In this week's Finshots Markets we talk about DFM Foods, Private Equity investors and the stock market.

The Story

Have you heard of this company — DFM Foods?

They make Crax Corn Rings and Cheese Balls. Snacks that people have come to love. But there’s something happening inside the company.

Just six months ago, shares of DFM Foods were trading at ₹196. Today, they’re at nearly ₹450.

So what’s driving the rally?

Well, the thing is — The company isn’t doing all too well financially.

Wait…what?

Okay, let’s go back to 2019 and see what’s really happening here. At the time, the Indian snacks market was growing rapidly at over 20% annually but DFM Foods was lagging behind. Its revenues had grown by only 7.5% in the previous three years and it wasn’t doing all too well.

That’s when the  global PE firm Advent International decided to make inroads into the Indian snacking business. They looked at the market and zeroed in on DFM Foods. They figured that they could capitalize on the company’s lacklustre growth and buy it out for a bargain. After all, it had lost half its value in just 2 years after being listed on the stock exchange. It looked cheap.

So Advent International stepped up. They picked up a nearly 74% stake in the company. DFM’s other investors cashed out for a nice payday. Advent tweaked the business model, overhauled the management, and waited for things to change.

But things didn’t quite go as planned. Maybe it was the pandemic, or maybe it was something else. But the company’s sales plateaued at 4%. The margins headed south. And the stock price went downhill too.

By mid-2022, Advent International had enough.

No, we don’t mean that they were looking to exit. They actually wanted to take the entire company private again. Or rather, buy them out and delist the stock.

Why?

Well, we don’t know for sure. But typically, PE firms do that when they want to get away from the glare of the public market ecosystem — quarterly calls, annual reports and all that brouhaha. They might have had a plan in place to take the company to new heights. Or turn it around. And perhaps they believed they could do this if the company is private. And don’t forget that FMCG companies aren’t having a great run at the moment — the cost of raw material is increasing every day as we speak and they’re having trouble passing these costs on to consumers. Explaining all this to investors in a quarterly meeting can be hard especially if you are not meeting expectations. So maybe Advent wanted to avoid all that drama and execute its strategy at its own pace. Away from the constant scrutiny of stock market investors.

Sidebar: Remember when Elon Musk tweeted that he’d take Tesla private? Well, with the value erosion we’ve seen in the stock of late (it’s down over 60% this year), maybe he should’ve done that instead of buying Twitter.

But this brings us to another point. Investors get quite the payout when a stock delists. You see, the buyer has to sweeten the pot for people to give up their shares. So they pay a hefty premium to its current price — typically it’s around 30% higher.

So when the news that Advent International was considering taking DFM Foods private began to do the rounds, investors perked up. They started bidding the stock price higher. They figured they’d be able to squeeze out a higher price from the private equity firm and everyone wanted in on it.

Now, this is how a delisting in India works.

First, the buyer does a valuation and sets a floor price. This is based on the price the stock traded during 26 weeks prior to the delisting. Think of it as the bare minimum price that the buyer will pay. And then begins the reverse book-building process. This helps to discover what price shareholders actually expect the buyer to pay. And it can be way higher than the floor price. The shareholders are given a certain window of time. They can offer their shares and say, “I’ll give you my shares if you pay me ₹xx.”

And for the delisting to be a success, the buyer needs to snag a total of 90% of the shares (including their own).

So, Advent International set the floor price at ₹263.80. And then set out on this journey of price discovery through reverse book building. Investors placed their bids and said, “We want ₹525 per share.”

Advent was shocked. This was way, way higher than what they wanted to pay. So on 21 December, they told shareholders that they were rejecting this offer. Instead, they made a counteroffer and said, “Hey, how about we pay you ₹467 per share? You have to remember that just 6 months ago, the shares were languishing. The only reason it’s soaring today is because we said we’d take it private. And all of you jumped at the chance to make money.”

Will investors accept this new deal? We don’t know.

But here’s the thing about this delisting process in India. In the US and UK, the buyer is in charge. They simply decide on the offer price and fix it. In India, the bidding process ensures that small shareholders have a say as well. It works in their favour.

But there’s a flipside to this. Reverse book building can create too much price uncertainty. Investors can really quote whatever price tickles their fancy. And it can be quite unrealistic in some cases. For instance, Bloomberg looked at delisting deals worth over $100 million in India in the past 7 years. And they found that most deals happened at a premium of 45–67%. That’s actually double the premium that buyers in other parts of the world had to pay.

The classic example was when Baring Private Equity Asia tried to take IT firm Hexaware Technologies private in 2020. Investors demanded a premium of 66.7% over the floor price of ₹285 per share. And Baring accepted it. Simply because they’d tried to exit the firm many times in the past. But each time news emerged of a potential sale, the stock price would jump. And that would deter potential investors from making a high-value offer. It wanted none of that. So it first took Hexaware Technologies private. And then sold it off to another PE firm Carlyle for $3 billion in 2021.

So yeah, delisting in India can get quite complicated. And apparently, bankers and financial institutions are lobbying for a change. They want to do away with reverse book building. Because while PE money-backed delistings are witnessing a boom globally, India’s not seeing much action on that front. So maybe some change in rules could help attract foreign investors.

But if you ask Indian investors, they’ll probably want to stick to the old way of doing things. After all, they seemingly make more money this way now.

For now, we’ll have to wait and see how Advent International navigates the delisting process in India. Will the deal go through as the Hexaware delisting did? Or will it fail due to the high price being quoted?

You tell us.

Until then…

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PS: We won’t be publishing the Markets edition on 31st December. Since it’s New Year’s eve, we’ll be taking the day off to unwind with friends and family. We hope you have a relaxing start to 2023 and we’ll see you on 7th January!

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