Bajaj Auto de-merger: A jolt for stocks

With the Bajaj Auto de-merger turning out to be a damp squib, there appears to be limited room for upside in the near term.

 

It's a tale told quite often in stock markets -- splits are good for shareholders. It does not matter if it happened because of a family feud or due to a well calibrated strategic initiative.

 

Recently, we have seen it happening in the case of India's largest private enterprise Reliance Industries and also several other medium sized companies.

 

In the case of Bajaj Auto however it has turned out to be otherwise. Even a high powered performance by Rahul Bajaj at the packed press conference and analyst meet at the Oberoi Hilton in down-town Mumbai couldn't stop the stock from sliding on the bourses.

 

On Thursday when the demerger was announced, the Bajaj Auto stock plummeted 6.7 per cent as leery investors got stumped by an earlier undisclosed call option googly. The stock lost another 8.5 per cent to Rs 2,287 on Friday ending the week with losses of nearly 16 per cent.

 

"A demerger is fundamentally a move towards value unlocking, but the call option disclosure has made the deal appear value destructive," says Amitabh Chakraborty, President (equities), Religare Securities.

 

"For investors who were expecting insurance value discovery through the demerger as the key trigger for the stock, the prospect of Allianz exercising a call option at a nominal price was truly a let down," exclaims Umesh Karne, Senior research analyst, Emkay Shares and Stock Brokers.

 

By all measures, the structure of the demerger proved to be quite a surprise. While the holding company Bajaj Holding and Investments Limited would hold a lion's share of the cash and cash equivalents, to the tune of around Rs 6,000 crore (Rs 60 billion), out of Rs 8,600 crore (Rs 86 billion) that exists in Bajaj Auto's coffers, it would also hold a 30 per cent stake in the two new entities viz the new automobile manufacturing entity Bajaj Auto Limited and Bajaj Finserv Limited which will house the wind power, insurance and consumer finance businesses.

 

The reaction of brokerage houses has also been, with a few significant exceptions, negative. Citigroup revised its price target from Rs 2,886 to Rs 2,600 due to a downward revision in its core valuations as also a massive cut in the insurance per share value.

 

Similarly, Morgan Stanley downgraded the stock to equal weight "essentially reflecting concerns on the core implied automotive operations." Most other domestic broking firms aren't really enthused by the event either.

 

Although the stock market has given its verdict for the time being, how should investors play the stock till the listing of the new entities? And what should be their long term strategy with respect to the stocks post listing? Here is a low-down.

 

The insurance tangle

If the Bajaj Auto stock was, in recent times, trading at a premium to peers, one of the key reasons was its financial services exposure primarily represented by Bajaj Allianz General Insurance and Bajaj Allianz Life Insurance.

 

Besides, its huge investments with a market value of Rs 8,600 crore served as a cushion to its potential downside.

 

In fact, before the details of the demerger were known, various analysts pegged the value of the insurance business at anywhere between Rs 600-1000 per share. Now however they are cutting the fair value of the share by Rs 300-500.

 

And the reason is not far to fathom. Much depended on the price Bajaj Auto would get by selling its shares in its insurance business to its foreign partner Allianz whenever the regulators raise the foreign direct investment limit. Allianz SE holds 26 per cent stake in Bajaj Allianz General Insurance and Bajaj Allianz Life Insurance.

 

Now under the recently disclosed call option clause, in the event of policy changes Allianz could increase its stake in the general insurance entity to 50 per cent at Rs 10 per share and life insurance at Rs 5.42 per share, plus interest at 16 per cent per annum compounded since April 2001 in both the cases.

 

This stipulation would last till 2016. Thus, the prospect of profiting through a stake sale to the foreign partner, whenever it happens, at near market value considering the potential of the insurance business have been virtually quashed.

 

While both the entities are currently at the number two position among private general insurance companies, they have experienced robust growth in the last fiscal.

 

While the gross written premium for life insurance has shown an increase of 40 per cent over the previous year, for the general insurance entity, the gross written premium showed an increase of 69 per cent. And the losses in the life insurance, typically a back-ended business, have reduced to Rs 71 crore (Rs 710 million) this year from Rs 98 crore in the previous