Delisted stocks: High-stakes game with insane pay-offs

Delisting can be a scary word for minority shareholders. Often, the shareholders exit the stock, taking whatever offer price is being offered. (Photo by Daniel Abbatt/Pexels)

On May 9, despite spirited resistance from minority shareholders, the proposal for voluntary delisting of Elcid Investments went through.

Elcid Investments is an investing and trading company, majorly owned by the founders of Asian Paints.

Eighty eight percent of the shareholder votes were in favour of the move and only 11 percent were against it. But, if you look closer at the voting pattern, it is easy to see that this isn’t what the minority shareholders wanted. While promoters and promoter groups voted unanimously for delisting, public shareholders voted overwhelmingly against it – approximately 68 percent said no, 32 percent said yes.

Delisting can be a scary word for minority shareholders. Often, the shareholders exit the stock, taking whatever offer price is being offered. Even if they think the company isn’t offering a fair value – at Elcid, minority shareholders believe that the stock is worth nearly 6x the floor price.

The history of the stock market is littered with such examples – shareholders of Bharti Telecom in 1999, Philips India in 2004, Vedanta in 2020, DHFL in 2021, and so on.

But, is the delisted world so fraught with trouble?

Moneycontrol spoke to a few brokers who have placed their own money in such stocks, and asked them why and how they play this field.

Rajan Shah, of 3A Capital Services, is considered to be one of the biggest names in the delisted shares space.

Shah was recently in the news for selling 9.04 percent in Elcid to Hydra Trading, a trade which allegedly moved the needle in the holding company promoter’s favour. A minority shareholder Dhiraj Mittal had alleged that the trade moved a large amount of shares to the promoter’s friends, which would make it easier for the promoter to delist without paying minority shareholders their fair price.

The delisting may place many minority shareholders in an unfamiliar territory, but not Shah. He knows it like the back of his hand.

Shah spotted his first opportunity in the delisted space in Phoenix Mills while doing his CA articleship in 1996. The company’s shares were suspended at the time.

“I realised that it had a huge land bank and so took a loan for Rs 50,000 and bought the company’s shares which were then trading at Rs 100,” he told Moneycontrol. When the company was relisted on the BSE a few years later, he sold his entire holding for Rs 4,000/share (after a share split of 1:10).

With the profits – of around Rs 20 lakh – he dived into the trading business.

One of his biggest returns came from one of the biggest failures in the telecom industry – Iridium India Telecom. The company was founded as a consortium of nine financial institutions including ICICI Bank, IDBI and SBI, to invest in one of the world’s first mobile phone models. It was invited to invest in Motorola’s Iridium System/Project, which was to develop “global digital hand-held telephone data, facsimile, paging, geo-location services similar to today’s cellular phone” (according to a petition filed by Iridium India Telecom at the Supreme Court of India).

The project never took off and the consortium filed a case against the telecom giant, for cheating investors of Rs 500 crore. Four years after the Supreme Court started hearing the petition, Shah bought 24.97% of Iridium India Telecom’s shares – which numbered approximately 3.13 crore – for Rs 27,000.

It was a dud company at that point.

“To my good luck, Motorola wanted to settle in 2017. I was to be given Rs 31 crore but the banks negotiated and settled it at Rs 19 crore,” he said. Over three years, he had made a return of 7,037x!

But what was the logic behind investing in a company that had nothing but a criminal case it was pursuing against a global telecom major? “I knew that Motorola had placed a deposit of Rs 200 crore in the court (during the course of the case). Since it was a settlement case (where even equity shareholders have a right over the claim) and not a winding up case where only creditors have a claim, I thought there might be value there,” he said.

He admitted that it was a bit of a gamble but Rs 27,000 isn’t a big bet to place if the reward could be that big. “We used to buy this sort of junk stock regularly and one out of a hundred of these buys could pay off,” he said.

Spotting these opportunities does not come easy. “In the beginning, it was easy. We were the only players around and so there wasn’t much competition for these companies’ shares. But now, it is different,” he said.

Shah has been buying small stakes in thousands of companies over the years, which gives him access to their balance sheets.

He reads the balance sheets of at least three or four companies every day without fail. “I look at the topline first, then the cash flows and reinvestment of cash flow. We want a consistent management that is focussed on one particular business,” he said.

He evaluates these companies like he would any listed company, by analysing the business model, its management and valuations of peers. “The stock should give at least 25-30 percent return. A listed blue-chip company gives 13-14 percent returns. So, with a delisted share, it should give this much more (as risk premium),” he said.

After buying a small stake in companies and reading their balance sheets over two to three years, if Shah is convinced about the growth prospects and does not see any red flags in the statements such as unreasonable expenses or extending loans to subsidiaries, then he buys a bigger stake in the companies.

The next leg of the battle used to be getting shares transferred to his name, when there was physical delivery. His hardest fight was with a Hyderabad-headquartered manufacturer of raw cotton and cotton yarns. “They have a huge land bank of around 1,100 acres near Hyderabad. I had to fight a case for five years for that to be transferred to me. Meanwhile, they sold a portion of the land to one of the brothers at a highly marked down price,” he said. After that he fought another case to stop the promoter from converting partly paid-up shares to fully paid-up shares even after the deadline for it had passed. This time he lost and his 40 percent stake was diluted to 30 percent.

This risk is now largely eliminated with dematerialisation of shares.

The risks in the delisted space, as far as he can see, are fighting these legal battles, finding buyers and the lack of transparency. Finding buyers isn’t too much of a problem for him or anyone who has been in the game for long. They have built their network of HNIs who have the capacity to wait and fight cases if need be. Transparency is another ball game though.

Keeping track of the company’s activities becomes more difficult since companies aren’t bound by the regular disclosure requirements for listed entities. “By and large there is risk. Even when we meet them, we can’t be sure that the promoter will definitely say whatever they are doing,” he said.

In his experience, when the promoter shareholding is about 60-70 percent, the management usually doesn’t do anything to reduce the value of the company. That said, Elcid (a listed company with a massive promoter holding) was a “big hassle” for him. He said that he ultimately sold 9 percent (approx) of his 11 percent (approx) shareholding, tired of the long and hard fight – going to court, approaching the exchange and even the regulator.

After the delisting, Shah may retain a small holding in Elcid. “It is a good company,” he said, and if the going gets tough, he is familiar with the battlefield.

Altaf Siddiqui, CEO and MD of Enrich Advisors, is a rare kind of investor who does not trade in listed stocks at all. Usually, traders of delisted, unlisted and pre-IPO stocks have a share in listed stocks too, but not Siddiqui. It is a tough and risky investing strategy, and involves a lot of leg work and having clear boundaries on the risks he is willing to take.

Many traders in delisted stocks enter through the unlisted space and Siddiqui did too. Delisted stocks are stocks that drop out of the exchange either voluntarily or because of a Securities and Exchange Board of India (SEBI) order, and unlisted stocks are those that were never listed.

Around 2010, RBL Bank was in the unlisted market. Whenever it raised funds in the primary market, the private equity holding in the bank fell below the statutory cap of 5 percent (IS THIS RIGHT?) and private equity (PE) funds would want to buy more. It wasn’t an easy thing to do because the bank’s shareholders were in thousands and they were scattered across the country. Siddiqui and his team used this logistical opportunity and bought holdings from these shareholders and sold it forward to the PE.

“You can get the details of the shareholders, that is their address, phone number, and so on, by writing to the company secretary. If we found a shareholder in, say Kolhapur, we would also reach out to others in that area through him… we sourced shares worth several crores for three to four years till it got listed,” he said.

After this, he has been trading in delisted stocks too.

It isn’t easy to find an opportunity here. “Finding good quality delisted stocks is like finding a needle in a haystack. The universe is very big but the area we operate in is very small,” said Siddiqui, who largely sticks to companies which delisted voluntarily.

“I don’t go by tip-offs. In fact, I am generally suspicious of them,” he said. If any idea looks promising, it is run through the team’s checklist, which has about 13 conditions that a stock must fulfil.

The first few are broadly on corporate governance. “I see if there is any litigation, say on the promoters, the parent or subsidiary companies… and not just in the company I am considering, even in other companies the promoters are associated with. Second, I check if the companies follow law by the letter or law by the spirit, (and pick the latter). Third, if they are treating their vendors fairly, like paying them on time. Our team talks to the vendors for this. Fourth, we check how they are treating their employees. We even scan social-media posts for this. Then, I go through the auditor reports and look at their comments, if they are the usual that the auditors record for peer companies or if they are out of the ordinary. Since we don’t have direct access to the management, these things help.”

Corporate governance isn’t a one-time check for him. It is an ongoing one. It is a hard lesson he took from a bad experience in the unlisted holding of a stock exchange, because he believed that there was space for a third stock exchange. “It had passed our checklist, but there were corporate governance issues that were being reported consistently. We ignored it and that bet went badly,” he said.

Usually, delisted stock owners tackle corporate-governance issues through litigation. They treat it as an occupational hazard. But Siddiqui steers clear of it. “I never go to litigation. If there is a red flag in corporate governance, I dump the stock. I don’t chase value there, even if it is a Rs 100 stock selling at Rs 10,” he said.

It isn’t easy to drop a stock or an investment idea. Finding an opportunity in such a wide universe filled with duds involves a lot of research, and the tendency is to justify the effort by backing it. “The human mind plays such tricks… but one thing I remember clearly from my education is that you don’t throw good money after bad,” he said.

One easy way to ensure that corporate governance standards are maintained is to buy into companies with foreign holding, according to him. For example, Philips India.

In the late seventies, the late George Fernandes who was then the industry minister pushed foreign companies to dilute their stakes in their Indian operations to 60 per cent. The foreign companies grudgingly did so and many exited the stock market through delisting at the first opportunity.

These stocks are valuable in the delisted space.

In general, the checklist seems to have worked because promoters he has associated with have been fair and responsive to the demands of the minority shareholders.