happen ALL of the above three events must happen.

Suppose that the probability of Event A happening is 40%, that of Event B happening is 20%, and that of Event C happening is 25%.

Then the probability of seeing cash flow which is valuable is 0.40 x 0.20 x 0.25 or 0.02. That comes to just 2%!

I wonder if the market participants think in those terms before valuing oil exploration stocks.

The man who said that "a chain is only as strong as its weakest link" was wrong.

He should have said "a chain has to be weaker than its weakest link."