Special Situation in Solvay Pharma

This is my first post on a special situation. Abbott of US announced to acquire pharmaceutical business of solvay group of Belgium for EUR 4.5 billion on 28 September 2009. Both Abbott and Solvay has listed subsidiaries in India. Since Solvay has a listed subsidiary in India, SEBI's takeover code comes into effect and the acquirer, which is Abbott in this case, needs to make an open offer. The open offer has been announced and the offer price is INR 3054.73. The last traded price of Solvay shares on BSE is INR 2879.85 on 17 Feb 2010. So how can a value investor take advantage of this opportunity?



Firstly, open offer is announced only for acquiring 20% shares or 1009942 shares, while the public holds around 31.15% shares or 1573072 shares of the company. Thus it is a possibility that not all the shares can be tendered. This makes calculation a bit complex. Consider the worst case scenario when the whole public tenders shares. Then acceptance ratio would be 64.2%. The rest 35.8% shares would either have to be held or sold in the open market after the offer is over which creates a risk since the intrinsic value of the company is not more than INR 1600 per share.



Let's analyze the profit/loss possibility in both best and worst scenarios. In the best scenario, if less than 20% public shares are tendered, all the shares would be accepted. If say an investor acquires the shares from BSE at an average price of INR 2850 including brokerage during March 1 - March 15 and gets INR 3054.73 on all his shares by say May 31, the total return from his investment would be 7.18% in around 3 months, i.e. 28.73% annually. This is great.

In the worst scenario, if all the public shares are tendered, 64.2% of an investors shares are accepted and the rest of the shares needed to be sold in the open market for INR 2000. Thus an investor can get 0.642*3054.73 + 0.358*2000 = 2677.13 for his average price of INR 2850. This is a loss of 6.06% in around 3 months or 24.26% annually.

So what are the odds? If we give a probability of 60% to the best case and 40% to the worst, the annual return comes out to be 0.2873*.6+(-0.2426)*.4=7.5%, which does not justify taking risk. There are two main variables here , the acquisition price of the shares by an investor and the open market price of shares after the offer which decides the returns. Based on these I am showing the returns below:

Annual Returns(in %)
Acquisition Price	Open Market Price after offer
	1600	2000	2200	2500	2800
2850	-0.5%	7.54%	11.56%	17.58%	23.61%
2800	6.63%	14.81%	18.9%	25.04%	31.18%
2750	14.02%	22.36%	26.52%	32.77%	39.02%
2700	21.69%	30.18%	34.42%	40.78%	47.15%
2650	29.65%	38.29%	42.62%	49.1%	55.59%

The table shows that the risk adjusted returns become better only if the acquisition price is below INR 2750. Even if the price falls to INR 1600, an investor would get annualized 14.02% returns, which is not bad. We have to remember that as the acquisition price, which is nothing but open market price right now, goes down, future open market price will also be lower. So the real returns will be somewhere between 14.02% and 42.62%. Of course, nobody has any idea about future prices of the share.

Remember that this table shows probability based returns not actual returns. If an investor buys shares at INR 2750, only 64.2% of the shares are accepted and the post offer share price falls to INR 1600, the investor will get only INR 2533.93 back, yielding a loss of 7.86% of his capital. If all the shares are accepted, he will get INR 3054.73 back, yielding a gain of 11.08% of his capital. The weighted average 11.08*0.6+(-7.86)*.4=3.504 which is the return in 3 months and annualized will be 14.2%. The favourable 60% probability of best case can also be wrong.

There also is a caveat that the open offer price gets revised upwards whose last date is April 15, 2010. Since this is my first post on special situation, comments are welcome if you feel I am missing anything. Happy value investing!!!