by Aakash Athawasya

It’s not every day you see a mid-cap company rise by 60% in a week to its lifetime high and then a month later lose 46%. Yet this is what transpired with GMM Pfaudler. 

The glass lined equipment manufacturer servicing the pharmaceutical and chemical industries is now at the center of a shareholding and unauthorized insider trade controversy. In a span of one week, the company’s promoters decided to cut their stake in the company at a deep discount via an Offer For Sale (OFS), an insider possibly used that information to short-sell, and the management cried foul after falling share prices, accusing parties of ‘misrepresentation of information.’ The street, sensing trouble, offloaded the company’s stocks as quickly as they could.

GMM Pfaudler, as it is known currently, is owned partly by the Patel family and the Pfaudler group as a joint venture. GMM or Gujarat Machinery Manufacturers was established by the Patel family in 1962, listing on the Bombay Stock Exchange. In 1987, Pfaudler Inc., the world leader in glass-lined equipment acquired a 40% equity stake in the company, leading to the joint venture. In 1999, Pfaudler stepped up its stake to 51% and the company was renamed as GMM Pfaudler.

Buying out the parent

Fast forward to August 2020, to an unusual sale involving GMM Pfaudler. On August 20, the company announced that it would be acquiring a majority stake in its parent company the Pfaudler Group for $27.4 million (~ Rs. 202.2 crores) from Deutsche Beteiligungs AG (DBAG), a German private equity company. The GMM Pfaudler India management called this "a proud moment". 

This would account for a total 54% stake in the company, of which 34.4% would be taken by GMM Pfaudler directly and 19.6% would be through Mavag AG, its wholly-owned Swiss-subsidiary. Back in 2014, the private equity firm DBAG had agreed to invest 8 million euros (~Rs. 69.2 crores) in the management buyout (MBO) of Pfaudler from National Oilwell Varco, a US-based oil & gas distribution company.

But then, September's Offer For Sale (OFS) announcement riled up investors. On September 24, DBAG released a statement stating that the PE-firm has “partially exited” Pfaudler. The exit would amount to 18% of their stake in GMM Pfaudler, which would decrease their holding from over 50% to approx 33%. DBAG would still remain the largest shareholder in the company. The PE-firm added that it would maintain its 20% stake in Pfaudler’s European and American core business. The statement read,

“GMM Pfaudler is enjoying market-driven tailwinds: as a leading provider of production systems for the pharmaceutical industry...DBAG Fund VI and DBAG continue to participate in GMM Pfaudler through their remaining equity stake.”

DBAG’s 18% sale would be accompanied by the Patel family also offloading 2.3% of their 25% stake in the company. The market’s immediate concern however, was that the price of the OFS at Rs. 3,500, was a deeply discounted one, a 33% discount against the trading price at the time.

In price terms, this seemed like a steep discount, but in valuation terms it isn’t. The discounted OFS was still over 72 times GMM Pfaudler’s price to earnings. Before the OFS announcement and the subsequent sell-off, the company was trading at a PE of over 120 times. 

In the industrial machinery market, currently, only Elgi Equipments has a higher PE than GMM Pfaudler.

Management panics, holds investor call

The discounted OFS pulled the trading price down by a difference of 33% in less than a week, causing the management to run helter-skelter to provide explanations. Following several appearances with broadcast media after the OFS, the management addressed investors during a hurriedly scheduled call on September 25. 

Tarak Patel, the managing director of GMM Pfaudler said that the proceeds from the family’s sale would be “directly reinvested in the international business.” Following the sale, DBAG would hold 32%, the Patel family 22%, with the rest sold to the public. He added that this shareholding proportion would be “locked in for the next 3 years” with no dilution of shares or any other liquidity event.

Once the 3-year lock-in is complete, Patel said, the parties will take a “call on [in] terms of what needs to be done.” However, Patel did throw some light on the possibilities of what could transpire following the lock-in. He stated that DBAG could look to monetize their stake, alluding to a potential further sale of the PE firm’s stake, but the Patel family would look to deepen their ties and their holding with the company.

He said, “As we [the Patel family] will also look to increase our stake, we want to emerge as the dominant promoter. After a 3 year period, we would like to increase our stake close to 30% and that is something that we will time the right mechanism to do that at that time.”  

Freedom to float

One of the main points raised during the OFS ordeal is the float capitalization of the company. Prior to the sale, GMM Pfaudler’s free float stood at 25%, a relatively low amount that increased the company’s valuations owing to the low supply of publicly traded shares and its high value. Now with around 20% combined stake of DBAG and the Patel family being sold to the public, GMM Pfaudler’s stock is expected to see an uptick in liquidity.

Speaking on the issue of GMM Pfaudler’s low float before the OFS, Tarak Patel stated that this prevented the company from attracting new investors. However, following the expansion of the floating capital, he argued, the company can “bring in high-quality investors to increase the free float to close to 45%.” With reference to the discounted price of the OFS, he compared this to a “re IPO,” stating,

“We believe that the value is a fair value, there has to be price discovery when the stock is so closely held in a niche business, in the business that is not very was able to bring in very high-quality investors it’s really like a re-IPO for there is definitely price discovery that happens and I am very happy to share with you today that we have a very-very strong shareholders roster.”

This argument from Patel suggests to investors that the OFS price is the true value of the company shares. 

Not naming names, Patel also stated that the company has “about 3 or 4 top money managers from the US” and it has “a very strong institutional investor base here from India which includes the top 3 to 5 mutual funds.” He added, despite it being less than a week since the OFS was announced these potential bulk buyers were already in the process of conducting their due diligence prior to investing. He said,

“They have checked on the governance, they checked on the business aspects, they have looked at every minor detail of the company and they found it good to invest in...These are long-term investors, they normally hold for 7 to 10 years, they give the management bandwidth, time, and space to really work out and do and focus on the business.”

Unusual behaviour in the SLB segment: Someone in the know?

During this entire episode, the trading price was quickly catching up to the OFS discounted price. And in the market, someone privy to this insider information was making large volume trades on GMM Pfaudler’s stock using the securities lending and borrowing (SLB) mechanism. 

SLB is a short-selling mechanism by the NSE which allows traders to sell a stock they do not own. Idle stocks can be borrowed through the clearing corporation/clearinghouse for a specific fee. If the price drops, the short seller will re-purchase the stock, and pocket the profit. 

Even before the management revealed that the OFS was priced 33% below its trading price, there was a lot of borrowing in the GMM Pfaudler market. Data from the NSE on GMM Pfaudler’s trading via the SLB method suggests massive short-selling between August 11 to September 29. 

On August 11, before GMM Pfaudler announced it would acquire a majority stake in Pfaudler Group, 38 shares were borrowed through SLB. Between 11 August to 15 September, not a single share was borrowed. But in the next 15 days, 88,745 shares were borrowed in 544 separate transactions. 

The borrowings peaked on 17 September, a week prior to the OFS announcement, with 44,558 shares borrowed, representing over 50% of the total borrowings between 11 August to 29 September. In fact, between 16 September to 24 September, the average shares borrowed per trading day was 12,229 shares. As the price drop reversed so did the borrowing. This week only 1,500 shares were borrowed, or 1.6% of the total borrowing between the period.

Data source: GMM Pfaudler, SLB, NSE 

GMM Pfaudler’s SLB surge wouldn’t have drawn attention if the stock was highly liquid and in the F&O segment. But such behaviour for a low liquidity stock is unusual.. Speaking to ETPrime, a market research analyst said that “For stocks like GMM, which are not in F&O and very illiquid, people don’t do such kind of trade in the SLB market.” The analyst added that since the SLB volume rise was a clear anomaly, “somebody in the know is trying to benefit.”

The party privy to this insider information about the OFS possibly borrowed heavily, sold at a high price, and pocketed the gains as the price fell. The analyst stated,

“The party knew that the floor price will be at a discount at INR3,500 per share and they knew this will be a large dilution. So basically, they used that information to make money.”

Tarak Patel said during the investor call last week that the SLB matter had brought the company into “negative limelight again.” He stated the process of transferring ownership when the company is bringing in high-quality investors, there is no need for anyone with insider information to take a “risk-on short term benefits which in the long-term will have more reward.” He added,

“So that’s something again that I want to just reiterate that our conscience is clear. We are willing to help any agency that would like to check or need information from us. We as a company are very conservative when it comes to governance”

With an investigation by the market regulator SEBI all but certain, there are several questions to be answered. Was this a case of unauthorized insider trading? Did anyone from the company, or related parties use this information to short-sell? Who is the source of the massive SLB borrowing?

Additionally, who are the new onboarded or yet to be onboarded investors for which the OFS was discounted so heavily? While the answers to these questions will be revealed in time, one thing is certain. For GMM Pfaudler, the story is far from over.