The Inefficient Market Hypothesis: Ballarpur Edition


Efficient Market Hypothesis (EMH) is a theory by Eugene Fama that argued that markets are efficient nearly all the time. So stock selection either based on the concept of value or the concept or market timing. In other words he argued that it was fruitless to engage in investing by buying undervalued stocks or selling overvalued stocks since markets never either undervalued or overvalued stocks based on the information that was currently available on hand.

But this, for the most part, is a load of bull.

We have seen, time and again, that you can indeed generate excess returns through selection of stocks. If Efficient Market Hypothesis was really true, we should have not seen the likes of Warren Buffett, who has made his name buying undervalued stocks (or businesses) or Jim Chanos who has made his name generating returns by selling over valued stocks.

Jim Chanos was the guy on the other side of the table as a big stock picker, Bill Ackman, in the Valeant trade. Ackman lost 95% on that trade. Chanos calls it a fraud equivalent to Enron, and has made a significant profit.

If there was any doubts about Efficient Market Hypothesis, the year 2008 well and truly buried it deep. Nothing’s efficient about markets – other than by sheer accident.

Opportunities which defy logic is available multiple times on a host of stocks. Just the other day, we wrote on the opportunity in the Motilal Oswal MOSt Shares NASDAQ 100 ETF which was and is still trading at an abnormal premium to its Net Asset Value.

The interesting case of Ballarpur Industries

Ballarpur Industries is India’s largest manufacturer of writing and printing paper with a market capitalization of 1200 Crores and an Enterprise Value of 8200 Crores. But being the largest doesn’t count for much if the company cannot make profits.

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The company’s profit has been in a steady decline for a few years now and in the current year the company hasn’t even been able to generate operating profit. With Debts now at 7000+ Crores, interest in itself can eat up a lot of the profits that get generated. Over time, Interest as % of Operating Profit has moved up from 25% to 104%. In other words, the entire operating profit as of end of financial year 2016 wasn’t enough to cover the Interest part alone.

Recently bad stuff hit the fan. The company defaulted on some of its short term debt. The resulting downgrade hit many debt / liquid funds from the Taurus Mutual Fund house that this became public knowledge. We covered the same here and a follow up here.

While the company defaulted on its debt on or around mid-January 2017, it was only towards the end of February 2017 that the rating agency downgraded the company to default and one that triggered a cascade of events that are yet to settle.

But, what about the stock?

One would expect a company which has 7000 crores of debt to be able to pay up small short terms such as the one it defaulted. If you can’t pay a few 100 cr., how will you pay more? And if you can’t pay, the lenders can take over your assets and sell them and try to recover their money. The shareholders will be left with nothing (or just what’s left). That means the share should crash.

A stock such as that one would assume will hit 52 week lows since there is a real issue on hand and an equity share holder is the last in the list of who will get paid, if anything, if the company goes to bankruptcy.

Our efficient market in action:

But markets being irrational, we instead have seen the stock hitting a new 52 week high. Markets while can be irrational in the short term, is rational in the longer term.

Ballarpur’s debt is a hot potato on the debt markets: no one wants to own it. Mutual funds are making deals to convert some of the debt to be covered by other promoter managed entities like Cromton Greaves Power. While this can help the books of Ballarpur on the face of it, you know that if there should be any recovery, the money will go back to debt investors. Shareholders are likely to be diluted substantially as banks and other lenders step up the game.

Yet, the stock doesn’t seem to care. Call it euphoria, or anything else, but this is a matter of things known to a few people but not to others. In other words, an inefficient market.

In 2012, we wrote about a similar story with regard to Deccan Chronicle where we strongly felt that the stock which then was trading at 13 would go to zero. The last traded price on BSE before it was delisted was 2.07 (it was delisted from NSE way before that).

Does Ballarpur go the same way as Deccan Chronicle? Or does it stage a miraculous recovery by somehow making bond holders take a hit, but shareholders don’t? But the simple point is this: equity markets love this stock, and debt markets hate it. The inefficiency is in one market or the other, and this will serve as yet another example of why markets are supremely inefficent, due mostly to information asymmetry.

(Big words. It means someone else knows more than you do.)