Just Dial buyback case study and Framework for analyzing buybacks – Financial Tales

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Overview of the Company:

Just Dial Limited, headquartered in Mumbai, is one of the leading local search engines in India. The company’s operations began in 1996 by offering local search services under the Just Dial brand. The company launched the official website in 2007. The company offers local search, search-related, and software services through various platforms, including the Internet, mobile Internet, over the telephone, and text.

It also provides review and rating certification services under the JD Ratings name; and online payment services under the JD Pay name. Also, the company engages in advertising and events businesses; and the operation of JD Social, a social media platform, as well as Search Plus, JD Maps, JD Omni, and other platforms. Further, it offers website development and maintenance services. As of March 31, 2019, the company had a database of 25.7 million listings.

Buyback details:

Just Dial Ltd.’s board approved to buy back shares worth up to INR 220 crore at Rs 700 apiece. That represents 4.84 percent of its total outstanding equity. The buyback price implies a premium of 106 percent to Friday’s closing price.

*Source: BSE Website*

Timelines:

The general period for completion of the buyback is 3-4 months. The BoD approved buyback on 30th April. One month forward, shareholders will approve buyback via postal ballot. One month forward, record date. Two weeks forward, buyback opening. Two weeks forward, buyback closing. Two-three weeks forward, Intimation regarding acceptance and payment consideration. So, being conservative the process will get completed by mid of August.

Calculating theoretical Acceptance Ratio:

Theoretical acceptance ratio means if every shareholder of the company tenders the shares what proportion of our shares will be accepted by the company. So in Just Dial’s case theoretically only 484 shares out of 10000 will get accepted (4.84% of tendered shares)

Retail Quota: Important norm to consider in case of tender route buyback:

The Securities and Exchange Board of India mandates companies to set aside 15 percent of the total buyback size for retail investors, or those holding shares worth up to INR 2 lakh on the record date – the cut-off date to decide which shareholders are eligible. Which means, Just Dial will have to set aside INR 33 crore to buy shares from retail investors.

Considering that INR 2 lakh is the threshold to be considered for quota, the maximum number of shares which can be bought to qualify as retail shareholders can be calculated as: 2,00,000/CMP = 2,00,000/340 = 589 shares.

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But on the record date, the cut-off date as which shareholders are eligible as retail shareholders will be decided and in the meantime price may move up. Hence, I will consider 550 shares as maximum shares an investor should purchase.

Calculating Entitlement ratio:

The entitlement ratio is the number of shares offered under a buyback to the total outstanding shares of the company. For retail investors, it’s the ratio of shares buyback reserved for retail shareholders to the total number of shares held by retail shareholders.

The total buyback size is 31,42,857 shares. The buyback shares reserved for small shareholders 15% of 31,42,857 = 4,71,429. The total number of shares held by retail shareholders can be taken from the latest Annual report.

Distribution of shareholding as on 31st March 2019:

To be a retail shareholder, an individual can buy approximately 550 shares as per my prior calculation. But given the fact that we do not have distribution of shareholding up to 550 shares, we will consider the total range of 0-5000 as retail shareholders being extremely conservative.

So, the entitlement ratio will be equal to 4,71,429 divided by 17,20,248 = 27.4%.

Remember, that’s based on an assumption, and the entitlement ratio changes with the share price and the total number of shares.

What is the difference between the acceptance ratio and entitlement ratio?

The acceptance ratio is the proportion of shares accepted to the total number of shares tendered in the buyback by investors. Acceptance ratio is generally lower if a higher number of eligible investors tender shares. But it cannot be less than the entitlement ratio. To summarize, the entitlement ratio of retail shareholders is the minimum acceptance ratio i.e. when all retail shareholders tender for buyback.

Practically, the total number of shares tendered in the buyback by retail shareholders may vary from 65% to 95%. Let us create scenarios for the same:

Scenario Analysis:

I have considered three scenarios where tender for buyback for retail shareholders is 95%, 80%, 65% respectively. In Bear case, the tender for the buyback from retail shareholders is 95%. The tendered quantity of shares would be 95% * 17,20,248 (held by retail shareholders) = 16,34,236 shares. Hence acceptance ratio will be equal to 4,71,429/16,34,236 = 28.8%.

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Similarly, for base case 80% of retail shareholders will tender and for bull case 65% of retail shareholders will tender and acceptance ratio for base and bull case will be 34.3% and 42.2% respectively.

A certain portion of shares bought will be accepted in buyback and rest has to be sold in the open market. Given the fact that the period for completion of buyback maybe near 3-4 months, the exit price of shares may drastically change in the next 3-4 months given the current market volatility.

I have assumed exit price in bear, base, and bull case as 300, 350, and 400 respectively. Hence, the net return will be 22%, 38%, and 55% respectively.

Assuming the buyback process may take 4 months from today, the annualized return will be 67%, 115% and 165% respectively.

Major drivers of returns:

In buybacks, acceptance ratio and exit price for unaccepted are two major drivers of return and if our assumptions go wrong in either of two, the analysis may go for a toss. Let us analyze the sensitivity of both the factors on profit generated.

Hence, the net return may vary from -6% to 73%. Hardly, you will lose money if you participate in this buyback. It seems too good to be true. Let us understand the risks.

What can go wrong?

  1. Getting acceptance ratio wrong: There is a possibility that there may be a substantial increase in participation by retail shareholders hence the acceptance ratio may fall below 20%.
  2. Market Volatility: Given the current market volatility, if the market corrects substantially, the exit price may even fall upto 50% from CMP.
  3. Shareholders do not approve the buyback scheme or changes are made to it.

Apart from this, sometimes managements do buyback at extreme valuations to give confidence to shareholders and stabilize the price of the stock. To give an example, a year back, a cyclical company did buyback at 14-15x price to book multiple and stock price is down nearly 80-90% from highs. So, let us go through financials and do basic valuation exercise.

Basic Financial Data and Pricing Multiples:

*Amount in INR crores except share price or stated otherwise*

As of Dec-19, the company had a book value of 1200 crores and Net cash approximately 1,500 crores which shows that this business virtually requires zero capital. The company has healthy TTM pre-tax operating margins nearly 22% and TTM RoE of nearly 21.5%.

The company’s revenue and net profit are growing in mid-double digit and it is pretty impressive to grow at this rate given the competitve landscape with such healthy operating margins and virtually no capital requirement for incremental growth.

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Market Pricing decline of business:

As of 8th May, the company had a market cap of 2205 crores, and considering Net cash approximately 1500 crores, it results in an Enterprise Value of 705 crores. In Fy19, the business generated a free cash flow of nearly 260 crores, which implies less than 3 years payback period considering zero growth, which should be attractive for an investor.

Even after considering zero growth in the business, the Enterprise Value of the business should be approx 1500-2000 crores, and considering Net cash of 1500 crores, the Market Value of Equity should be near 3000-3500 crores.

Given the fact that the market is pricing this business very cheap, the management and BoD are considering to buyback the stock as they have healthy cash on the balance sheet.

Theoretically, buybacks act as price stabilizers. When a company indicates that it is willing to buy back the stock at a certain price, it generally gives a signal to the market of a fair price for the stock. However, this need not contain declines as there are instances too, of stock prices falling below the buyback price. Besides, buyback is a reduction of the outstanding capital, it improves the earnings per share (EPS) of the company and thus, valuation and also help promoters consolidate their stake in the company, if they don’t tender their shares.

Closing Thoughts:

Given the negligible possibility of losing money, risk-reward is favorable for investors. For individuals having portfolio size near 1-2 crores, it is smart to buy shares from 5-6 family Demat accounts to take full advantage by allocating 4-6% of portfolio in such opportunities giving returns in a short period.

I am sharing my spreadsheet to quickly analyze the buyback. If you want to judge whether a buyback is attractive or not, you can input the details and your assumptions. You can create a copy of the google sheet & tinker with it.

https://docs.google.com/spreadsheets/d/10l5q6qxsT8B7u6msOmQPQt_ZpXYqe5crNOC2Gz6Vsjg/edit#gid=945945043



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Ahmed Madha
Ahmed is building a core competency in investing in Indian equity markets by learning all the investment philosophies. He reads about business valuations and inspired by Michael Mauboussin's writings.
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