45% Discount due to an "ill-managed" Rights Offering
and the 84% majority owner can't get enough of it
disclaimer: this article talks about a time-sensitive special situation with high volatility. Not investment advice.
Summary
Through a head-scratching rights offering that raises a mere $5Mn from public shareholders, Sify SIFY 0.00%↑ caused the market panic and lost ~30% (adjusted for dilution effect) of its market cap ($70Mn) in the last 2 weeks. If one buys its rights SIFYR 0.00%↑ now, and exercises to purchase its share before 6/21 (rights expiration date), it gets another 20% discount off its current share price.
That is a total of 45% discount to its pre-offering stock price, with no fundamental change to its core business.
Background
Sify Technologies SIFY 0.00%↑ is an ICT (Info Communication Technology) company providing telecom, data center, and Cloud services in India. At ~$400Mn LTM revenue, its 6-7% operating margin roughly covered its interest payment, thus a, by and large, breakeven business.
The sequence of Events (Rights Offering)
3 months ago, on 3/20/24, Sify announced a rights offering plan: each share is offered 1.36 rights, and each right could purchase a new share at $0.14. (The stock was traded at $1.34)
5/10, amended registration statement (F-1) was in effect.
5/21, it announced 3 key dates: 5/31 rights record date, 6/7 rights commence date, and 6/21 rights termination date.
On 5/31, the rights were issued. The majority (84%) owner (Raju Vegesna, also the chairman of the Board) intended to participate in the offering and exercise its over-subscription right. (aka backstops the offering)
On 6/7, the rights started to trade as SIFYR 0.00%↑
The market’s initial reaction after the announcement (3/20) was positive. It last traded at $1.34/share before the 3/21 announcement, and it closed at $1.67 on 5/30 and opened at $1.03 on 5/31 after the rights record date, which priced the rights at $0.47/share.
That math by and large checks out. On 6/7 (the first trading day), the rights traded between $0.45 and $0.55 a share. However, it dropped from 0.5/share to $0.1/share in the next 2 days (6/10-6/11). It recovered some and closed at $0.2/share on 6/13 (see SIFYR price chart below).
The Why
How to explain the sharp rights price drop on 6/10 and 6/11?
On 6/7, Sify released a 6k filing, titled “Voluntary Delisting Date of its ADS Rights from Nasdaq”. The filing is consistent with the offering plan and offered nothing new: the rights are tradable from 6/7 to 6/18 and expire on 6/21. However, the head-scratch title caused confusion and panic among investors. The other possible factor is that before the rights offering, the stock had been hovering around its lowest price since Covid, and many investors hesitated to throw the good money after bad, thus deciding to sell the rights.
The Deeper Why
At first glance, Sify mismanaged the equity raise. To raise a total of $30Mn, it wiped out nearly $70Mn equity value. Noted that its largest shareholder (also Board Chairman) owns ~85% of equity, thus it effectively raised $5Mn from the public shareholders.
Why not raise the money via debts from the majority owner (Raju Vegesna), and avoid all this drama? And as we examine the balance sheet, the raise doesn’t warrant any urgency either.
One plausible explanation is Mr. Vegesna’s true intent was to increase his equity ownership (expect some might give up the rights, and he will backstop), thus reaching the 90% threshold to qualify for a squeeze-out. If that’s true, he doesn’t care about price drops due to rights offering, it benefits him.
If that’s true, it could also explain the head-scratching 6k filing on 6/7 that we discussed before that caused market confusion and panic.
The Math
The rights SIFYR 0.00%↑ trades at $0.2/share (as of 6/13 closing), one can buy the rights and pay 0.14/share on or before 6/21, thus owning the stock at 0.34/share.
The stock trades at 0.43/share, a 25% value gap between the rights and the stock.
If I use $1.34/share (the last trade price before the rights announcement on 3/21) as the benchmark, and with 1.36x dilution (from 183Mn to 433Mn share), and $29Mn equity raise, the equivalent after dilution stock fair price is $0.63/share. It currently trades at 0.43/share, and one can acquire it via rights at 0.34/share today, offering ~45% discount to the pre-rights announcement price.
The Risk
I don’t have a view of the company itself. I use relative valuation to compare pre and post-rights offerings, assuming the offering has no impact on the company's intrinsic value, other than the injected cash ($29Mn).
Thus if all else is equal, the stock shall trade where it was valued before ($0.63/share) once all dust settles.
The primary risk is there are many ‘if’s in the scenario.
2nd risk is if Vegesna reaches 90% equity ownership, it sets the stage for its squeeze-out, I’m not familiar with Indian market rules and regulations, and how minority public shareholders are protected in the event of squeeze-out, thus risks of being taken private at a substantial discount to the pre-offering price.
Two Execution Strategies
A basket trade (Long Rights, short stock in parity) offers a lucrative 25% upside in 8 days. SIFY borrowing cost is 18% (last checked with Fidelity), a relatively high %, but still a neglectable dent to the overall profit. However, its borrowing availability is dwindling as we speak.
If borrowing becomes unavailable, the 2nd strategy is to buy rights* and purchase shares at a total cost of $0.34 per share.
Note 1: one risk worth noting is Sify has the right to cancel the right offering anytime before its expiration.
Note 2: if one plans to purchase rights, check with the broker to ensure it supports the rights conversion. Also note the last trading day of the rights (SIFYR) is 6/18, next Tuesday.
Parting Thoughts
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