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The Orchid Saga: Still Worth A Dekho

Orchid Chemicals has had a very exciting 2008.

First in January the big crash took Orchid Chem with it, from the highs of 320+ down to the 240 levels. After hanging around there for a couple months, with some drama in the middle – a 20% drop in Feb 2009 included, the stock tanked 40% in a single day on March 17th, 2008.

Turned out the Bear Stearns fiasco had taken Orchid Chem with it – Bear owned a significant chunk of shares which were offloaded at “whatever they get us” prices. Which also resulted in the promoters selling off 7% of their stakes, because of margin calls.

Promoters and margin calls? Something shady, one thinks? It’s not quite that, as it seems the promoters held very little of Orchid anyhow. K.Raghavendra Rao, the big boy of the episode, and the promoter group held only 14% – to throw out any unwanted hostile takeovers, Rao bought 7 more percent and pledged the shares with Religare and Indiabulls. The pledged shares are checked for price everyday – and if they fall below a certain value the promoters needed to come up with more “margin” money to cover the loss. The Bear Stearns sale took the price below the threshold and Rao couldn’t come up with the margins – so the brokerages sold the shares. Rao now owes other institutions 65 crores, and is repenting for his act.

So the share fell further, down to 106 levels a few days later. This is when it looked extremely attractive to me – heck, trailing 4 quarter EPS is 29 bucks! At a P/E of 4 and a growth rate of well above 30% a year, this looked good. But you never catch a falling knife, so strength would decide the fate.

Since then the share has had a mighty recovery. In just a few days the stock closed in on 160, and then zoomed up to 240 levels. The funda: Solrex Pharma, supposedly a Ranbaxy promoter company, picked up a huge stake in the company. The stock went up to 245, and then retreated a little when Ranbaxy flatly denied a hostile takeover attempt.

But in two days, in which a lot of speculators would have gone bankrupt from the abrupt moves, the stock was back at 245 or so – with Solrex acquiring nearly 15% of Orchid. Any more would trigger an open offer for Orchid, for another 20%.

Now how does this pan out?

  • Rao doesn’t want to be acquired. That’s what he says, but he’s 65 crores in the negative and just got margin called for a lot of money.
  • Rao has warrants – 50 lakh of them. The company has around 6.5 lakh shares out there, and these 50 lakh shares will give him another 7% or so. But for them, he has to fork out another 90 crores, which, if he’s just paid out on a margin call, he is unlikely to have on himself.
  • He could of course find someone nice to give him the money, but in this business, no one is nice without strings attached. He’ll use the Telugu card (he seems to have, by getting Apollo’s Reddy to help him keep control) – and that is not surprising, because we have even seen Tata help Wadia on a Parsi card. Still, there will be strings.
  • The warrants are valid only till August 2008 or so, but I’m sure this stuff will unravel by then.
  • There is also another huge dilution – $200 million of FCCBs convertible at Rs. 348 per share.
  • Solrex is a promoter company, not Ranbaxy itself. So no assumptions can be made of a Ranbaxy acquisition.
  • The stock is still cheap. Considering the massive dilution fully, including the warrants, we come to an EPS of 22, for which the last price of Rs. 245 is only a P/E of 11. That is much lower than other Pharma companies.
  • There is the issue of debt – nearly 700 cr. apart from the FCCBs. Still, that’s not a big deal, as after FCCB conversion the debt-equity ratio will be around 0.5 or so. Till then there will be lots of screaming that no, there is big debt and so on.
  • FI’s have pledged their support to Rao, and Macquarie Bank even bought more shares recently. Still, I think they would be happy with a Ranbaxy acquisition, as the combined strength will be very very attractive.
  • If there is an end-game, it is likely to take the stock above the 350 levels. That’s a 40% upside from here.

Problems: What if there is derivatives exposure? I don’t know. They will have some forex losses this quarter from the FCCB, as the dollar has appreciated against the rupee this quarter. I just hope they haven’t speculated on the forex, and they have denied it. Rao may be troubled, but I don’t believe he’s dishonest.

Okay big time disclosure: I am long on this stock. I still hold as there is a lot of upside potentially.

What’s my target? 350 is reasonable, and this is a momentum story so the time frame is three months or less. There is a good margin of safety.

On the lighter side, I hope this doesn’t turn out like this kind of Orchid.

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