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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.

  • Shankar Nath says:

    >Hi Deepak,

    Why would the promoters sell shares for his cash requirement? 65 crores is not a big amount. If the company was doing well (i’m assuming that coz firms like Bear Stern had a stake in them) .. he needn’t forego precious equity. He could have taken loan against shares which a number of NBFCs do give to promoters who pledge their company’s shares. This might have cost him about 14% p.a. and would have been at a margin of about 40%.

    Now, if we’re saying that the promoter bought a further 7%, it’s probable that he knew of the impending acquisition attempt. He may not know it’s Solrex but then, he might have had an idea. I just cant believe the promoter would have just sit on his 14% for a few years and woken one fine day when the markets are much higher than levels 2-3 years ago and taken a huge 7% .. thats quite some money and a stale coincidence.

    If the 15% stake is breached, Rao (if he is desperate for holding onto the company) needs a white knight. But lets look at one more angle … what if Rao itself sells off the 21% (14% + 7%) to Solrex at say 350 rupees a share .. wouldnt that make things interesting?

    Emotions and business donot mix well … Rao might want to hold onto his company, but a thick wad of cash might make him think otherwise.

    My 2 cents,
    Shankar

  • Anonymous says:

    >Hmm..I wish that you had come out with this exactly 2 weeks earlier..not exactly at 109 but at least around 150+,,any negative news will lead to a quick down swing to 150 levels (IMHO)

  • Deepak Shenoy says:

    >Shankar: Good points, let me point out a few notes.

    Rao did pledge shares to NBFCs (Religare/Indiabulls), at 50% margin. He lost 65 crores because the share price fell by Rs. 150, which triggered margin calls. He didn’t sell for cash, he sold because there were margin calls he couldn’t meet.

    Orchid was an acquisition target anyhow, as Rao professes he was aware.

    I think there is weight in the theory that Rao and Ranbaxy may be on the same side of the coin. Let’s wait and see.

    Anon: I’d twittered about this earlier, but didn’t have too much time for a blog. I think you’re anchoring yourself to earlier prices – that may have been a one time aberration. I don’t deny this stock has risk, but I would avoid looking at immediately past prices or much earlier prices to determine value.

  • Akshay J says:

    >I have got a big bag of orchids myself, when it hit the lows :). I agree with Deepak on Rao – he may be in trouble, but he is not dishonest. Which is one reason, I put in lot of money at the lows. Whatever happens, there was nothing wrong with the company and it was probably a blip. On the upside from this point, it is generally difficult to say, after such a huge runup. The uncertainity now needs to be priced in. But if the fight for control starts, you can assume that the price will rocket up.

    Deepak, I checked out on Mudra on taxes and it looks good to me. I picked up a big lot at 37. The management is unproven, but worth the risk. I will wait to see how much dividend they declare.

    Another stock, I have bought quite a lot in to is Lakshmi machines. The track record is excellent and people are reading too much on the Ritter stuff. It is priced very attractive. And the growth. OMG.

    Best luck with investing.

  • Akshay J says:

    >Do you have view on Lakshmi machines?