Spinoffs represent strategic moves by companies to restructure their operations, often with the aim of unlocking shareholder value. These actions involve separating a company into distinct entities, each with its own focus and potential for growth.
One recent example of this is the demerger of Jio Financial Services from Reliance Industries Limited (RIL). Following this demerger, shareholders of Reliance Industries witnessed a surge in the cumulative stock price of (Reliance Industries Limited and Jio Financial Services Limited), outperforming the headline index by a significant margin.
An investor who had invested in Reliance Limited just post the Jio Financial Services demerger announcement would have made an absolute return of around ~28.5%, outperforming the headline index by approximately thirteen percentage points in the same period. Similarly, despite initial skepticism surrounding Vedanta Limited due to solvency and debt repayment concerns around the parent entity Vedanta UK, a deeper analysis of management intent revealed the potential for value creation through demerger. Investors who saw through the noise and recognized the opportunity witnessed superior value creation as the cumulative estimated market value of all demerged entities was greater than the market capitalization of the conglomerate which led to superior price appreciation in a very short time frame.
Similarly, holding companies, despite owning valuable assets across various sectors, often trade below their net asset value (NAV). This discount, primarily due to the complexity involved in valuing diverse holdings, presents an enticing opportunity for investors. By investing in holding companies, one can gain exposure to high-quality businesses.
Typically, holding companies tend to not liquidate their assets, causing their valuations to reflect a persistently discounted rate relative to their underlying value of the businesses the own. In scenarios where the discount broadens significantly, these entities provide special opportunities with a strong investment potential. In India listed companies like Godrej Industries and Bajaj Holdings illustrate how investors can benefit from holding companies by allocating capital to these companies at steep discount to the net asset value and benefit on the narrowing down of the discount. Another interesting area in the special situations investing is the Insider Mirroring strategy which is characterized by focusing on significant purchases of a company’s stock by its promoters or top executives serving as a valuable indicator of confidence in the company’s future prospects. Tata Motors Limited and Poonawalla Fincorp provide compelling examples where significant promoter buying activity preceded strong price appreciation in the company’s stock. An investor who had observed promoter buying activity in Tata Motors Limited during the June 2019-July 2020 period would have witnessed a strong price appreciation in the next three years which was an outcome of turnaround of JLR business and significant market share gains in the EV space. Similarly, the acquisition of Poonawalla Fincorp was followed by promoter buying in multiple tranches. The stock price saw significant appreciation during the same period and was paralleled with superior turnaround and growth in the financials and operations of the company.
These instances indicate that promoter buying is one of the unconventional or soft market signals indicating confidence of promoters in the business with empirical evidence of generating superior returns for investors.
Thus, in today’s evolving financial markets where market dynamics are ever-changing and information overload is the norm, retail investors often find themselves overwhelmed by the sheer volume of data and news. Amidst this chaos, however, lie hidden opportunities that have the potential to unlock substantial wealth for those who dare to explore beyond the surface.
By understanding and capitalizing on special opportunities such as demergers or spinoffs, holding company discounts, and promoter buying, investors can generate superior returns as these strategies have a positive historical track record. As we reflect on these examples, one thing becomes clear: the path to wealth creation often diverges from the beaten track. By embracing a more nuanced approach to investing and staying vigilant for special situations, retail investors can position themselves to capitalize on opportunities that often get overlooked, ultimately unlocking hidden wealth in the process.
(The author Umeshkumar Mehta is CIO, Samco Mutual Fund. Views are his own)