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Piramal Healthcare Buys Promoter Cos, Gets into Financials, Merges Part of PIRLIFE

PIRHEALTH logo Piramal Healthcare has been in the news recently for having sold their formulations division to Abbott, for about 17,000 crores.

With the cash, they bought back about 4 crore shares out of the 20 odd crore shares they had outstanding (20% buyback) at Rs. 600 per share, so they spent about 2,400 crores there. After that, and taxes, they’re left with about Rs. 11,000 crores in cash. This adds up to cash per share (of the remaining 17 crore shares) of Rs. 650 or so.

The current share price is Rs. 421. Looks like a great opportunity, no? Wait.

Update 11 Aug 2011: PIRHEALTH is buying 5.5% of Vodafone. And they’ll spend 6500 cr. on contract manufacturing, OTC and Critical Care. Added to links.

Update 10 May 2011: Added a links section in the bottom. Some minor edits and fixes in.

Today they announced in a board meeting that:

  • Piramal Healthcare (PIRHEALTH) will buy two promoter owned companies in the real estate investment management space for 225 crores.
  • They would also buy a division of Piramal Life (another company promoted by the Piramals) at an equity swap rate of 1 PIRHEALTH share for every four PIRLIFE shares.
  • PIRHEALTH will set up a company in the financial services space with a seed fund of 1000 crores.
  • They’ll pay a dividend of Rs. 12 per share.

After screaming “FRAUD!” (my first reaction), I think we should analyze the action in some detail. It’s not as bad as it sounds. Especially since the stock has fallen 8% – or 40 rupees – today. That’s a market cap reduction of Rs. 650 crores. Does this make sense.

Promoter Company Buys

PIRHEALTH is buying out two companies – Indiareit Fund Advisors Pvt. Ltd. and Indiareit Investment Management. Together, they manage about 3,800 crores of real estate assets, and they’re getting 6% of assets as the price.  Assuming they charge 2% of assets as mgmt fees, it’s 3x revenue, not counting any profit share.

Promoter purchases are usually linked to promoters siphoning off cash from the company. But the 225 crores is like 2% of the overall cash available and less than Rs. 15 a share. That’s piddly. Tiny. Very small. Yes if they did 20 or 30 such buys one might be worried, but one shouldn’t hurt so much.

Merger with PIRLIFE’s division

PIRHEALTH offers 1 share for every four in PIRLIFE, which is largely a research company, owning about 77 patents. What’s left in PIRLIFE is a herbal division, which is very tiny (4 crores revenue estimated) and it’s been a huge loss maker. Given the Piramal’s background, I would assume they are capable of taking those patents and making money out of them.

The cost works out to be 250 crores or so. How? PIRLIFE has 2.5 crores shares. This will result in an increase of 60 lakh shares in PIRHEALTH, or a dilution of 4%. Assuming they paid 60 lakh shares at current prices the cost is about 250 crores but of course no cash will change hands. Considering the Piramals own about 45% of PIRLIFE, their shareholding will marginally increase in PIRHEALTH (but they’re at 53% already so it’s a tiny increase).

Even PIRHEALTH owns part of PIRLIFE (about 15%), and I’m not sure how that works right now – will the equity issue be treasury stake? (When Reliance merged with RPL, Reliance ended up owning shares of itself as treasury stake, which it sold later) Or will it be extinguished? It’s not a huge amount, really, just about 40-50 cr.

Is this good? PIRLIFE is up 7% on the ratio, so it’s good for them. The business left over will be interesting and probably merged with PIRHEALTH at a later date if it gets useful. But the chemical entity is a good bet for PIRHEALTH going forward, given the Piramal’s track record in making money out of research.

Update 10 May 2011: Seems about 500 cr. of debt from PIRLIFE’s division is coming onto PIRHEALTH’s books. That makes it a slightly pricey acquisition (500 cr. of debt plus 250 cr. equity). I can’t value medical patents so I’ll have to wait and see if what they’ve acquired is decent.

Foray into Fin Services

They’re putting in 1000 crores into an NBFC for Infra and Real estate lending. I don’t like real estate. But Infra is a nice cozy field, honestly, with guarantees from everyone around. There are good return on leverage here, if the promoters aren’t shady (even in many promoter-shady companies the returns have been good).

I think the space has huge potential, so I like it, but there is, according to me, a large financial crisis looming. Depending on the amount of time this deal will take and money deployed, the idea may be horrible (too early) or great (fantastic bargains). We’ll have to take this one step at a time, but I absolutely would love it if they became a bank. To be a bank without any NPAs (because you JUST became a bank!) in a high interest, high default time is delicious.

I’d written something earlier about something I knew – I must withdraw that comment because I can’t provide more details, but suffice it to say I’m a little skeptical here of promoter motives. And at 10% of remaining cash this is a significant move. I must reserve comment on it, until there is more clarity.

Dividend

With Rs. 12 per share as a dividend, they’ll give up about 340 crores, and 50 crores in dividend taxes.

Results

FY 2011 results were announced, and the EPS is Rs. 574. Yeah, a lot of that was the sale. But the results aren’t comparable because prior years included what was sold. Operationally, I can’t find easy ways to compare results but here’s a thought – remove investment income from both years, and the profits from “discontinued” operations of the formulations business sold (declared in the press release), and you can see something.

image

So there has been a loss, and we need to see that turned around.

Verdict

If you consider the cost of this announcement, it was about Rs. 225 cr. in cash, and an equity cost of about 250 cr. The market cap has fallen by 650 cr., some of which is a reaction to the results too.

Even if you write off the entire 1000 crores of the financial foray, and the 225 crores paid out, and the equity dilution, the company will be left with around Rs. 9500 cr. in cash, for less than 18 crore shares. That’s still about Rs. 530-540 in cash per share, which is 25% higher than the current cash (and I’m assuming all businesses go to zero, or at least pay off current debt).

I wouldn’t write off the Piramals that much. Perhaps there is some siphoning off (tiny bits) to the promoters, but the money isn’t a big part of the valuation (2% or lesser). The fin services foray is a little scary or a little good, depending entirely on how they do things going forward. The cash is still useful. The track-record is great.

For an ultra long term story, this could be worth picking up, on the same lines as SmartLink (which is even more attractive) I’ve decided to pick up a few shares today and will buy more as the shares go up (I hate buying more on the way down). The idea isn’t to buy in bulk. If this share is really worth it, it’ll be a 10 bagger. That means if I invest Rs. 10,000 it will become a lakh. That doesn’t mean I invest a lakh to hope it’ll go to 10 lakhs; there is a significant risk of loss of capital (or at least opportunity cost as against other deployments). So I put in lesser amounts of money – if it goes up that means the story is correct, and I buy more. Otherwise I don’t lose much because of the lesser amount bought in the first place.

Links

For the record, SP Tulsian doesn’t like it. That’s how markets should operate, different views etc.

Sanjay Bakshi has a glowing reco of the chairmal, Ajay Piramal. I think this is where I got the idea from, just that I didn’t remember. In fact SmartLink is mentioned there in the comments, and I definitely heard about it from this link. (See Smartlink: Cash>2x MarketCap)

PPFAS likes it from all sorts of breaking down and EV/Sales and other ratios. This is overkill. You don’t need to go by ratios when a company is valued at less than cash. You hope that promoter-bhai will do solid work and make use of that money and generate earnings.

They’re buying 5.5% of Vodafone, at what seems to be a good valuation. They’ll pay about 3,000 cr. for the stake. Supposedly Vodafone is planning an IPO in India too.

Also, ET says PIRHEALTH will invest 6500 cr. in the contract manufacturing, OTC and Critical Care areas.

Disclosure: Long the Stock

  • Praveen says:

    >Sanjay bakshi wrote an article in his blog one month back with a lot of positive opinion on Ajay Primal's ability to deploy the cash in a purposeful way.

    http://fundooprofessor.wordpress.com/2011/03/26/the-grand-strategy-of-ajay-piramal/

  • Jagadees says:

    >"I know a few financial deals with the Piramals from the past where things have been, er, a little murky, so I'm a little skeptical here"
    can u elaborate on this point/give some links? because as far as i searched i could not anything like tat….

    Regards
    Jagadees

  • Anonymous says:

    >The murkiness of the above deal beats the eye. "PIRHEALTH is buying out two companies – Indiareit Fund Advisors Pvt. Ltd. and Indiareit Investment Management. Together, they manage about 3,800 crores of real estate assets, and they're getting 6% of assets as the price."
    if Piramals are doing own development business and also fund management business it should be a cause of concern for the retail investors in the funds because Piramal as controlling shareholder of the funds can influence investment decisions and can divert attractive deals to own business. World-over investors dislike such conflicts and like to invest with independent fund managers.
    No wonder the stock tanked, the market knows when there's a promoter making a quick buck, and when they are actually creating value.

  • Deepak Shenoy says:

    >Jagadees: Tough – I've taken that off the blog and it's something someone told me in confidence so I'm not going to dwell on it.

    Anon: Agreed completely that the realty business is murky and it could be siphoning out of the money. Yet, the total is just 2% of the cash, so it might not be that bad.

  • Mohit Satyanand says:

    >Deepak,

    If I recall correctly, the cash-flow from the Abbott sale has been discounted to present value at 11% p.a. Now, if I value cash at a higher discount rate, this makes the whole thing less valuable.

    Difficult to make more than 11% for most investors, but that doesn't prevent them from having faulty perception, and discounting cash at, say 20%. I work at 15-17%…

  • Deepak Shenoy says:

    >Mohit: Did a quick calculation. After about 3700cr. in tax, 2400 cr. in the buyback, 250 cr. on this purchase, they still have 3350 cr. in cash. Add the subsequent paymetns at 17% (this year's payment at par because it'll be here in the next few months). We end up with about 9000 cr. That's still Rs. 514 per share.

    Another way: Assume that you get 17% on your cash. Then the Rs. 420 you spend today on this share should be worth at least Rs. 672 in three years.

    Then, assume the company can get a post-tax return of 8% on the cash it deploys (this is available today on three year CDs or FMPs) The money adds up to about 12150 cr. after three years, which is Rs. 695 per share.

    That's on a Net Profit return of 8% which I think may be achievable on the cash alone. If he uses the cash to set up businesses that return higher in the long run (3 years is not long enough, I agree) then the return is greater.

    Eventually the deal's about whether the promoter can use the cash to get higher returns, and I'm assuming this guy can do a return on capital of much higher than that. But track records are past. He could become this shady person and decide to move the cash out instead. So there is uncertainty, no doubt.

  • Vishal Narang says:

    Hi Deepak,
    I have been following the stock since your initial blog/cautious recommendation. Do you think it is a good pick now that it is near its 52-week low?
    Thanks