Quick Quiz: What’s the Mistake in this Document?

Question: ICICI Securities recently issued a strong buy recommendation on Tata Motors stock. Take a look at this document. Now tell me what’s the biggest mistake in it?

Request to my colleagues: Since you already know the answer, please don’t give it here!

60 thoughts on “Quick Quiz: What’s the Mistake in this Document?”

  1. I think the mistake is that the analyst has not taken the debt out after the EV valuation for coming down the target price. I guess.

  2. Hi Prof,
    I think the mistake is in the SOTP valuation. To be honest, I really never ever got the hang of this method of valuation..SOTP is of good use if one wants to justify something, i guess. 🙂
    Well, here goes…
    In the SOTP, JLR has been valued on an EV/EBIDTA multiple, to get Rs.836 per share value. Now shouldnt this value be the EV/share? And the other parts are valued on a PE multiple basis. How can these 2 be added to get final value of Rs.1523? You will get neither EV nor market cap.. jumbled up situation i guess.

    1. With you Neeraj. I guess if you follow EV/EBITDA then follow that for all companies and take out the net debt at the end of the calculation. Else give PE based multiple to the group which anyways would be gross over valuation.

    1. Is it about the debt level of the company? the D/E ratio is around 4.3 for the consolidated entity which seems to be quite high. They also have more than Rs. 4100 crore of convertible debt which can dilute the equity significantly if converted.

  3. JLR calc in SOTP – Already assumed EV in the calculation and then calculating on per share basis. I can arrive at any number I want too!

  4. Dear Sir,

    Is It something to do with the Strong BUY change wherein in earlier report target remains unchanged and due to decline in CMP it is Changed from BUY to STRONG BUY?

  5. Many mistakes, but the important ones to my mind were:

    -1). The EBDITA for JLR for FY12 is assumed to be Rs.10,000 odd crore in the table on page 8 and on the same page there is another table with estimates for JLR numbers. In that the EBDITA estimated for JLR in FY12 is around 1.7 GBP which roughly translates into an EBDITA of Rs.12,600 crore…on a multiple of 5x, the difference in valuation will be of the order of Rs.12,500 crore!

    -2). And the other being the shares outstanding used by the analyst in this report, viz. 63.3 crore shares…this includes about 53.7 cr fully paid up shares and about 0.96 DVR shares. Now, I am not sure whether that is the right way to compute total shares outstanding? Maybe Prof. Bakshi can throw some light on that.



  6. This report is full of mistakes…the mcap of Tata Motors on the first page is Rs.76565 cr and on page 9 it is Rs.62166 crore!…everything else staying the same 🙂

  7. I would have expected the analyst to comment/analyse/ incorporate some weightage in his analysis to the fact that crude in on the verge of almost doubling especially considering a significant chunk of the EV is assigned to gas guzzlers like Land Rover.

  8. Guys, see my hint above. The problem is not about what’s in the document.

    It’s not what the analysts wrote about which is the issue here, its what they missed.

  9. Given your hint, I took a cursory glance at TML’s FY10 annual report and was wondering if it has anything to do with omission of TML’s increasingly negative working capital when only the standalone results are considered ( although the consolidated results show +ve WC)

    Even though -ve working capital is a cause of concern it is not always a sign of future trouble ( companies with high inventory turnover may have -ve WC) and we need to carefully consider a company’s balance sheet and cash flow to arrive at any conclusion.

    However in the case of TML, given the deteriorating AR and inventory situation , I would be a bit concerned before giving a “strong buy” recommendation.

  10. Issue is in valuation of companies based on future estimates rather than present balance sheet and profitability. Future is uncertain due to competition, currency exchange rates, oil price etc.

  11. Projected Balance Sheet for FY 11 and FY 12 missing in the report which’ll be reqd for EV.
    Also JLR is not yet listed.

  12. Debt includes Foreign Convertible Notes which will be due for conversion over the next 2 yrs…the total number of shares that can be issued upon conversion is about 5 crore shares….this is about 8-9% dilution! The face value of this debt is about Rs.4161.9 crore.

    1. Not sure about this. The FY’11 Estimates for EPS already factors in a 10% dilution in shares outstanding.


  13. Hey Prof.!

    My try:
    TATA has a very complex equity structure, two types of shares plus their ADR’s (http://ir.tatamotors.com/index.php?CardID=11). For the last quarter, they have issued massive amounts of new shares, on top of that, thousands of their convertible notes have been converted into millions of new shares. They still have many thousands of convertible securities outstanding. And take a look at this (Taken from Q3 FY 2010-11 – http://www.sec.gov/Archives/edgar/data/926042/000119312511033773/d6k.htm):

    a) During the quarter ended December 31, 2010, the Company has issued shares aggregating US$ 750 million, comprising ‘A’ Ordinary Shares aggregating US$ 550 million and Ordinary Shares aggregating US$ 200 million through Qualified Institutional Placement (QIP). Consequently, the Company has allotted 32,165,000 ‘A’ Ordinary Shares at a price of 764 per ‘A’ Ordinary Share (including a premium of 754 per ‘A’ Ordinary Share) and 8,320,300 Ordinary Shares at a price of 1,074 per Ordinary Share (including a premium of 1,064 per Ordinary Share) aggregating to a total issue size of 3,351.01 crores.

    9) During the period, 46,313 notes of 1% FCCN Due 2011 and 2,555 notes of 4% FCCN due 2014 have been converted into 27,56,571 and 1,92,65,389 Ordinary shares respectively.

    10) Subsequent to December 31, 2010, 4,823 notes of 1% FCCN Due 2011 and 21 notes of 4% FCCN due 2014 have been converted into 2,87,066 and 1,58,345 Ordinary shares respectively.

    11) Public Shareholding of Ordinary Shares as on December 31, 2010 excludes 18.23% (12.27% as on December 31, 2009) of Citibank N.A. as Custodian for Depository Shares.

    Cheers Prof.!

    Mario R.

  14. The equity consists of Ordinary shares and ‘A’ Ordinary shares. ‘A’ ordinary shares receive a slightly higher dividend and have lower voting rights. Other than that they have the same rights as Ordinary shareholders. However, the ‘A’ shares are selling at nearly half the price of Ordinary shares. I haven’t been able to figure out the reasons for it trading a half the price.

  15. DVR (Differential Voting Rights) has 1/10th of the voting rights of the common stock (How many people vote?)

    BUT gets

    5% extra dividend as compared to common stock

    So you get HIGHER economic rights in the DVR than in the common stock

    And YET, the DVR Price is 45% below the price of the common stock (as of 24 Feb close)

    How can you be bullish on the common, and yet ignore the DVR?

    The problem in the ICICI report is that there is NO mention of the DVR.

  16. Yes. I dont see any reason except one of these A Ordinary shares (DVR) to be trading at a substantial discount to the normal shares. This can only happen during a hostile takeover as these shares have lower voting rights. I am sure thats not happening right now. The other reason for the same can be that most of these DVR shares are with the promoters.
    Also if we look at the historical trading discount of similar shares (Pantaloon & Gujarat NRE coke) they have traded at much lesser discount. Pantaloon is at ~15% discount only. Gujarat NRE coke is at ~40% discount in spite of having only 1/100 of the voting rights.
    I think there can be a good arbitrage oppurtunity in this case by shorting the Tata motors shares and longing the DVR’s. Am i correct prof? We should ideally expect this discount to go down.
    As for the document if Tata motors shares is a Strong buy then DVR is a super strong buy..each leg could be individually played out as well if you just wanna long tata motors…:).

    1. Interestingly, illiquidity cannot possibly explain the discount. The DVRs are so liquid that they trade in F&O segment of NSE.

      I have already written that the economic rights, so far as dividends are concerned are greater in the DVR than in the common stock. Moreover DVR holders are protected from corporate actions that will have a bearing on the common stock including buybacks, bonus issues, and tender offers.

      There is only one explanation I can think of: Ignorance by analysts possibly leading to Market Irrationality.

      If you own Tata Motors shares, and wish to continue having an equity interest in the corporation, you should promptly sell them and replace them with DVRs. There is a lot to gain and very little to lose (if anything) in that exchange.

    2. I’m not sure about looking at this as an arbitrage opportunity. At the time the DVR shares were issued, the two were trading at close levels for some time. But gradually, the difference between their prices has increased, probably due to ignorance by analysts. They may continue to ignore it for a much longer time. In the absence of any event which can cause the prices to converge, the difference may perhaps even widen over the next few years.
      if u want to buy shares in tata motors, it makes sense to buy the DVR shares instead of ordinary shares. But i would be apprehensive about shorting the ordinary shares.

  17. Is it because of liquidity, in this case around 80% of DVR is held by promoters and liquidating their holding will lead to discounts? is40% discount justifiable

  18. I am not able to but i would love to paste the chart of DVR discount of tata motors. Its at its all time highest at ~45% with ample liquidity. This is its historical highest discount. Lets consider it to the holding company discount. Also comparing it to other DVR shares like Pantaloon(~18%), Guj NRE coke, Berkshire, Google, News corp, Volvo, john wiley & sons, Biorad labs etc this is the highest of all. Gets more dividend also. I would consider that the risk reward ratio is quite high from this point.

  19. i had prepared a similar chart 🙂
    The discount is at an all time high, but it might increase further as analysts can remain ignorant for a long time. About an year back the discount was ~40-42%. had u done the trade then, expecting the discount to decrease, u would have seen the discount increase to 45% now. it could widen further an year or two down the line.
    i would be more comfortable shorting the ordinary shares if there was some event in the near horizon which might trigger a convergence of the prices (even if the discount was a little smaller).

  20. These would be my scenario analysis:
    If there was an event for certain conversion: I will take leverage for that trade depending on milestones.
    Even without conversion: Will put a small amount in this trade (2% of portfolio):
    Its like shorting the DVR discount. I think there is 80% probability of discount decreasing to 20% (On basis of Global & locally listed peers) and 20% probability of this increasing to 70%. I think risk reward ratio in my favour is all I can look for while taking investing decision for a small amount of a portfolio.

  21. Hi Prof

    A simple question – would not another mistake be a ‘Strong buy’ recommendation, when there is not really a large margin of safety. After all, as per the analyst’s own computation (and I did not even try to look inside the doc), the margin is barely 20% (25% upside).


  22. Dear Sir,

    Couple of doubts in my mind. Are you suggesting a narrowing the spread trade or only a long on the DVR? With the former, I have the same concern as previously highlighted by LJ (lack of catalyst). With the later, there is a risk of the common itself being over-valued and consequently, the huge discount on the DVR being a mirage. ( Personally, I am no good at valuing the common and with TML turning “hot” of late, I feel jittery about investing even in the DVR).

  23. Tanmay, I am suggesting nothing except the fallacy of not mentioning the DVR in the ICICI Securities Report. My colleague Arpit sent me another report by Anagram Capital titled “Pre Budget Stock Picks.” One of the stocks mentioned is Tata Motors. Again, there is no mention of DVR in this report either…

    1. The appropriate discount for the difference in the voting rights of the DVR stock is very qualitative and non-measurable in its nature. Considering this, any such number would have to largely be arbitrary and subjective, which makes it prone to a high amount of speculative activity. Analysts not mentioning the DVRs in their report may have been too apprehensive to put a number to it, more so because no else seems to be doing it and they wouldn’t want to be the first ones lest they end up looking foolish for being way off the mark.

      Further, its non-measurable nature also makes it prone to wide fluctuations. What the discount has historically been may not contain much information of what it will tend to be in future, other than the fact that it will continue to fluctuate widely. I don’t think it is a good idea to make any bet on what the direction of these fluctuations, whether up or down, will be.

      I think the only reasonably sound conclusion one can arrive at in this case is that if the discount is large enough, a minority investor who has anyways decided to hold on to the common for the long-term, would be better off switching and holding on to the DVR instead. If and when the discount does narrow significantly, he may want to switch back to the common (again assuming that he all times wants to continue being a Tata Motors shareholder for the long term).

  24. Ok, two more questions:

    1. Why may the trade involving going long DVR in the futures market and selling futures on the equity not be a profitable one?; and

    2. What should Tata Motors do about this discount?

  25. I think:
    1) This may happen because futures may keep trading at a discount and we may loose all the spread in rollovers from month to month.
    2) Tata motors could probably allow a convertible to normal shares in some ratio (lets say 1.2:1). This way most people will try and buy the DVR and tender and Tata motors will reduce the total equity of the company and along with it reduce the discount.

  26. Viraj, I agree with your answer to 1) but not 2) because to get the DVR to become convertible into normal is onerous. Moreover, even if Tata Motors did this, there is no upside for the company although the promoters who own 19% of DVRs (I am told) will stand to gain.

    Think of something the company can do which closes the discount, helps the company, AND helps the promoters too.

  27. I think the company as a whole stands to gain. This is because the total number of shares decreases (ratio of conversion is less than 1). This increases the implied EPS. This for me is a functional equivalent of a buy back without paying any money for it. The current holding of promoters is 19% (this is reduced from 84% in last 6 quarters). This is one major reason for this discount. I think almost everybody gains from this transaction including current shareholders.

    Except this i think promoters can pay higher dividend thus increasing the yield for the DVR can be another trigger. I know this doesnt help the company as its debt ridden but cant think of anything else right now.

  28. Dear Sir,
    The promoters will not do it ofcourse they have sold DVR’s and bought ordinary shares all this while paying a lot higher value for the voting rights of the ordinary. So i guess this is not feasible. These voting rights are very valuable for them.
    Let me know if I am wrong.

  29. The document on the DVR shares mentions that “The ‘A’ Ordinary Shares will not be convertible into Ordinary Shares at any time. ” I am not sure if it will be possible to overrule this clause and make them convertible to ordinary shares.

    A buy back offering similar prices for the ordinary and DVR shares might reduce the gap, but that will be beneficial only if the company is undervalued.

  30. This idea was given to me today by an experienced banker and I liked it. Tata Motors can raise equity capital by issuing new shares (the stock closed today at 1,163), and use the money to buyback the DVRs at premium to market (the DVR closed today at 653. This would be beneficial for the company because it would be using the proceeds from high priced currency (the underlying stock) to retire a low priced currency (the DVR). This buyback could be structured as one where the price is discovered in a reverse book building process.

    The announcement of the company’s intention alone to do this, would reduce the DVR’s discount to the common stock very significantly and very quickly.

    This would benefit promoters because the market value of their DVRs would rise and it would benefit the company because it would lower its cost of capital. This would happen because the company would be replacing a low P/E stock (implying high cost of equity capital) with a high P/E one (implying a lower cost of equity capital), while keeping the total capital unchanged.

    What’s the hitch then? Why would the promoters not initiate something on the lines of the above?

  31. Yes, that’s true because the company would necessarily need to raise new equity capital at a price which is below the prevailing stock price. In a sense, the common stockholders would stand to get punished for allowing the large disparity between the common’s price and the DVR’s price. And why, I would argue, would they deserve this punishment? Because they have the option to close the discount by selling the common and replacing it with more DVRs. This would make the disparity disappear and also make the common stockholders better off. But they are not doing that. The shareholding pattern of the company consists of large institutional investors who can very quickly switch from the common to the DVR on very favorable terms. They are not doing it.

    The key reason, in my view, why the Tatas may not like the idea of doing a buyback of DVRs by using the proceeds of a common stock offering is that unless they participate in the offering, their total voting rights will get diluted. While they stand to make money (because the value of the DVRs they hold would rise substantially), the prospect of having a reduced voting control over the corporation may hold them back.

  32. Dear Sir,
    I think Tata’s should ideally do what you have mentioned. But for a few reasons I dont see this happening.
    1) Tata’s issued the DVR in the first place because they didn’t want to dilute their voting rights.
    2) Also if Tata’s had to do something about this discount, they would have done it when they owned ~84% of the total DVR’s rather than now when they have only 19%.
    3) Again they have sold DVR’s in the market and bought ordinary shares from the market in large chunks also paying a premium for the voting rights (~70% premium). It is highly unlikely they would so anything to reduce the precious voting rights they have bought at such a premium from the market.

    So now they have no incentive to do anything about this discount.
    Please correct me if I am wrong.

    1. need clarification on the 1st point. Most of the DVR shares were subscribed by the promoters. Wouldn’t it have made more sense to issue ordinary shares with full voting rights? didnt they dilute their voting rights by purchasing the dvr shares?
      agree fully on the other 2 points

      1. They actually had to subscribe to the DVR issue originally as there were no takers for the DVR issue (During original issue in 2008) and they can’t let a Tata motors issue go unsubscribed. So promoters had to buy it but quickly (after subscribing it) started offloading DVR’s in the secondary market to boost the voting rights by buying ordinary shares (Even if it came at a premium).

  33. Regarding the ICICI Sec report, since the job of the analyst is to induce transaction, its easier to do so in common stock than in DVR. It might be just incentive bias.

  34. [quote]http://www.sebi.gov.in/circulars/2009/cirla2.pdf[/quote]

    Dear Prof,
    According to the above circular, DVR shares have to be void or their clause amended. Going by this i suspect there might be a change in terms and conditions of the DVR shares which might explain the disparity. Please let me know if i have gone off track with this.

    Thank you.

  35. Hi Professor

    Going by the logic that if one is long on tata motors its preferable to buy tata motors DVR rather than equity shares, Is it advisable to buy shares of Balmer Lawrie Investments Ltd (Holding company) instead of shares of its subsidiary Balmer Lawrie. I think if one is long on Balmer Lawrie, it makes sense to buy shares of Balmer Lawrie Investment, as unlike other holding company this company purpose is only to hold shares of Balmer Lawrie. Almost entire dividends are distributed to shareholders and by virtue of huge discount, offers a better dividend yield compared to the operating company and in a way same as DVR. No way I am seeking your opinion on Balmer Lawrie investment merit, but just trying to test my understanding of this post on DVR.

    1. That’s not strictly true because Balmer Lawrie Investments and Balmer Lawrie are DIFFERENT companies whereas in the case of Tata Motors DVR, the issuer is the same company.

  36. And we are now 9 months after the last comment was made. Would it make sense for a now cash-rich Tata Motors to buyback DVR stock? If I think of the book, The Outsiders, I see that there is a dearth of capital allocation abilities of Indian promoters.
    The company would much rather spend on capex, R&D for their India PV business, in a sector that is seeing a flurry of new entrants and is anyways laboriously competitive and capital intensive, than buyback stock, which is akin to acquiring shares of a company that the management knows the most about.

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