Dear Readers,

Do we have an arbitrage opportunity in case of the proposed de-merger scheme in Piramal Life Sciences Ltd (PLSL) and Piramal Healthcare Ltd (PHL)? Let’s find out.

Some details about PLSL

Since being de-merged from Piramal Healthcare Limited (PHL) in April 2007, PLSL as an independent drug discovery & development Company has made significant progress. The pipeline of R&D programs has increased from nine to twenty four, with nine additional programs moving into Phase I/II clinical trials and two additional program moving into Phase II clinical trials. The development projects from pipeline would need strong financial support going forward. Hence the Board of PLSL has approved the de-merger of NCE Research unit of PLSL into PHL.

What’s the de-merger scheme and the swap ratio?

Under the proposed de-merger scheme, each shareholder of PLSL will be entitled to one (1) fully paid up equity share of PHL for every four (4) equity shares held in PLSL. All assets and liabilities of the NCE division will be transferred to PHL at book value.

The herbal products division that markets neutraceutical products to less regulated markets globally will continue to be with PLSL.

Let’s do some calculations

Current market price of PLSL – Rs 86.00

Current market price of PHL – Rs 355.00

Now for every four shares of PLSL, we will receive 1 share of PHL. So, cost of acquisition of 4 shares of PLSL = Rs 86.00×4 = Rs 344 = Cost of acquisition of 1 share of PHL. So, we are basically getting an arbitrage opportunity of 3%.

Did we miss out something in the above calculation?

Yes, we missed out accounting for the residual business of PLSL i.e. Herbal Products division. Even after the proposed de-merger of NCE Research unit of PLSL into PHL, PLSL shareholders would still be left with Herbal products division that markets neutraceutical products.

On the ex-date, the shareholders of PLSL may see the stock price of PLSL trade in the range of Rs 5-20 (We haven’t done the appraisal of Herbal products division, so can’t comment on the valuations of the same). At Rs 5.00, the market’s will be valuing the business at Rs 13 crores, while at Rs 20, the market’s will be valuing the business at Rs 20.00 (Remember ex-date is a high volume trading day, so stock can quote at any levels).

So let’s do the calculations again for determining the cost of acquisition of 1 share of PHL for two extreme case scenarios.

Ex-date price of PLSL as Rs 5.00

You buy 4 shares of PLSL before the ex-date at Rs 86 (Rs 86.00×4 = Rs 344).

You sell all the 4 shares of PLSL on the ex-date at Rs 5 (Rs 5.00×4 = Rs 20).

Your cost of acquisition of 1 share of PHL thus comes at Rs 344 – Rs 20 = Rs 324 against the CMP of Rs 355. This gives you an arbitrage opportunity of approximately 9.56%.

PHL is listed in the F&O space with a lot size of 500 so one can lock in profits by going short in Futures. While the Sep’11 and Oct’11 series are fairly liquid, the spreads are very high in Nov’11 series.

Ex-date price of PLSL as Rs 20.00

You buy 4 shares of PLSL before the ex-date at Rs 86 (Rs 86.00×4 = Rs 344).

You sell all the 4 shares of PLSL on the ex-date at Rs 20 (Rs 20.00×4 = Rs 80).

Your cost of acquisition of 1 share of PHL thus comes at Rs 344 – Rs 80 = Rs 264 against the CMP of Rs 355. This gives you an arbitrage opportunity of approximately 34.46%.

Very Important:

  • PHL is listed in F&O space so can always lock in profits by going short in futures, however for the same more funds will be required as the lot size for PHL is 500.
  • The scheme of de-merger has not yet been approved by High court, so if you perform the operations now and if the approval gets delayed you run yourself against mighty Market risks.

Disclaimer: The above article is based on some initial research done at our end. This should not be construed as an investment advise, nor have we advised our members of Alpha Plus portfolio until now. The finer nitty-grities are yet to be determined.

Ekansh Mittal [ekansh@katalystwealth.com]