On March 2, my colleagues and I bought shares in Britannia at an average price of Rs 1,680 per share. Exactly one week later, on March 9, we sold all these shares at Rs 1,645. Why did we do this? We did it to create very cheap bonds in Britannia.
On 25 February, the company had fixed March 9 as the record date for its bonus debentures issue which had been announced way back in May 2009. One bond having a face value of Rs 170 per bond, a coupon of 8.25% p.a., and a maturity at par three years after issue was to be allotted for every one share held on the record date.
This is a form of a mini leveraged recapitalization. It’s not unusual for markets to ignore these corporate actions, and that’s what we were expecting. After all, given that the stock was selling at Rs 1,680, a carve-out of a security having a value of Rs 170 out of the equity of the company was only about 10% of the latter’s market value.
An operation like this involves buying the stock on a cum-entitlement basis, and selling it on ex-entitlement basis on the record date, hoping that the market would ignore the corporate action. Obviously, such operations are not without risk. After all, markets can crash over the one week holding period (and we did not put in a market hedge because the trade size was small). If this happened, we would have cursed our bad luck. However, we were not very concerned about this because of low volatility of this stock (it has a beta of 0.5), and the high quality of its business.
By buying the stock at Rs 1,680 on cum-entitlement basis and selling it for Rs 1,645 on ex-entitlement basis, our cost of creating a bond of Britannia turned out to be Rs 35 (i.e. 1,680 less 1,645). After considering trading costs, the effective cost of creating a bond of Britannia was approximately Rs 50. It’s fair value is Rs 170 given that the company is a very good credit risk, and the coupon offered is in line with AAA bond yields.
While Britannia cookies may be very tasty, its high-grade and very cheap bonds, are much tastier to a deep value investor!