Everyone likes a story that ends full circle - Simba defeating Scar, Krishh bringing his father back, and in today’s story, a company acquiring its foreign parent after being under its rule for 22 years.
But unlike the first two, today’s story has a hidden subplot. While the protagonist is engaged in a rather glorious act, there is some non-heroic behaviour under the covers.
This is the story of GMM Pfaudler, a company that stands tall in its industry but is falling short in the investor confidence department, thanks to the actions of its promoters - the Patel family.
So get your popcorn (or khakra) out as we narrate the story of a multibagger stock (4x over the last 5 years), with questionable corporate governance standards!
A German inventor (Pfaudler) invented something known as Glasteel in the 19th century. This was used in the chemical industry because of its corrosion-resistant properties.
His company continued innovating in this space and became a leader in making equipment used for chemical processes, throughout the 20th century.
Parallelly, in India, a Gujarati family (Patels) started GMM (Gujarat Machinery Manufacturers) in the 1960s.
In the 1990s, two forces created a beast that lords a 40-50% market share in India and the world in glass-lined equipment.
💡 Glass-Lined Equipment - This is the equipment in which chemicals are mixed at extremely high temperatures. While regular metal equipment might melt, the glass-lined ones are insulated to keep the machine from turning to mush. It is used mainly in the pharmaceutical and chemical space (although it was initially invented for beer breweries)
Pfaudler had initially acquired a 40% stake in GMM, in 1987. However, it further increased its stake to 51% in 1999, and the company's name changed to GMM Pfaudler. Essentially, control shifted from the hands of the Patel family to Pfaudler. However, the family continued to remain shareholders and part of management throughout.
After being owned by foreigners for 22 years, just 3 years ago, the Indian entity (GMM Pfaudler) acquired a majority stake in its parent company Pfaudler International, which was then owned by a German PE firm known as DBAG (yes, that is exactly what it is called).
With this, the Patel family regained control of not just the Indian entity, but also the international business.
While deals are complex, we’ll try to simplify this bit as much as possible. In a nutshell, earlier, DBAG owned Pfaudler Inc., which along with the Patel family owned GMM Pfaudler.
However, now, DBAG is out, the Patel family is the largest shareholder in GMM Pfaudler, which owns Pfaudler Inc.
Essentially, the entire structure is reversed.
However, the transaction wasn’t as simple as it sounds. To simplify things, we can divide the shareholding changes into 3 major phases.
Phase 1 (DBAG is the majority shareholder)
German PE firm DBAG owns a 100% stake in Pfaudler Inc., which owns a 50% stake in GMM Pfaudler
Thereby DBAG owns 50% of GMM Pfaudler, and the rest is divided between the Patel family (25%) and the general public (25%)
Phase 2 (DBAG reduces share)
DBAG sells most of its stake in Pfaudler Inc. to GMM Pfaudler (54%) and the Patel family (26%) and retains just 20% of its stake. Here, the ownership flips - from Pfaudler Inc. owning GMM Pfaudler, the reverse ends up happening
DBAG also conducted an OFS (Offer for Sale) to reduce its 50% stake in GMM Pfaudler. Post the OFS, DBAG’s stake comes down from 50% to 33%
Phase 3 (DBAG exits)
DBAG exits Pfaudler Inc. completely. Its stake is entirely bought by GMM Pfaudler
DBAG also exited GMM Pfaudler - most of its stake was bought by retail and institutional investors, and some of it was bought by the Patel family
While the full circle moment being experienced by GMM Pfaudler is warranted, what doesn’t seem to add up is the involvement of the Patel family in all of this.
To flip ownership, DBAG’s stake in Pfaudler Inc. simply had to be bought by GMM Pfaudler, which happened from Phase 1 to Phase 3.
⛳ However, in the interim, the Patel family bought a 26% stake in Pfaudler Inc. from DBAG for Rs. 100 crore (in Phase 2), and just 2 years later sold it to GMM Pfaudler for Rs. 194 crore (in Phase 3), pocketing a Rs. 94 crore profit for itself.
What would have counted as clean is for GMM Pfaudler to have bought 80% of DBAG’s stake in Phase 2, and the remainder 20% in Phase 3.
Why did the Patel family have to get involved at all?
It’s not like GMM Pfaudler couldn’t afford it. GMM Pfaudler had to pay Rs. 200 crore for the 54% stake it bought in Phase 1. Of the Rs. 200 crore, it paid Rs. 120 crore in cash and took Rs. 80 crore as a loan. At that time:
GMM Pfaudler had about Rs. 150 crore in cash balance, an annual net profit of Rs. 71 crore and a market cap of Rs. 8,900 crore
It partly funded the acquisition using a loan, which brought its Debt-to-Equity ratio to 0.3x. Even if it funded the acquisition fully with debt, its leverage would have gone up to 0.6x
Even if GMM Pfaudler had to buy an 80% stake, it would have to spend Rs. 300 crore. If it funded this entire value using debt, that too would have been very well affordable, bringing its Debt-to-Equity ratio to 0.9x.
There was absolutely no need for the white-knight-ish involvement of the Patel family here.
While the Patel family bought the 26% stake in Pfaudler Inc., as an apparent display of conviction, within two years, the “long-term conviction” towards the company resulted in an opportune return of almost 2x.
The beauty of the entire story is that the Patel family didn’t have to shell out too much of its own money to make these gains.
It sold its shares in GMM Pfaudler to fund its acquisition of Pfaudler Inc., then sold the shares in Pfaudler Inc. to GMM Pfaudler for ~2x value, and used those proceeds to buy more shares of GMM Pfaudler.
While the Patel family gained ~2x in the deal, who lost? Well, GMM Pfaudler, and hence its non-promoter shareholders!
GMM Pfaudler could have just paid an additional Rs. 100 crore to acquire an 80% stake in Pfaudler Inc. from DBAG. Instead, it had to pay Rs. 194 crore to the Patel family just two years later.
What we call questionable corporate governance is the participation of the promoter in a deal, where gains were made at the cost of the company and its minority shareholders.
The market clearly hasn’t been happy with the deal. Coupled with some insider trading chatter and investigations, the stock fell by 40% within 2 months of the announcement (August 2020) and is still down 20%!
Despite having a stake of more than Rs. 1,750 crore, and drawing more than Rs. 10 crore per annum in remuneration, a relatively petty gain of Rs. 94 crore for promoters can become quite expensive for stocks as valuations take a hit.
That said, GMM Pfaudler is a market leader in the glass-lined space, and has acquired/built significant capabilities across the value chain of chemical processing. Its legacy, strategy and inorganic foray has positioned itself well to capture multiple processes across several industries.
Moreover, the company becomes a strong proxy play if one were to be positive on a turn in the fate of the chemical and pharma sectors. What lies in your hands though is the choice of investing in a strong business when the markets are particularly supportive, or getting protected against potentially disadvantageous decisions for minority shareholders!
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