Description

This is a special situation in India. This company was written up in 2015 by Briarwood988 also, so do check that out for additional background (ticker was WELE IN at the time). Some important things have changed since then.  

We have a company trading at ~INR 70 per share, which has ~INR 67 per share in net cash. So you are paying INR 6 per share for (1) a new infrastructure business that may be at the right place at the right time, (2) a 35% equity stake in an O&G exploration company which appears to have proven reserves and (3) 6 small toll roads which are pretty insignificant but have some value.

Why is this interesting now? Because the company announced a buyback offer for 25% of the equity at INR 62 per share, and the controlling shareholders (the “promoters” in Indian markets parlance) have indicated that that they will not participate in the buyback, thereby increasing their stake meaningfully.  

I characterize this opportunity as a “safe speculation”, as oxymoronic as that sounds. Its Heads I win, Tails I don’t lose much. The upside case is hard to quantify, but the downside seems pretty tight due to the cash pile. It’s a coat-tailing opportunity where we (and the market) do not have much hard information (I probably won’t be able to answer all VIC questions) but the downside is limited.  

Here is my attempt to lay out the most important points in more detail:

1.       As things stand, the market cap is INR 12,200m ($185m) and the net cash is ~INR 11,700m which gives us an enterprise value of ~INR 500 ($8m).

2.       The net cash position is real and the company is “clean” – there are no hidden liabilities there (had to do some scuttlebutt with an ex-employee to confirm this). They may have to invest some additional money into the O&G JV, but the expectation (hope?) is that this will be done with returns in mind.

a.       The management confirmed this in a conference call in February 2017 – the cash position pro-forma the buyback and incoming cash proceeds from an earlier stake sale of a subsidiary will be INR 900 crore (which is INR 9,000m). My number of INR 64 per share in cash includes the cash received from the sale but excludes the cash to be used in the buyback. So in effect you have INR 9,000m + INR 2,700m (the amount to be used in the buyback) = INR 11,700m net cash in the company pre the buyback. Cash per share clearly won’t change irrespective of the buyback success. These numbers broadly make sense and are corroborated by the company press release in Dec: http://corporates.bseindia.com/xml-data/corpfiling/AttachHis/D48CCBCD_1064_49C1_BB1E_CA4703B5BF07_151025.pdf

b.      The buyback period is now complete, but nothing official has been announced yet (more on this below)

3.       The infra division may turn out to be a decent operating asset

a.       Their infra projects division has won 1 Hybrid Annuity Model (“HAM”) project so far. They seem to be focusing exclusively on HAM projects for this division going forward.

                                                               i.      HAM projects only started in late 2015 in India, and it appears to be working rather well. The Indian gov’t is on a road building spree (40 km per day target) and it seems like ~40% of all orders are via HAM (expected to be around INR 250,000m to 300,000m total in FYE Mar-18).

                                                             ii.      Under HAM, the government gives out contracts after competitive bidding. Using approximate numbers, if the contract is worth INR 10,000m (WEL’s one contract is worth ~INR 8,500m) to be built over 2 years; the company makes money by: (1) physically constructing the road, at a 12-14% margin usually, (2) getting the repairs and maintenance contract post the construction (~INR 50-100m a year) and (3) by getting bi-annual payments from the government for the following 15 years to recoup the investment and make a return. Companies tend to “sell-on” these annuity payments to third-party investors and move on to reinvest the money in new projects. The government contributes INR 4,000m (40%) of the total capital for the project while the private company brings in the rest. The INR 6,000m contribution is usually financed with ~INR 1,500m of equity and ~INR 4,500m of debt. Note that the fact that the companies are guaranteed the annuity payments from the government is in itself an advantage because companies do not take on the traffic/toll risk for these projects, the government does.

b.      WEL has been very disciplined in its bidding so far, having not won many bids due to them not fitting their “high teens” equity IRR requirements. (A disciplined infra company in India!) As I write this, they are waiting to hear back from 5 further bids (all are of a similar size/scope to the bid they have won, more on that below)

                                                               i.      Their winning bid for the Delhi-Meerut road will see them get ~INR 8,500m revenues over an 18 month period for the construction of the highway (at 12-14% margin, although management didn’t confirm this for competitive reasons. Most companies bid in this range).

                                                             ii.      They have previously stated they want to have a normalized order book of around INR 20,000. Assuming the future order book has similar economics / time horizon, that may lead to a normalized EBITDA of ~INR 1,750m annually just from the construction margin. Then you have to factor in the high-teens IRR from the joint development of the project which they will eventually securitise + the maintenance income (which is unlikely to be significant, but will be high margin).

c.       They already have 6 Build, Operate, Transfer (BOT) road assets. They only produce INR 300-400m of revenues and the profitability is negligible as it stands. Bonus.

4.       The Oil and Gas division has some proven value (potentially a lot of value)

a.       WEL has 3 relevant blocks that may have value, of which at least 1 seems attractive

b.      In the last conference call, management mentioned the “B9” field has proven, viably recoverable gas assets of ~INR 10,000m. I think this may be a lowball figure, the management had to be pushed to put a number to this in the conf call. WEL’s participating interest in this is around 25-30%. They also have other O&G assets, but this is the most promising. To be conservative, I am assuming the rest of the O&G assets have zero value.   

5.       The insiders/promoters seem to want to increase their stake and are possibly lowballing the true value of assets

a.       The buyback period is now complete and it looks like 62% of their targeted shares got tendered at 62 per share (~16% of total shares). At first glance this is surprising given the stock was at 67-70 for the entire timeframe of the buyback. However, there are a couple of big investors that own 10m-30m shares and they may have had liquidity constraints while selling the stock in the open market. Note the buyback was done through a tender process.   

b.      The promoters’ (the Goenka family) stake will increase to 43% vs current 36% post this. Them lowballing the true value of the company until the buyback was done is just speculation from my side, but it would make sense. As Munger has said, “give me the incentives and I will give you the outcome”… or something to that effect.

So, what’s it worth? What am I getting for my INR 70 per share? It’s near impossible to get to a normalized EPS number here. I think of it like this: I am getting: (1) ~67 per share in net cash (2) Potential infra EBITDA of INR 1750m (INR ~8rs per share after tax of 30% with 147m shares outstanding) that has the potential to grow, (3) call option on 3 O&G blocks, with 1 of the blocks having definite value, potentially as much as INR 10,000m (of which WEL gets ~30%) (4) an ambitious, proven and incentivized promoter group that wants to increase its stake at my expense.

Warning: unfortunately the promoter group doesn’t enjoy a pristine reputation in the market, and that is possibly why this opportunity exists (along with the complex restructuring the company has gone through). As Briarwood has said, Apollo Global is on the Board and presumably keeping the promoters in check (unless they have now sold part of their holdings in the buyback, which is a very real possibility).

Some useful links:

Conference call transcripts: http://www.welspunenterprises.com/content.asp?Submenu=Y&MenuID=5&SubmenuID=74

Buyback offer doc:
http://corporates.bseindia.com/xml-data/corpfiling/AttachHis/654C09A1_8201_4587_9342_D1F8E6A96A22_152451.pdf

Live buyback data:

http://www.bseindia.com/markets/publicIssues/ACQDisp.aspx?id=532553&type=OTB&idtype=1&status=L&IPONo=3355&startdt=3%2f3%2f2017

MEP Infra (a HAM competitor) conference call transcripts:

http://www.mepinfra.com/Investor/transcripts

Catalyst

1.       Stock buyback completion and promoter stake increase. Perhaps “the game” will start post this.

2.       Announcement of new HAM project wins

3.       Better understanding of value of O&G blocks over time