When Bad News is Good news

When bad news is good news

Sandeep Singh

Posted online: Monday , May 28, 2007 at 1347 IST
Updated: Wednesday, June 29, 2005 at 1257 hours IST -->


In December, about the time that its IPO opened, oil exploration major Cairn was rocked by news that its partner, MRPL, didn’t want to build a pipeline with it. The issue barely scraped through, the stock listed below its issue price of Rs 160 and slipped to Rs 112 on March 5. Without a pipeline, Cairn’s oil is worth nothing. But in the past few weeks, the two partners have been talking about the pipeline and, word is, Cairn might even be a takeover target. Its stock has since rebounded 34 per cent to Rs 150.In April, Fortis Healthcare too made its IPO amid a conflict-ridden backdrop. Its 90 per cent acquisition of Escorts Heart Institute and Research Centre Limited — the source of 60 per cent of its revenues — was being contested in court. If Fortis lost, it stood to lose control of the Escorts hospitals. Like Cairn, the Fortis stock also listed below issue price. And 10 days ago, when the Fortis promoters fired Dr Naresh Trehan, the man who built Escorts and owner of 10 per cent in the company, the stock slipped further. If Fortis manages to resolve ownership and management issues, its stock could well see a Cairn-like spike.

What’s the opportunityTwo things are clear from these examples. One, when companies face trouble due to extraordinary circumstances, as opposed to a decline in business prospects, the market is quick to hand out a harsh verdict. Two, if and when the situation is resolved favourably for the business, the bounce back is equally sharp and quick. In that pattern lies a money-making opportunity. When applied to good, growing businesses, it’s an effective strategy to buy them at attractive prices. When the Ambani brothers were shadow-fighting for control of the Reliance empire, the share price of Reliance Industries, the group flagship, moved in the Rs 480-600 range, even as the market galloped. But the demerger, which was necessitated by the family squabble and unlocked a lot of value, the Reliance Industries stock has risen almost three-fold. But not every company is Reliance and not every stock will respond the same way. Says D.D. Sharma, vice-president of retail equity, AnandRathi: “Fundamentals are supreme. If a good, strong business is facing turbulence, the opportunity is worth considering.” However, being a relatively risky strategy, it’s not for the conservative investor. Even for investors with a greater appetite for risk, in no circumstances should such calls form the mainstay of a portfolio.
What goes wrong Getting it right is as much about understanding the implications of an adverse development for the business as it is about gauging whether the company can ride through this rough patch. The nature of one-off situations that threaten to cripple a company can be broadly categorised into three.Legal issues. For instance, control of the Escorts hospitals, the cash cow of Fortis, is mired in litigation. Although the IPO money will enable Fortis to expand, Escorts can be the difference between an average and a good business.Management feud. Since a majority of businesses are still family-run, siblings fighting for control is common. In such cases, a settlement usually unlocks a lot of hidden value, and is well-received. Says Kamlesh Gandhi, country head - investment banking, Religare: “If there are two or three parties involved, and a demerger is a possibility, it could be beneficial. But if there are more parties, it can be a drag, as it happened with the Modi group, which didn’t take the demerger route.”Big shareholders too can have a disruptive effect on the business. Fortis, which began with legal issues, now has another problem on its hands: Trehan. The Fortis promoters want Trehan to leave Escorts, as it sees him as a competitor (he’s involved with another hospital project, Medicity) and nuisance value (he holds 10 per cent in Escorts); Trehan doesn’t want to go. Policy changes. Businesses that are sensitive to policy changes can go into a funk. As oil marketing PSUs, BPCL and HPCL, have been since mid-2003 — disinvestment is on the backburner and the government is not allowing them to hike fuel prices in sync with the increase in input (crude) prices. The BPCL stock is exactly where it was on 1 December 2003, while HPCL has fallen from Rs 374 to Rs 287. And they are quoting at ridiculous PEs: 6.1 and 3.1, respectively.
When to buyHowever, businesses as big and important as BPCL, HPCL and Fortis can’t keep languishing like this. But in order to surmount these temporary hurdles, they either need a stroke of luck, or some proactive steps that might cause some pain but signal a clean break from the past. There are two attributes on which you should analyse businesses facing strife. Management intent. With PSUs held hostage by reforms, or rather the absence of it, there’s little a management can do. But that’s not the case with managements of private companies, which are more empowered, perhaps even keener, to move on. A good management, showing intent, can make the difference. Says Sachin Neema, head of research, India Infoline: “Buying a company’s stock when it is facing trouble is essentially about taking a call on the management. What you need to look for is intent and foresight.” Resolution surety. There are bad situations a good management can salvage, there are some it can’t or can’t do so as effectively as it would have liked to. Fortis seems keen to buy out Trehan and have him go, which might be the ideal situation for shareholders; or if he stays, Fortis gets a piece of Medicity. At the time of going to press on Friday, word was that status quo had been restored. Given the distrustful relationship between the two, any settlement could be uneasy. Add the legal fight for Escorts, and it seems like a long road ahead for Fortis. At some point, you might want to get on. Now is not the time, though.

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