ABB Buyout Offer – What Should I Do?
ABB group, the parent company of ABB India, made a public offer to increase its stake in ABB India. The company wants to increase its stake from approximately 52% to 75%. The buy price being offered is Rs 900 per share (34% premium to May 14 closing price). As per the annoucement, the reason for increasing the stake is “facilitate the long-term development of ABB’s business in India”.
Investors like me, who are investing for long term and practice buy-and-hold philosophy, need to put these types of corporate events under the lens. Buy-and-hold in real life is not blindly holding any stock forever. What it means is; one should continue to hold the stocks as long as it is meeting portfolio objectives. And the investor has an expectation that it will continue down the path.
I have owned ABB shares since 2005. I believe this buyout offer is significant event. I should evaluate if it makes sense for me to continue holding shares in this company.
Path to fully owned subsidiary
It is very expensive affair for multinational parent company to fully buyout the remaining stake (to make fully owned subsidiary) in its local subsidiary. I have observed that most of these companies take a two step approach towards full buyout. First, they increase their stake to maximum possible limit by method of open market offer. Second, after sometime depending upon how opportunity presents, they go for buyout of remaining stake using method of delisting offer. This two step process has shown to significantly reduce the cost of full buyout. So is this a precursor in case of ABB India?
- In a teleconference, ABB management stated that they do not intend to, or have no plans to delist ABB India from any of local exchanges. Increase in stake allows them to control the decision making process, and give them more flexibility in making investments.
- Management also mentioned that they would be looking for acquisition in Indian market space for increasing their business.
- On a personal note, I take management declaration with a pinch of salt. Two years down the road a new CEO will say business environment has changed and we need to take full control or something else. History suggests, likelihood for full buyout is high.
Future Growth Potential
All emerging markets, including India, are growth opportunities and source for future profits. Whenever, these multinational companies get bullish and can foresee that future profits are in offing, they would go all out to increase their stake. Higher stakes allow them to take away higher profits. They believe that buyout is probably an effective way to deploy cash or use of their capital. It is less likely that they will go for buyout when they cannot see future profit. For companies like ABB, capital is not a problem, while investing them for higher return is a challenge. Even after this buyout offer, ABB group has USD 5 billion cash, waiting to be invested. How many Indian companies will have that type of cash readily available and waiting to be invested? ABB India is practically a zero debt company. To think of it, most of the Indian companies are in opposite side of the spectrum. Indian companies are continously looking for extra capital, they either go debt route, or increase capital base, or dilute existing capital base. So does this mean, there is good growth in offing?
- ABB management mentioned that they believe this is the right time to make organic invesments in India. They have identified India as one of the key export market for growth in revenue. In recent years, the revenue growth in their key businesses have come from India and China. In addition, it seems their capital expenditure is also concentrated in India, China, and Poland.
- It is quite certain (not only to ABB, but to many other multinational companies) that India’s power sector is bound to grow due to lack of capacity. Large scale investments are expected to continue in power generation, electricity transmission and distribution.
- Similarly, the industrial sectors will resume its growth with increasing GDP. Increased investment are also expected in public mass transport systems, and industrial automation products for improving services/availability. All this present significant growth opportunity for ABB as a company. ABB is not a newcomer and already has an established customer base.
- This action suggest that, we could potentially see good growth in EPS, and hence value appreciation in next 5 to 10 years. Furthermore, the parent company would likely increase their dividend payout ratios.
Impact to Company
The contribution of revenue from Indian market is very small at USD 1.4 billion compared to the ABB AG’s kitty of $ 32 billion. Similarly, the contribution of net profit is only USD 117 million (in down year of 2009) to the USD 4.1 billion. However, it has had maximum growth rate in Indian markets among all emerging markets. It has grown at approximately CAGR 36% between 2003 and 2009. So it may seem that contribution is very minisule for now, but management sees significant growth likely to come from India.
Why the buyout now?
As early as 2006, there were media reports or ABB India management expressing its desire to buyout (or buyback) shares. However, the market price of shares kept increasing. At one point, the ABB India shares were trading at Rs 1500+. In addition, the earlier CEO had some aversion towards buyouts, and mergers and acquisitions. At such high prices, it would have not been good use of capital.
- During last down turn in 2008 and early 2009, ABB India share price dropped below Rs 500. It would have been an opportunity for parent company to buyout shares at that point in time. The issues are (1) other shareholders or board members would not easily approve such an action. Because remaining shareholder do not get true value of their holdings; and (2) It also creates a brand image issue where such companies are not perceived as friendly. When you are in another market, you have to create an atmosphere of sincerity into your business dealings to demostrate you are interested in local development too. Anyways, I believe all foreign companies tend to wrigle out in some way or other. Its nothing personal, just pure business sense for them.
- Recently, ABB India’s share price dropped below Rs 700 becuase of bad quarterly performance. In my view the parent company, grabbed this opportunity. It is being marketed as 34% permium to the days closing price which, on the face of it, seems very attractive. But, it is only 14% premium to floor price as per Indian regulations. Does it look attractive now?
What should I do?
I continue to believe ABB India is a good company. It continues to invest in business, overall it has stable return on investments, zero debt, etc. There are only three options for me to think about. Buy, sell, or continue to hold.
- Buying is not an option. I am already fully allocated. Additionally, the current market price is much higher than my buy price of Rs 450 to Rs 500 that I would be willing to pay.
- Selling could be an option. (1) Assuming I believe buyout offer of Rs 900 is quite high a valuation; or (2) Assuming I believe the future growth would not meet my expectation.
- In my view, the buyout offer of Rs 900 is on higher side of my sell valuation range, but not insanely high. Based on future direction, growth potential, favorable market segment, and managements focus, I believe there is more growth to come (and hence capital appreciation).
- I also expect that value of my ABB India positions will continue to have 12%+ growth for next 5+ years.
- Continue to Hold is an option. We are free to define any expectations. Right? The key is to make sure it works. As of today, ABB India shares have given me XIRR of 26% which validates my reason holding it. It has given me returns as per my expectations. It has fallen short on one of my expectations. It’s dividend has not grown in-line with growth in EPS. It is stable but not grown enough to my satisfaction.
Summary is….
When we put all of above discussion together, I believe there is much more growth to come. Management has more freedom to grow its business in India. It has all elements such as market presence, organization, manufacturing, techoology, strong balance sheet, and business environment in place. There are two risk factors (1) management does not increase dividends; and (2) in next few years it will go to delisting at lower price. I will continue to hold ABB India.
ABB, ABB buyout, ABB stock analysis
I came across this blog while surfing and I like the honesty in the article.
Regarding ABB, accept the buyback offer and buy from the market, am I missing something?
Hello AVS,
I did not understand your question. Can you please elaborate?
Best Wishes,
Hi,
If I buy these shares today, Can I sell them to the company at 900, withouit even considering its market price? If yes, then why the stock has fallen today. Shouldn’t it reach to the levels of 875+ when 900 is almost assured returns.
Hi,
If I buy these shares today, Can I sell them to the company at 900, without even considering its market price? If yes, then why the stock has fallen today. Shouldn’t it reach to the levels of 875+ when 900 is almost assured returns.
Hello Sunny,
Good question. Note that this is just an offer. It has not yet been accepted or executed or started yet. It is likely other major shareholders (mainly financial institution) have not taken this offer. ABB Group will not buy if they cannot amass the required number of shares. Also there is always an option for ABB Group to just buy institutional shares (and only buy remaining percentage from open market).
What you suggesting (like buying now and sell them to company at 900), that can be done, and it is called arbitrage. I am sure, there are many out there who are, perhaps, doing it. The risk in this arbitrage is as I mentioned above.
Good luck, if you decide to go for this arbitrage.
Best Wishes,
Since this stock has already far overshot your fair valuation mark would it not make sense for you to rotate out of this stock.
At this point of time even after reconsidering the increased mgmt focus , would it still be a buy according to a valuation screen?
I don’t think so from what you have written here.You have made this holding into a “hopeful” holding rather than a “valuation” holding?
BTW your comment on MNCs incereasing their focus in India by raising their local subs stake is significant , makes me think of buying into MNC subsidiary even those with a low growth profile (something like Esab India).
Hello Abhishek,
Good question about hopeful vs. valuation.
(1) when I want to buy I would go for cheapest possible price. But, when I want to sell, I will look for highest possible price point. The only question remains is what is highest possible price, and this is very subjective. No two people will have same estimates. As I mentioned in the post, to buy ABB shares, I would not pay more than Rs500. Now when I want to sell, I think Rs900 is on higher side, but it is surely not extremely insane. I have discussed my thought process in series of articles referenced below.
http://www.tipblog.in/risk-management/selling-an-important-part-of-portfolio-management/
http://www.tipblog.in/risk-management/selling-is-important-continuing-the-discussion-i/
http://www.tipblog.in/risk-management/selling-is-important-continuing-the-discussion-ii/
(2) For example, I own 30yrs old car. I can easily get 30K because of it is getting more closer to having antique value. I could sell it now, because it is way higher than its intrinsic metal scrap value. However, if I wait another 10 years, it will fetch me still much higher, right? So why settle for 30K? It is my expectation, or hope, that ABB will continue to grow more than this. I expect to continue to receive sustainable XIRR of 12%+.
(3) The risk is something gets broken in ABB (i.e. car accident) or gets screwed, which I am willing to take. Because my cost basis is so low (i.e. less than 500) that it would not break my portfolio.
(4) However, if I had large position, yes, I would use this opportunity to take some capital off and put it somewhere else.
Any thoughts?
Best Wishes,
Hi TipBlog,
Some points though I have not analyzed the ABB stock like you have
1) Rebutting you old car analogy , would it make more sense to take the 30k and invest it in something that gives you higher returns than keeping the old car
2) I understand that you would not like to sell the position if you do not have a better stock to rotate into.I think ABB might be overvalued here and you could find better investments.
I don’t know the right valuation for ABB so I am shooting a bit in the dark here and using your judgement.
Abhishek
Hello Abhishek,
(1) Fundamentally, I agree with your thought process in absolute terms. It makes sense to take 30k and put it where you get higher returns. The only point on which I have different viewpoint is ‘how to do it’.
(2) I also agree that ABB is on higher side, but not insanely high in the context of other factors such as (a) my investment thesis is to consider 12% to 18% expected return at sustained level. I believe I can get that by continuing to keep ABB. So why take risk of going to somewhere else? This would change if my expectation is 20% or more (b) if my allocation to ABB was significantly higher, yes I would probably sell at this price point. but it is less than 6% as of May 2010.
Since you touched fundamental question, let me mention, I did trim my position ABB, i think, sometime in 2007 at 1300 level. I consider it dumb to justify in retrospective because there is no traceability. Doing that is a loss of credibility or quality of discussion. My blog post are 2009 onwards where I can go back and say that was a mistake. So all discussions are Feb 2009 onwards.
fundamentally, i agree with your thought process. But whether it is right/wrong depends upon a given context, which in this case is my objectives or my expectations or risk I am willing to take.
Thanks for your thoughts, it was a good conversation.
Hi,
When a company de-list from exchanges…. is that okay if a person can still hold it shares? If that is possible only issue would be capital appreciation and block of funds?) I guess still every shareholder will get the dividends if company pays it. what all other issues one should face if company delists?
Hello Young,
At personal level, I have never undergone this scenario. So I do not know how demat account (or brokerage house where you have demat account) will deal with this. Ideally, brokerage house/demat account should sell it. In reality, I don’t know if it works that way. However, let us assume shareholder does not sell or surrender on company’s request, I would tend to think the shares become junk, with no value. Most likely company will consider it as forfeited. Summary is, no, it is not OK for individuals to hold after de-listing.
Best Wishes,
Thanks TIP for your comments
i mean accept the buyback offer at 900 and than buy shares from open market at 34% discount so you still hold same number of share, i hope its clear.
Hello avs,
Please see my response to Sunny Talreja above. It is an arbitrage situation, which has associated risk. Hope it helps.
Best Wishes,
I understood the points…. Just a qn… if the price falls to 450.. etc due to a market correction.. How you decide if you have to take additional position in ABB? …. still it is sound company, good management, good growth, good dividends…we donno if it would delist or not…. how you look at it?
Hello Young,
based on my allocation. If it is not 3% of my portfolio, then I will buy, otherwise I ignore it.
Best Wishes,
Buy Back of shares means the company is cash rich and that is a positive parameter to hold the company for long term. Buy back also increase the value of shares which holds by other shareholders. In my best opinion, there is no reason to throw our shares at this point..
Sherin Dev from Money Hacker finance blog..
Hello Sherin,
Good point.
i love the nifty relative pe charts you have put on side bar. they are awesome.
Thanks
hi tip guy…we always talk about fundamentals…but fundamental always work..i m not sure…many time sentiments and news drives the market and many stock with strong fundamentals lag behind with others
Chetan,
Was there a question?
Yes, it’s true at a given point in time. And that’s where investor like me or any other value investor finds opportunity. If not always, then in most cases fundamental does work.
The only challenge is to really understand what fundamental means. To me, fundamentals means; business model, how management runs it, how it is generating cash/sales/profit. Numbers that we usually talk about are mere reflection. Those numbers need to be put in the context of business. So if business cannot be developed or grow in short span of few months, HOW can we expect to grow our investment in few months? It takes few years!! And that’s the mistake all of us make.
So I believe, in most cases, fundamental works. We just do not understand what it really means and what are realistic expectations.
Best Wishes,
what is your openion about metal stocks….
like tata steel,hindalco,hindustan zinc..
i found i bad time like slow down metal stock hammer lot..but they give excellent returns ..as per my understanding all metal stocks follow cycle..and if we want to make money we need to catch them at bottom of cycle..they also provide good divident i.e. tata steel…what you say..
Hello Chetan,
I do not have any specific view (positive or negative) about metal stocks. However, they do not fit into my objectives of sustainability and consistency in my dividend/core portfolio. These are cyclical industry which I find it difficult to visualize, and how they will pan out.
I believe these are good in opportunistic situations like, buy low during their down turn, and then sell as they grow. I considering them value based opportunistic play. I have started looking into such ideas, but restrained myself from discussing on the blog for now. I still need to figure out well thought our process for myself. I don’t know when, but surely, I will start discussing in them in near future.
Best Wishes,
One silly qn, may be it is dump qn…(sorry in advance). many times i have come across writings saying that buy back by company increases the EPS.. how is that true… when there is stocks in the market of a company.. it has to be 100%, it does not matter promoters/ public/ any one else hold it!!!! so when promoters buy back how does it affect anything about the company.. except the confidence it can give to others.. like promoters bet big and have sound finance to perform buy back. when dividends are declared… promoters will get better amount as they own more stocks… how does a buy back affect a common investor.. (not considering the desisting option, confidence boost etc factors). Any comments highly appreciated!