ax+by=c

Ax + By = C .. sometimes simple mathematics can help you earn loads of money .. here is one example :)

The Scheme of Arrangement from Birla Group

Recently Aditya Birla Nuvo and Grasim announced a mega re-structuring which was as follows

Incorrect analysis by top analysts 

This is what one of the senior analyst from CNBC had to say about the scheme of arrangement

On the day of the announcement AB Nuvo was trading at Rs 1560 and Grasim at Rs 4500. As per the announcement  for every 10 AB Nuvo shares (10*1560 = Rs 15600) you get 3 Grasim shares (3*4500= Rs 13500) so the % difference is (15600-13500)/15600*100=13.4% which is the ~14% spread mentioned above by the CNBC analyst

And here is what another senior analyst from ET Now had to say about the scheme of arrangement

Here the analyst analyzes the deal based on how much he would have to pay in terms of Grasim or AB Nuvo shares to acquire 210 shares of ABFSL. However he quickly forgets to account for the actual shares in hand of AB Nuvo or Grasim and calculates that Grasim gives him an advantage of 13% over AB Nuvo only based on the value ABFSL shares acquired through his holding in AB Nuvo or Grasim

Clearly both analysts got it totally wrong. For AB Nuvo shares you get Grasim shares but with those Grasim shares you get additional ABFSL shares. Who will account for that in these calculations?

Correct analysis based on simple mathematics ax+by=c

Let's look at the scheme of arrangement again. 

The correct equation to model this scheme mathematically actually has two parts as follows:

On the date of announcement AB Nuvo  was trading at 1560 and Grasim at 4500

Now say you have 100 shares of AB Nuvo so the value will be 100 *1560. Post the scheme of arrangement your 100 shares of AB Nuvo get cancelled and you get 30 shares of Grasim for it. Everyone got this right and included it in their calculation but they forgot to include the second part of the scheme of arrangement to calculate the return on their holding in AB Nuvo shares. Further for every Grasim share you get in return of your holding in AB Nuvo you get additional 7 shares of ABFSL.  So the correct equation is 

100*1560 (AB Nuvo) = 30 * 4500 (Grasim) + 30*7*X (ABFSL)  

c = ax + by

which is favorable for AB Nuvo shareholders depending on the value of ABFSL

However using incorrect calculation as done by the analysts above shows the scheme to be favorable for Grasin

100*1560 (AB Nuvo) = 30 * 4500 (Grasim) 

c = ax ?

This equation incorrectly implies a 14 % arbitrage discount to Grasim holders and hence favorable for Grasim holders It is incorrect because it does not consider the "by" part of the equation ax+by=c Shareholders of AB Nuvo get Grasim (ax) shares which in turn gets them shares of ABFSL(by) so we need to include both parts when calculating what we get in return for AB Nuvo shares

Panic mode on 

I tried my best to explain this on twitter, but there was way too much panic going on because of foolish analysis of 14% discount posted by some very senior members of the top business news channels in the country. 

Not everyone was foolish, some got the point and appreciated. 

Opportunity in Insanity
Sensing a complete panic about the deal from twitter, I decided to be ready with a war chest and go "all in" if markets loose their shit on this. Next day as trading started, market did go insane and AB Nuvo crashed more than 20% to 1290 per share from 1560, while Grasim went down by around 5% from 4500 but recovered the whole loss by market closing since everyone thought that the deal is favorable for Grasim. However it actually made the already better AB Nuvo even better by giving a much wider arbitrage between the two in favor of AB Nuvo. The new equation looked like this

100*1290 (AB Nuvo) = 30 * 4500 (Grasim) + 30*7*X (ABFSL) 
c = ax + by (with c revised after 20% fall in Nuvo)

So for Rs 1,29,000 in AB Nuvo you now get 1,35,000 worth of shares in Grasim and 210 shares of ABFSL! Now that's insane !!!
210 shares of ABFSL for free and 1,35,000 - 1,29,000 = 6000 in net value extra. How cool is that ?

ALL IN
I simply closed my eyes and hit the single largest buy order of my life with money pooled in from every source possible. The only money left with me after that were a few 100 Rs notes that were in my wallet (thankfully) and another 19 days to go for the month before I get my next salary credit. This was going to be a really cash strapped month for me :)

Fruits of simple mathematics & calculated risks
The markets re-opened on Tuesday after a long weekend including Independence day holiday on Monday and AB Nuvo started it's recovery from insanity. There are other aspects also. A side factor to the crashing of the AB Nuvo stock besides the panic created by foolish analysts was also the fairness opinion about the restructuring. Some experts pointed out the the deal is too complex and will make Grasim a very complex holding company attracting a hefty discount and will also dilute the stake of AB Nuvo shareholders in ABFSL considerably and is effectively a bad deal for both. Great shareholder activists like Anil Sanghvi blasted the management for this restructuring move and many institutional shareholders came up with some really tough questions for the management and so the deal is in a flux state currently. No doubt the deal is indeed one of the worst seen in recent times but the market panic reaction was way overdone and that provided a golden opportunity to vigilant and active investors.

How much did I invest & make?
a lot :) But goes without saying that most of the story has played out and I am already booking partial profits on this deal. In near future this looks like will get into a prolonged battle with the management trying to convince the shareholders and the shareholders acting tough on management. In recent memory a similar example was Cairn - Vedanta deal that took several years to close. No fun in that! The real fun lies in looking for such opportunities and then playing it big. It's a mega feeling..