We exited an investment that was part of the Special Situations portfolio. Naturally, the first question that comes to mind is – what is special situation? Well, long-only or traditional investing involves buy low and sell higher. Buy at a price (known) and try to sell at higher price (unknown). What if I were to tell you that, in special situations investing, the sell price is also known beforehand! This seems to have piqued the curiosity. The unknown portion here could be the special situation not materializing or delay with the expected timelines. These special situations arise from activity that businesses undergo like mergers, spin-offs, buybacks, issuance of rights shares, debentures etc. Just as an investor studies at many companies and filter them through various models to come out with a handful of investment ideas, not all special situations are investment worthy. We skip a large majority of them for various reasons. The most common being – there is no “margin of safety”. This post is about one such investment opportunity we identified and exited at a decent gain.
The Background: Healthcare Global Limited issued this press release to the exchange on 4th June. It essentially said – the company has entered into an agreement with CVC partners and associates, a Private Equity (PE) firm, to issue 3.65 Cr shares and warrants at 130 apiece. With this issue of shares and warrants, the new investor would own about 29% of the expanded share capital of the company. Since they have acquired more than 25% of the company, the SEBI Substantial Acquisition of Shares and Takeovers (SAST 2011) regulations comes into play. And this is where things get interesting.
The Open Offer: All this appears good but look at it from another angle. This agreement was between the management (promoters) and new investors. What about the non-promoter or minority shareholders? Are they being sidelined? Are their interests being looked after? To avoid any shenanigans (for want of better word) from the management, SEBI (SAST) regulations say that, other shareholder should also get an opportunity to exit at the same price. Whether they accept the price or whether they wish to exercise their right to sell is a different matter. The idea behind the regulation is to provide equal rights to all shareholders. Since the PE firm would now come to own little more than 29% of the company, they would have to make the same offer to the other shareholders too. So, this Open Offer is to buy 26% of the expanded capital, that is 3.26 crore shares at Rs.130 per share. Understand a key difference here. In the first instance, the investors were issued new shares and the investment of 475 Cr goes to the company. In the second instance, when shareholder tender their shares in open offer, shareholders would receive the money.
Capital Structure: The company is in healthcare industry and operates hospitals at multiple locations specializing in cancer care. They also diversified into fertility care and standalone diagnostics. Total capacity is roughly 1900 beds, operating at around 45% utilization.
They came out with an IPO in Mar’2016 offering 2.98 Cr shares at Rs.218. The issue was subscribed 1.5 times. The existing and proposed capital structure is:
The Nitty-Gritty: The current offer is to buy 3.26 Cr shares at Rs.130. Let us evaluate each of the category of investors who can tender in the open offer and understand if there is an arbitrage opportunity here.
It is imperative that the promoters would not tender their shares in the offer. Plus there is no mention of it anywhere in the press release. The next big group are the Mutual Funds. A little research led to their detailed holding:
Kotak Equity Opportunities Fund had 9L shares till Mar’20. They sold it in Apr’20. Sundaram AMC seems to have special attachment with this company. They have exposure in 28 of their schemes! Most of these mutual funds have purchased shares in 2017 and 2018 post IPO. Their weighted average purchase price is 200+. Hence, they might not tender their shares in the open offer at 130. They might want to hold onto the shares for some more time. Plus, the momentum in healthcare/pharma is just beginning to pick up.
The next category – Foreign Portfolio Investors (FPIs) hold about 25%. These are some of the major names:
One institutional investor is not very different from another institutional investor. Agreed they might have better datapoints or management access, but there is very little distinguishing when it comes to decision making. Presented with the same data points, they would all come to similar conclusions. And mind you, some were anchor investors during IPO. With this background, we are assuming the entry price of FPIs would not be very different than that of Mutual Funds. Hence expecting them not to participate in the open offer.
To be or not to be: With this assumption that IF (a big IF at that) MFs and FPIs do not participate in the open offer, would leave about 3.06 crore shares. This is just about the size of the offer. Meaning, one can expect almost 100% acceptance if they were to participate. Let us now evaluate if there is an investment opportunity in the open offer.
The record date is not yet declared. Meaning, one can theoretically purchase from the market and tender in the open offer. The stock closed at 120 on Friday, 5-Jun. Assuming one is able to buy at this price or better, the absolute return works out to be around 8.3%. Economic activity has re-started post lockdown and pending corporate actions of other companies are also moving. One can assume this offer to be completed in 2 to 4 months. Therefore, the annualized yield works out to be 25% to 50%.
This all seems good but what are the downsides? Well, for one, it could get delayed. Which means, our annualized yields could be lower or much lower, depending on how long the actual delay is. Two, the offer could get cancelled. For a variety of reasons. From regulatory permissions to shareholder approvals to company reneging on their agreements. If that happens, we would have to sell those shares in the open market at then prevailing rates. In this scenario, it could as well result in a loss.
The actual trade: We weighed the pros and cons of the case over the weekend. And decided to buy the stock with an intention to tender in the open offer. We bought it on 8th and 9th June and waited for the strategy to play out. The successful and timely execution of the mega rights issue of Reliance Industries was also a solace that regulatory approvals have begun. But then again, Reliance is Reliance. There is no comparison with any other business house in the country. We did what we could do at the time. To wait.
Meanwhile, on 13th June, shareholders passed the resolution to allot shares to CVC partners. One hurdle crossed. On 18th June, company filed the draft offer of letter with SEBI. One more hurdle crossed. The stock was moving in a narrow range. Which is not a bad sign. Then all of sudden, during trading hours on 17-Jul, I see the price at 130+ on screen. This was more than the offer price. I frantically search for any updates from company. Nothing. Search for update on SEBI portal. Still nothing. The options were:
I took the no-brainer option. Exited in the market around 131. This resulted in absolute yield of about 9% in 40 days (annualized yield works out around 75% but that’s not the right way to look at it). This turned out better than anticipated. Better than expected returns and that too in less than expected timeframe. The capital it freed could now be used elsewhere. I must reiterate, this was a one-off incident. Such windfall gains do not happen often.
Many people have asked this question and I thought best to answer it here. Question was – when healthcare/pharma is looking good, then why did you exit so early? And why for so little gain? The answer is very simple. This position was entered with the framework of “special situations investing”. We are not looking at multi-baggers here. These typically last between 2 to 6 months. Rather we are looking for opportunities that can yield above average returns, albeit for a shorter timeframe. This is very different from “long term investing”. Let us not mix them up and create unnecessary bias for ourselves.
Meanwhile, I will keep looking for more such Special Situations and Long Term investing opportunities. Until then, stay safe. And stay inquisitive.