Tuesday, September 7, 2010

How long is Long-Term?

I have already done a lot of bashing of mutual funds here, here, here and here. This post is one more addition to the already long list. I was studying a company called Vimta Labs lately. The company is a 20 year old pharmaceutical company in India. I was looking at the company's latest shareholding pattern and found that some of the mutual funds are holding large amount of shares in this company. The shares were getting traded on BSE at INR 32 and change with the total market cap of the company around INR 75 Crore. Since most of the mutual fund are holding shares of around 1-3%, I thought this to be their meager investment compared to their total Assets Under Management (AUM). But I was wrong as usual. Why? The mutual funds had invested in the company when the market cap of the company was somewhere around INR 275 Crore. Got a shock? See the history of the company's share price movement here. The company was trading at INR 255 in March 2006, just after a 5:1 split and a preferential allotment. The company issued some 4064690 shares of INR 190 to following entities as preferential allotment in March 2006:
1. India Fund, Blackstone group, 1165395
2. Voyager Fund, Mauritius, 1102925
3. Minivet, Mauritius, 466155
4. Franklin India smaller companies fund, 886810
5. Franklin India Prima Fund, 443405



This is not all. shareholding pattern of September 2007 shows that Reliance Pharma fund jumped in to the story. What was the average price during all these times? If you look at the price chart of company's share, it was trading at more than INR 115 during July-September 2007 quarter. Even if you take the least price of 115, the investors have lost more than 70% of their capital and that too after three years which should be considered long enough to make some comparison with benchmark indices. Reliance Pharma fund bought 297,713 shares at say INR 115, making an investment of around INR 3.42 Crore. This investment is worth less than INR 1 Crore today. Of course, the company is giving INR 0.8 as dividend every year to satisfy mutual fund managers.

HDFC Long Term equity fund had bought 700000 shares in June 2006 quarter, but it was bought from fund house's other scheme HDFC Capital builder fund which entered the share in March 2005 quarter when again the lowest price was INR 105. HDFC Capital bought 140000 shares making an investment of at leat INR 1.47 Crore. The stock got split from 10 FV to 2 FV and these got converted to 700000 shares which HDFC Long Term Equity bought. Even the MF buys/sells at moneycontrol for June 2006 month shows HDFC Capital Builder sold 700000 shares of Vimta Labs. If the deal happened at arm's length, then the lowest price during that quarter was around INR 140. Thus HDFC Long Term Equity invested INR 9.8 Crore in June 2006. Today the same is worth INR 2.31 Crore, i.e. less then 75% of the original capital after more than four years.

Surprising thing about the company is that, the company got more than INR 78 Crore in the above preferential allotment of shares and today, the whole company is valued at just INR 75 Crore. What a destruction of wealth? So the company which was already a going concern at the time of preferential allotment is now given away for nothing, rather, the seller is giving money to the buyer to buy that part. The new capacities that has come up from the money collected from preferential allotment has not added anything significant to the company's topline or bottomline. The company even had to clarify in February 2007 that the funds are not being deviated from the actual investment. The company's depreciation has increased from around INR 5 Crore in 2005-06 to around INR 14 Crore in 2010 and is still on a rising trend. This has made the company loss-making but actually the company is generating around INR 20 Crore worth of operating cash-flow.

If Ben Graham was given this opportunity, he would grab it for sure. The company has debt of around INR 27.4 Crore with Net Current Assets at INR 28.65 Crore. The company is virtually debt free and most of the financing was done through cheap equity since the dilution was very less (around 25%) due to very high price of shares issued in 2006.

Now let's evaluate the investment of this mutual fund from a value-investor's perspective. The company's sales over the five years between 2002-2006 averaged around INR 35 Crore. Paying 7-8 times sales is nothing but disaster which the mutual funds did. The company's average profit for the same period was around INR 8 Crore. At INR 275 Crore, the price to average profit of five years comes to around 35, very high for a small company like Vimta at that time. Book value of the company was INR 53, so at INR 115-140, it was 2.2 to 2.65 times book. Dividend given was 80 paise, yielding less than 0.5%. Seems like the mutual funds were betting more on capital gains then any income from dividend.

You might be wondering where the title of this post came from? Surprising thing is that HDFC Long Term Equity is still holding shares of this company in a hope that if it comes to its buying price, it would be able to avoid capital loss. So the question is for the fund manager of this mutual fund, how long is long-term Mr Chirag Setalvad?

Investment losses are not distributed fairly evenly in point of time, but tend to be concentrated at intervals. - Benjamin Graham
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3 comments:

sajanvm said...

Hi

Interesting post. Depreciation going up must mean they are investing in facilities. So, I guess this boils down to execution risk - can they get sales going again ? Cash Flow from ops is impressive.
On an aside, I am also a long term holder of Gandhi Tubes.
Rgds
Sajan

karna said...

Hi

do you suggest to buy?

Thanks,
karna

Chinmay said...

Hi Karna,

You must have seen stock going above 48 and then coming back down to 30. In this kind of companies, investment can be done but you might have to diversify in more than 30 companies to keep your risk down.

Chinmay

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