Jul 8, 2013|
Can you really be a stock market genius-III?
In an earlier article we discussed Joel Greenblatt's views on how ordinary investors can make a fortune by identifying opportunities in major corporate events. We had discussed one such event- in detail corporate restructuring. We now discuss corporate mergers which can prove to be another significant event for investors if appraised appropriately.
As per Joel Greenblatt, a general rule he follows for merger is to believe that no one wants merger securities! This means that people generally sell shares in merged entities. This could be because of complexity of the merged entity or lack of transparency in valuations. Greenblatt says that this is indeed a chance for you to pick the stocks at dirt cheap prices. However, not before doing your homework! He advises investors to go through merger filings and look for explanation for the consideration that is being paid to the target for merging the entities. So in short, thoroughly study the rationale of a merger as well as compensation being provided for a merger.
Many a times; the complexity and circumstances of the merger makes assessment very difficult. In that case, Greenblatt's tips come handy. To provide an analogy, we take up the most awaited as well as scrutinized merger of Tech Mahindra and Satyam computer services ltd (now Mahindra Satyam).
We understand that the synergy of the merger is yet to be fully played out and it may be too early to assess whether the merger could indeed be a win win situation for both acquirer and target company. What is interesting is that features of this merger exemplify Greenblatt's ways of looking at a merger and evaluating its pros and cons.
How did it all begin?
In January 2009, a well crafted accounting fraud, India's biggest corporate fraud, came into light. In a shocking revelation, Satyam Computer Services Ltd's founder and then Chairman B Ramalinga Raju confessed that he overstated the company's financials by a substantial amount. He also admitted to several other wrongdoings at the firm.
Following this, Satyam was acquired by Tech Mahindra in April 2009. Lets weigh few positive and negative observations of the merger.
What made it look like a win- win situation for both the parties?
- The government took it upon itself to speed up the merger to quickly alleviate anxiety and uncertainty surrounding Satyam. Former NASSCOM president - Kiran Karnik as well as HDFC chairman- Deepak Parekh looked after the merger proceedings; both of whom have good reputation in the Indian industry. This indicates towards Greenblatt's emphasis on assurance to investors that there is a sense of commitment.
- Tech Mahindra was aiming to diversify in the IT sector rather than being focused on a single vertical, telecom. So it was indeed a good opportunity for Tech Mahindra to improve its profile as Satyam was present in almost all verticals from engineering, enterprise solution to banking and finance. This was a synergical benefit that Tech Mahindra was aiming for!!
- Tech Mahindra's shareholders are expected to gain from the merger as it is likely to be EPS accretive for them in the long run given the synergical benefits of the merger. This identifies with creating value for shareholders.
- Mahindra Satyam's financial performance has gradually improved over the years and this can be attributed to efforts of acquirer - Tech Mahindra to make the former entity profitable.
What are the factors which point towards uncertainty and skepticism?
- At the time of bidding, Tech Mahindra's consideration for Satyam seemed at a higher side (Rs 58/share) as its difference with the second lowest bidder Larsen and Toubro (L&T) (Rs 45.9/share) was very wide. However, Satyam's gradually improving performance alleviates the concern to a certain extent.
- Tech Mahindra had always been a lesser known brand. On top of it, Satyam's stained image may not help the company much. Also, there may be more risks down the road as well due to few contingent liabilities associated with Satyam.
- Tech Mahindra's biggest client- British Telecom accounts for close to 70% of its business. Satyam, on the other hand had a diversified client base. So, the operational efficiencies may be different in both the companies. Therefore, integration of operations may prove to be a tough task for the company.
What was our view?
We perceived Tech Mahindra and Satyam merger in a positive light. We believe that the expected benefits and synergies from the merger can actually fructify in the long run. However, we do realize that it may take 2-3 years post the merger before Tech Mahindra becomes a formidable entity. Also, one needs to be cautious about contingent liabilities that are associated with Mahindra Satyam.
To sum up, we would like to convey that corporate event like mergers need to be evaluated very very carefully and investors should not make a hasty decision. Simply following the market may not help all the times. In above case, both Satyam (now delisted) and Tech Mahindra did deliver returns in excess of CAGR of 40%; since the exposure of fraud in Satyam and Tech Mahindra's subsequent announcement of the former's takeover respectively. But this may not be the case with each and every distressed takeover or merger. Therefore, it is essential for investors to do their own research also about the management, integration process of the merger and value accrued to minority shareholders before making an investment decision.
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