Kiri Industries (NSE:KIRINDUS)

Disclosure: Invested today at 289.65. Not a recommendation to invest.

CMP: 288.85.

A Special Situation

A ‘special situation’/arbitrage, as Graham liked to call it, or ‘workout’ as Buffet likes to call it, is a situation in which a particular development is counted upon to generate a profit in a security, regardless of the movements in the general market. Kiri Industries is one such special situation/workout available in the market today.

Kiri Industries is a leading integrated Dye manufacturer in India with a global presence spanning over 50 countries across all seven continents and a market cap of ₹1518cr (approximately $190 million).

Kiri Industries has historically traded below book value due to a longstanding legal dispute over its most valuable asset – its stake in Dystar Holding. Although Dystar has been a profitable venture, Kiri hasn't reaped the rewards due to the actions of Dystar's majority stakeholders, Senda. As a result, Kiri's shareholders have discounted the value of its holding in Dystar, valuing the business solely on its standalone operations.

The recent resolution of the legal proceedings, however, provides an intriguing arbitrage opportunity, not yet reflected in the company's share price.

Dystar Holdings: A Brief Overview

Kiri partnered with Chinese dye manufacturer Longsheng Group in 2010 to establish DyStar Global Holdings (Singapore) Pte Ltd, intending to acquire DyStar's business. Kiri held the majority shareholding, while Longsheng possessed a convertible bond. By 2012, DyStar had become profitable, and Longsheng's subsidiary, Senda, converted its debt into equity, becoming the majority shareholder of DyStar. This development strained the relationship between Kiri and Senda as joint venture partners.

In 2015, Kiri filed a lawsuit in the Singapore High Court against Senda, alleging minority oppression. In July 2018, the court ruled in favour of Kiri and ordered Senda to buyout Kiri’s stake in Dystar. The Singapore International Commercial Court (SICC) valued Kiri's stake in DyStar at US$481.6 million as of July 2018. On March 3, the final value for the buyout order was increased to US$603.8 million. The court also awarded Kiri legal costs totalling S$8.11 million, payable by Senda by January 20, 2023. However, as of February 13, 2023, Senda had not made this payment.

With around 5.18cr shares outstanding, a successful buyout at $603 million (roughly ₹ 4974cr) would mean a cash enrichment before taxes of over ₹ 950 per share. Factoring in the S$8.11 million (roughly ₹ 49.2cr) in legal costs adds in roughly another ₹ 9.5/share. So, if the buyout and recovery of legal costs is successful - Kiri shareholders can expect a cash enrichment before taxes of ₹ 960 per share. Yet, it currently trades at under ₹ 290 - less than 3 times the value of the buyout sum.

Key Concerns

Kiri's shareholders are concerned about the company's ability to collect payment from Senda. They question Senda's willingness to buy out Kiri's stake at US$603 million if they have defaulted on their obligation to pay the relatively smaller legal costs of S$8.11 million. Shareholders lack confidence in receiving this payment and anticipate further legal expenses and delays. In the meantime, the company's operations are struggling to achieve net profitability.

Another concern is the low stake held by Kiri's promoters. The conversion of the last of several Foreign Currency Convertible Bonds (FCCBs) into equity shares by March 2022 has reduced the promoters' stake from 41.6% in March 2021 to 26.7%. If management is confident in receiving the buyout sum, why aren't they actively purchasing shares to increase their stake? Management cites a lack of funds as the reason, which neither convinces nor inspires confidence.

While the SICC is renowned for its expertise and impartiality in handling complex commercial cases, and its judgments are enforceable in over 100 countries through the Hague Convention on Choice of Court Agreements, China is not a party to the Convention. This fact adds further uncertainty to the enforceability of the SICC ruling in this case. However, there is some solace in the fact that China signed a Memorandum of Guidance (MOG) in 2019, which offers a framework for the mutual recognition and enforcement of money judgments in commercial cases between the two countries and establishes procedures for requesting and enforcing such judgments.

Statistically Undervalued

Despite these concerns, Kiri Industries presents a compelling investment opportunity, given the recent resolution of its legal dispute and the substantial value that the buyout order represents. While there are uncertainties regarding the collection of the buyout sum and the enforceability of the SICC ruling, the potential upside is significant.

Ben Graham offers a neat little formula to assess the attractiveness of a ‘special situation’ by expressing it as an indicated annual return with allowance for the risk that the special situation won’t transpire:

Where:

G - The expected gain in % in the event of success;

L - The expected loss in % in the event of failure;

C - The expected chance of success, expressed as a %;

Y - The expected time of holding, in years;

P - The CMP of the security

Note that the formula allows for the chance and the amount of possible loss.

It is hard to assign probabilities to the likelihood of the buyout. We know a successful buyout at $603 million would result in a cash infusion before taxes of over ₹960 per share. Assuming this cash infusion results in a share price of ₹ 1100, we can expect an upside of roughly 280%.

It’s hard to settle on a true value for the downside, but we know that the stock hit a COVID low of ₹ 220 and has traded over ₹ 200 since May 2016. Assuming a downside to ₹ 200 over the course of 1 year, we’ll assume a 33% drop in price.

Assigning just a one-third probability (C) of receiving payment for a 280% upside (G) and allowing for as much as a 33% downside (L) in case of non-payment, the expected return at the current price of ₹ 290 (P) for a one-year holding period (Y) is over 24.5%. Extend the holding period to 2 years and the expected annual return drops to 12.3% - still a neat return. Assume a 50/50 chance and the expected return for a 1 year hold shoots to 43.2%.

In conclusion, Kiri Industries presents an intriguing value play and arbitrage opportunity with multi-bagger potential. While there are risks associated with the enforceability of the SICC ruling and the company's ability to collect the buyout sum, the potential upside is substantial, and the conservatively estimated expected return looks promising.

Catalysts

• Promoters increasing their stake and buying from the open market will signal their increasing confidence in receiving payment.
• Senda paying the S$8.11 million will increase investor confidence and the likelihood of the buyout.

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