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Bajaj Auto's idea of spinning off its cash surpluses into a separate company will benfit shareholders only if the firm lists at book value. The possibility of that is doubtful. |
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Last week, Bajaj Auto chairman Rahul Bajaj said that the company is considering a proposal to offload a part of its cash surplus into a separate investment firm. |
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The company has a cash surplus of about Rs 2,700 crore - approximately Rs 2,500 crore after adjusting for investments in subsidiaries - and a third of this amount is to be transferred to the investment firm which will hav e a shareholding pattern identical to that of Bajaj Auto. |
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The move is essentially to improve the return on capital of Bajaj Auto and, hence, the share price valuations, according the company's chairman. |
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The Bajaj Auto stock closed at Rs 730 on Friday, up from Rs 728.65 on Wednesday, the day before the news broke out, suggesting that the market is not overwhelmed by the company's proposal. |
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The move is definitely positive as it attempts to eliminate the company's investments in debt which yield less than the invested capital. |
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After the spin-off, the company's return on capital employed (ROCE) will improve a bit. Besides, the company and analysts tracking it expect it to post robust earnings this fiscal, which should compensate for the fall in the earnings on account of lower income from investments (other income). |
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Would a shareholder actually benefit from this move financially? Possible. But it will happen only if the demerged investment company trades at a market capitalisation equal to the book value of the company when its shares gets listed. |
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In other words, if a cash surplus of Rs 1,000 crore is transferred to the company, which will be equal to the total book value of the company, it will have to trade at a price which translates into a market-cap of Rs 1,000 crore. |
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Or, at least about Rs 900 crore, as the investor would have ended up with only that much if the same amount had been paid by way of dividends after paying dividend tax. |
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However, most banks and finance companies with established credentials trade at prices less than their book values. |
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The chances of Bajaj Auto's investment company trading at book value look remote if it is positioned as a regular finance company. |
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However, if it positions itself as a mere investment company without any underlying business apart from managing liquid assets like gilts, bonds and shares; it could get a valuation closer to book value. |
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Here again, there are no companies which have such a mandate and hence it is difficult to take a call on how such a company will be valued. |
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If that's not the case, the market-cap of the investment company would at best Rs 490 crore, assuming that it will be able to earn about Rs 70 crore on a capital of Rs 1,000 crore and the market will attribute an earnings multiple of seven (which is what banks get currently) to the company. |
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Now the only way shareholders will make money is if the stock price of Bajaj Auto post-split rises to make good the loss of market-cap on the investment company after listing. |
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At current prices, Bajaj Auto's market-cap stands at around Rs 7,386 crore. A Rs 500-crore addition to market-cap would mean that the stock price will have to jump by Rs 50 (the company's equity capital stands at Rs 101 crore). |
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Last fiscal, the company's total earnings per share were Rs 52.84 and out of this Rs 29.20 came from other income, or income on investments. |
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Based on trailing 12-month EPS of Rs 57, the stock is currently trading at a price-earning ratio of 13. So assuming that after the spin-off, Rs 10 will be shaved off from Bajaj Auto's EPS, the stock will require a multiple of 15 to sustain current price levels. |
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On top of this, if it has to gain Rs 500 crore in market-cap, the price-earnings multiple would have to be 17. |
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Analysts are unsure whether the market will be willing to re-rate the company so much unless its performance in the forthcoming quarters is exceptionally good. |
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Having said that, most market players still feel that the company would have done better giving cash back to shareholders by way of dividends rather than taking this roundabout route. |
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