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eClerx Services Buy Back: 25% Higher But Not Worth The Arbitrage


eClerx has recently announced a buyback about 30% above the current price. Is this useful to investigate?
Founded in 2000 by Anjan Malik and PD Mundhra who graduated from the University of Pennsylvania, Wharton School of Business, eClerx Services is a leading knowledge process outsourcing (“KPO”) company providing middle/back office operations support to over 30 Fortune 500 companies.
With a lot of Buy Back offers flooding the markets in Q1, eClerx Services has decided to take a plunge by buying back 1,170,000 shares or 2.86% of the outstanding share capital (currently at 40,882,350 shares).

A Dividend Replacement

Effectively, this is just a dividend. The last budget introduced a 10% tax on dividends to people getting more than Rs. 10 lakh as a dividend, so companies have taken to using the buyback route instead, so the tiny 2%/3% buybacks happen. Promoters get the money as they tender as well, and they pay no tax as it involves STT (tendered through the exchange) and the stocks are held for the long term.

Worth it?

Now 1,170,000 is actually not this much for an individual investor. The number of shares (max) that would be bought back from “small” shareholders is 175,500 shares. This is a 15% reservation for shareholders who own less than Rs. 200,000 worth (market value) of shares.
See our last buyback post: Bharti Infratel – where the small shareholder reservation gave us a fabulous return.
So based on the amount of buy back and yesterday’s closing price, a small shareholder can own  around 125 shares (Rs. 200,000 / Rs. 1,600 share price = 125 shares).

  • Record Date is 28-Oct-16 (Friday) – remember that this does not mean you can buy the shares on 28-Oct. You need to initiate the buy no later than 26-Oct (taking into account T+2 delivery period)
  • Final Buyback Price of Rs. 2,000/- (Buyback Price).
  • Final amount for Buyback to be Rs. 2,340 million (Buyback Size)

Here is what an investor should action based on his risk appetite

Should you buy and tender? There’s Rs. 400 to be made, of course. That’s 25%! So you buy at Rs. 1600 and tender, and they’ll buy some back at Rs. 2000. How much will they buy back? We don’t know.
The small shareholder – owning less than 125 shares – will probably get a reservation of 175,000 shares. We don’t really know how many such shareholders these are. In the last annual report, we know that about 16,000 shareholders own less than 5,000 shares. But that’s a VERY large number – we want to know how much are less than 125 shares. Typical distributions are that very few people own large quantities, we can assume that 8,000 people will own less than 125 shares.
If there needs to be full or 100% acceptance, only 1,300 small shareholders must tender shares. (175,000 divided by 125 shares per shareholder). This means only about 20% of people who own shares should tender. That is unlikely, in our opinon, though many people are just lazy.
If less than 100% is accepted, then you have the risk that the remaining shares will drop in price. If you have 125 shares (bought for Rs. 200,000), and only 25 are accepted at 2000 then you get 25 x 2000 = Rs. 50,000 as buyback revenue. The remaining 100 shares are still with you. Then those shares should still be worth the remaining Rs. 150,000 for you to “break even”, or Rs. 1500 per share. That’s your break-even price! You can’t see the price go below 1500 (or you will lose money). Here’s the price drops for various levels of acceptance.
Here are the scenarios if an Individual Investor decides to buy the shares today up to a maximum of 125 shares or equivalent value of Rs. 2 lakhs.

Scenario 1:

If only 10% of the tendered shares are accepted in the buy back offer, an individual investor will only be able to earn profits only if the price of the remaining shares do not fall more than 3% i.e. Rs. 1,552/- per share.

Scenario 2:

If 20% of the tendered shares are accepted in the buy back offer, an individual investor will only be able to earn profits only if the price of the remaining shares do not fall more than 7% i.e. Rs. 1,488/- per share.
And so on.

Our View: Risky Play, But Long Term Holders Should Tender

We think acceptance ratios are likely to be around 25% to 30%. This will protect you only if prices don’t drop 11%. That’s not a whole lot, considering that the process will take about 50 days to close.
In this case that would almost stand at 5-10 December, 2016 which falls right before the Federal Open Market Committee meeting taking place on the 13th and 14th December. (We aren’t even discounting the fall in market over the Fed meeting early next month, Japan Monetary Policy meeting and the US Presidential Elections).
This offers a very risky proposition as an arbitrage. Not worth it, in our opinion, for an arbitrage play.
However if you like eClerx and hold it for the long term, you must tender shares. Even if the price falls, you don’t care as you intend to hold it longer. So while the arb won’t apply, why not take this opportunity to make some dividend instead?

End-Note: The Arb Failed

The buyback saw a huge response even from minority shareholders. The result: Only 32% acceptance even for small shareholders. The stock fell 15% to 1350, so the gains made on 1/3rd of a position would be negated by the losses made by the remaining 2/3rd, and it would be a net loss. As we said – too risky.


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