Merger delay costs IBP shareholders dear

Insight

The board of IOC has recommended a revised swap ratio of 1.1 for its proposed merger with its subsidiary, IBP, which means that shareholders in IBP will now receive 110 shares of IOC for every 100 shares held. Almost exactly a year ago, the companies had decided on a swap ratio of 1.25, that is 125 shares of IOC for every 100 shares held in IBP.

The markets didn’t seem too surprised by the downward revision. IBP shares fell 2.2% on Thursday, not drastically different from the 1.3% drop in IOC’s share price.

Quite obviously, the markets were already expecting a downward revision in the swap ratio in favour of IOC shareholders. The government was also known to be in favour of a change in the swap ratio since that would bring down its stake in the post-merger IOC marginally.

This possibility is reflected in IBP’s share price movement relative to IOC in the second half of this year. Since December 22, 2004, when the ratio of 1.25 was announced, IBP’s share price was about 1.2 times that of IOC’s. But towards the middle of 2005, this fell sharply to even below 1 - on Wednesday, prior to the announcement of the revised ratio, IBP’s share price was 1.07 times that of IOC, almost exactly in line with the new merger ratio.

Analysts point out that with the new ratio, the government’s stake in the post-merger IOC would drop by a smaller rate. But hardly just. Assuming that IOC’s shares in IBP would be cancelled out, the government’s stake in IOC would drop from the current level of 82.03% to 81.24%. Based on the earlier swap ratio of 1.25, its stake would have dropped to 81.13%.

There’s another reason why IBP’s relative valuation could have fallen in the past one year. The government has been slow increasing fuel prices in the domestic market this year despite a rise in prices globally, forcing IBP to post a loss of Rs 424 crore in the first six months of this fiscal. This is huge considering that the company had a net worth of only Rs 660 crore as on March 31, 2005, and a market capitalisation of Rs 1,307 crore.

IBP shareholders have taken a hit because of the delay in the merger, which was first proposed in April, 2004. At that time, IBP’s six-month average price was nearly 1.6 times that of IOC. The losses of the oil marketing company have since resulted in much lower valuations.

Fixed maturity plans: Asset management companies have over the last few months launched a slew of fixed maturity plans (FMPs). FMPs are mutual fund schemes that invest in financial instruments whose maturity dates coincide with those of their own.

For perspective, an FMP with a five-year duration will invest in instruments that mature in five years. FMPs invest in debt instruments (like bonds issued by, both, the government and companies) and money market instruments (like treasury bills, certificates of deposit and commercial paper).

Since the instruments are held till maturity, there isn’t any interest rate risk, which means there’s practically no volatility in the returns of these schemes, especially when compared to other debt schemes offered by mutual funds.

With bond yields going up on account of tight liquidity and fears of rising inflation, returns from normal debt schemes can be volatile. Given such a scenario, FMPs allow investors to lock into a rate of return.

One special advantage FMP investors can get is the ‘Double indexation’ benefit. This advantage can be taken of by investing in an FMP just prior to the end of a financial year and withdrawing it after the end of next financial year.

That is, an investor can invest on March 31 in one year and withdraw it on April 1 the next year. Thus, the amount remains invested for a period that’s only slightly greater than a year. This ensures the applicability of indexation benefits for inflationary changes in two years, which can help investors reduce their tax burden.

Double indexation, in some cases, can even lead to a net loss figure, even though there is a profit. This loss can be adjusted against other long-term capital gains.