Vedanta – Valuations and more…

Unless you have been sleeping under a rock, you know the story of Vendanta that has been splashed all over in recent days. Promoter wishes to buy the company back from its public shareholders. He proposes a price he thinks is a fair price to start discussions with, the biggest shareholder baulks and says the price he is willing to part with is multiple times that, others bid at various prices including a few at 1000 times the offer price. Offer fails – end of story.

The biggest non promoter holder of the shares who had once stymied a similar offer from the promoters came out publicly with his Valuation that was 3.7 times the floor price offered by the Promoter and 2.5 times the current market price. By making this number public, he essentially made it clear what he thought about the company and where he shall part company at.

On Twitter, a controversy has erupted over Mutual Funds that tendered at lower prices than what the biggest Institution had placed. How dare they sell the jewels at a price lower than what the other guy felt it was worth at. Mutual Funds chor hai resonated.

Warren Buffett says that he Invests for the Long Term. But that doesn’t mean he won’t sell when he finds an opportunity good enough to warrant such a sell. Our guy on the other hand is the Baap of Warren Buffett when it comes to Long Term holding. He is willing to bear any amount of pain as he holds stocks for periods longer than anyone else – sometimes even outlasting the promoters.

The biggest advantage of his pool of money that he uses to buy these stocks and hold them forever is that he really doesn’t have to sell just because a client comes calling and asks for his money back. While the source of the monies are its clients, because it’s an Insurance company and not a Mutual Fund, the whole business model of investing is different. The profits and the losses of the investments don’t flow completely to the unit holders. 

Mutual Funds on the other hand buy stocks with money from their clients and all the profits and the losses are directly attributed to the hands of the investor. What this means is that the thought process of a fund manager who manages a fund dependent on the public continuing to remain invested differs from someone whose capital is more or less permanent. 

Warren Buffett can afford to do what he does because he manages no money for the public in the way Mutual Funds do. This means that he can afford to play the really long game since the only option for his investors who hold shares of his company is to either continue to be an investor or sell the stock to another public shareholder. The cash flows of Buffett is immune to this.

Mutual Funds on the other hand have to provide an exit for their unit holders and if a large portion of them wish to exit, the fund manager has no other option but to sell even good companies at whatever price the market thinks it’s worth even if the fund manager himself thinks the companies are worth a lot more.

Markets are efficient in the long run but inefficient in the short term. This is why active investment strategies work. We buy stocks when we feel they are available at a price which is lower than what we believe the company is worth and sell when we feel they are well above what we think it worth. Whether we make a profit or not though is dependent not on our calculation but if the market thinks similarly too. 

The other day, I calculated the weighted average price at which Vedanta exchanged hands since 2005. The number came to Rs.190 even though the range the stock has traversed in the said period is between a high of 495 and a low of 28. 

Let’s assume our Mutual Funds guys have acquired the shares at the same price. The current market price is 120 which means their investors are underwater and if an investor exits the fund – he is indirectly booking a loss in Vedanta. Assume all the unit holders of a fund want to exit – the Mutual Fund manager has no option other than selling the stock he owns at whatever price the market asks for it regardless of what he believes the company is really worth.

So, the fund has  a buy price of 190, current market price is 120 and the promoters wish to buy back at 90 and a guy with permanent capital who plays a way different game than yours says its worth 320. What price should the fund manager tender the shares?

From the fund manager’s perspective, any price higher than 120 which is where he can sell his current stock at is a “Profit”. The reason I say Profit is because for the fund manager, a 160 Rupee buyback (if it goes through) is worth more than a 320 he thinks the company is worth at but one that may never see the light of the day.

A friend of mine who tried to take advantage of the arbitrage he felt was on offer had an interesting view – the promoter was no different from a value investor –  he was just trying to exercise his ability to buy the stock cheap than what it was worth and he better than anyone knows what is worth since he has inside knowledge as also control of the company’s future path.

Vedanta may be worth even more than 320. A blog post sometime back speculated that it’s worth north of 500. The issue though is not what we think a company is worth but what the market thinks it’s worth. Remember, when the time comes to Sell, it doesn’t matter what you think it should be valued at, you shall sell at what the buyer thinks it worth.