Jul 4, 2013|
Can you really be a stock market genius-II?
In an earlier article we had discussed Joel Greenblatt's views on how ordinary investors can become stock market geniuses. We had specifically discussed how investors can spot the value investing opportunity in corporate events like spin-offs. Restructuring is another significant event which if evaluated appropriately can help investors make a fortune.
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Greenblatt states that remarkable value in a stock can be uncovered through corporate restructuring if one carefully assesses 'big' changes. This means sale or liquidation of an entire division. The most viable investment opportunities are; where companies sell or close major divisions to stop losses, pay off debt or rather focus on more promising business.
Many a times, it may be the case that the division being sold out or liquidated has actually hidden the value inherent in the company's other businesses. E.g. a conglomerate has earnings per share of Rs 20 and its stock trades at Rs 300 per share. Actually, that Rs 20 earnings may combine Rs 30 earnings of two businesses and loss of Rs 10 of another business. So, if one liquidates the loss making business, the conglomerate's earnings increase to Rs 30 and P/E multiple declines from 15x to 10x; creating enough headroom for returns.
Let's discuss restructuring of two engineering companies- Larsen & Toubro (L&T) and Elecon Engineering.
L&T, an engineering conglomerate carried out restructuring of its non-core divisions between 2002-2004. L&T demerged its cement business into UltraTech Cemco Ltd. w.e.f. April 01, 2003. L&T retained just 11.5% stake in the business. L&T after few years sold its entire stake in cement business. Later on, it went on to exit Glass container business too which was another non-core business of the company.
Consequent to the above restructuring, L&T became a more focused player in Engineering, procurement and Construction (EPC). Share of EPC business in total sales went up from 57-58% to more than 80%.
What was our view?
We saw the restructuring move as a step in the right direction. We perceived that it will bring a semblance of focus into the company. In our view on L&T restructuring; we had emphasized on the importance of restructuring of its business divisions particularly cement business. Poor performance of L&T's cement division had marred excellent performances of the other divisions of the company. As a result, L&T also received lower valuation as compared to its peers.
And the restructuring decision proved right!! The demerger unlocked a considerable amount of value for investors. As a result, in a span of three years (April 2002 to April 2005); L&T's returns escalated to CAGR of 32.5% as opposed to negative returns for the earlier 3 year period (April 1999 - March 2002). This, of course was aided by the general optimistic environment for engineering sector.
Now coming to Elecon, it announced its restructuring plan in 1QFY13. The company consolidated group's material handling equipment (MHE) and transmission equipment (TE) businesses. Elecon created separate entities for both the businesses. The basic idea of restructuring was to have all the sub-segments (MHE & PT) under one roof of standalone and subsidiaries. As per the management, both the divisions faced different economic challenges and needed independent focus. The restructuring of businesses was also going to increase promoter's shareholding in both the MHE business and PT business. This would give them majority control; of over 50 % in the decision making process of both companies.
What was our view ?
We evaluated Elecon restructuring in a positive light. We expected that separating two businesses will simplify the group structure. This will boost productivity and also enable the businesses to raise funds separately.
While it may be too early to assess the impact of restructuring, the impact of the same on Elecon Engineering's stock price has not been very positive. After the restructuring announcement; Elecon's stock price tumbled significantly. We believe that it also has to do with the sluggish economy and poor performance of the company and engineering sector. Further, Elecon is a much smaller company than L&T and therefore carrying out a successful restructuring can be an arduous and long task for the former. However, all said and done, it has been less than a year since Elecon's restructuring initiatives began. Therefore, it is too early to contemplate a verdict on its restructuring
Thus, L&T and Elecon may prove to be two conflicting examples of the restructuring exercise. One major difference between L&T and Elecon restructuring is of timing. Because at present almost every engineering company is struggling to maintain its ground. Thus, we observe that restructuring can reap benefits if timed correctly. Therefore, before evaluating any restructuring prospect, investors should look at the company size as well as current business environment to assess whether it can pull off restructuring smoothly. It will also be more fruitful for investors if the company not just aims at increasing its profitability but also keeps in mind the interest of its minority shareholders.
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