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.
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.
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