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Tuesday, April 19, 2011

Are acquisitions beneficial for small investors?

The short answer is: ‘No’ (for small investors of the acquiring company), and ‘Maybe’ (for shareholders of the acquired company). The acquiring company ends up paying too high a price – usually financed through debt – which adds downward pressure to the stock’s price.

Integrating the business of a different company with a different set of values is not an easy task. More so if the business of the acquired company has little or no synergy with its own. If the integration fails, the acquiring company may be forced to divest its acquisition at a loss.

Shareholders of the acquired company typically end up with a smaller number of shares in the acquiring company, and some times get a monetary compensation instead of any shares if their original holdings were small. However, if several acquirers start a bidding war to acquire a company, thereby giving a boost to the company’s share price, then small shareholders can use the opportunity to book out with a tidy profit.

What happens when a company decides to sell one of its divisions, instead of the entire company? This happened recently when Aditya Birla Chemicals (formerly Bihar Caustic, and a subsidiary of Hindalco) acquired the Chloro-Chemicals division of Kanoria Chemicals. It was a win-win situation for both companies. Small investors in both companies have already seen their holdings increase in value, as share prices of both companies have moved up subsequent to the announcement of the acquisition.

Kanoria Chemicals had sales of Rs 421 Crores in 2009-10 with a PBIT of Rs 51 Crores. Its Chloro-Chemicals division (CCD) had sales of Rs 303 Crores with a PBIT of Rs 47 Crores. Obviously, the rest of their businesses are neither large nor very profitable. So, how do they benefit by selling off their largest and most profitable division?

Kanoria Chemicals will receive Rs 830 Crores in cash for CCD – valuing it at nearly 2.75 times its sales. Though there was talk of using the cash for acquisitions and expansions, the plain fact is that at 9% rate of interest in a bank fixed deposit Kanoria Chemicals can earn more money every year than they have ever earned running their company!

No wonder the share price has doubled in a month! Looking at the chart pattern, there are clear signs of insider buying, since the stock made a bullish rounding bottom pattern and started rising well before the acquisition announcement. The stock is looking extremely overbought, and existing investors should use the opportunity to sell. A special dividend offer is likely, but there doesn’t seem to be great future opportunities for the company.

Will small investors of Aditya Birla Chemicals benefit? It appears so, even though a high price was paid for the acquisition (which will be funded through debt and internal accruals). CCD will more than double the caustic soda production capacity of Aditya Birla Chemicals, and is located near Hindalco’s Renukoot factory, which will add to the synergy. Hindalco is significantly increasing its own production capacity, and this acquisition gets rid of a competitor plus doubles the capacity of an essential input for aluminium production.

Aditya Birla Chemicals has an excellent balance sheet, and has assured business from its parent company. The stock is in a bull market, and can be added on dips.

Related Post

About advantages and disadvantages of mergers and acquisitions (M&A) and demergers

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