As investors, we need to go through market news on a daily basis, as it would help us make important decisions. During the past few weeks, you might have read or heard about GMM Pfaudler. The company comes under India’s heavy engineering sector and is now under the scanner of regulatory authorities due to serious allegations of insider trading. Let us dive into the details of how the multibagger stock came into the spotlight, and how its latest offer for sale is too good to be true.

Company Profile

Firstly, we shall look into a brief history of the company, and how it has evolved over the years. GMM Pfaudler was established as a joint venture of Gujarat Machinery Manufacturers (GMM) and Pfaudler Inc. (an American multinational company that invented glass-coated steel). Ever since the technical collaboration began in 1987, the company has been a leading supplier of essential glass-lined and non-glass lined equipment for the pharmaceutical and chemical industries around the globe.

In 1999, US-based Pfaudler increased its stake in GMM to 51%, and it was at that point when the company was renamed GMM Pfaudler. Since the demand for their products is always high, the company has been showing great potential ever since its inception in the Indian market. It is notable that in 2015, Deutsche Beteiligungs AG (DBAG), a German equity company, acquired Pfaudler Inc.

Over the past few months, the company’s stock was rising sharply and had outperformed the Nifty 500 index. Its earnings grew by 27.7% over the past year. There has been a 6-time increase in share price since March 2018 to a high of approximately Rs 6,900 per share in August 2020.

GMM Pfaudler manufacturing plant in Gujarat. (Picture sourced from the company website)

Recent Developments

The company’s low-float stock (these are stocks with a low number of shares and more institutional ownership) has shown a decline of 35.97% since August 2020 on the NSE. This specific period in time becomes very important, as the company makes a major announcement. GMM Pfaudler would buy a 54% majority stake in its parent company, the Pfaudler Group, for $27.43 million (~Rs 202 crore). This stake would be acquired directly, and through its subsidiary called Mavag AG, while 26% would go to Indian promoter Patel Family, and the rest 20% would remain with the German company DBAG. It is interesting that GMM Pfaudler is buying stake in the international Pfaudler group. To fund this acquisition, GMM Pfaudler and its subsidiary will use its own reserve of earnings up to Rs 75 crores ($10 million) and also take on a debt of Rs 130 crore ($17.4 million). The question that comes to mind is, was this a necessary transaction?

In September, another major development that took place was their new issue of an offer for sale (OFS). An OFS refers to a method by which the promoters of a company sell a part of their existing shares and get an exit.

It was on 22nd September that GMM Pfaudler announced an offer for sale at a floor price of Rs 3,500 per share. This was a 33% discount from the previous closing of Rs 5,241. What this means is a sale of a 17.6% total stake of the promoters at a very high discounted rate. This could actually be a strategy to bring in high-quality, long-term investors into the company.

Things have been quite chaotic since then. What happened just before this announcement is what potential investors are worried about. A lot of positions were taken in the Stock Lending and Borrowing Mechanism (SLB) in NSE. In simple terms, SLB is a method by which traders can borrow shares that they do not already own, or can lend stocks that they own. So, a lot of shares were borrowed using SLB, and shorted (sold) during the OFS. It is quite strange when we check the SLB data, as it shows that a lot of activity has taken place from 11 August to 25 September- a total of 87,283 shares were borrowed. Also, the management did not produce a caution statement when stock prices went through the roof with abnormally high valuations, as this would have helped new investors to think about investing at high prices. Promoters of GMM Pfaudler had been selling shares below Rs 3,845, which might imply that lower prices are reasonable for them. This is what led to the allegations of insider trading, as the ‘insiders’ did not buy shares themselves, and rather, were trying to sell them off.

In the days that followed, stocks of GMM Pfaudler started declining by a maximum daily limit of 10% to Rs 4,717. The lowest price touched by the stock during this period was at Rs 3,432 on 29 September, which was even below the OFS price. On that day, Plutus Wealth Management, a UK-based financial advisor, bought 1,65,000 shares of GMM Pfaudler at Rs. 3,528.75 per share from the open market. On the same day, stock prices were locked in a 5% upper circuit at Rs. 3,821. For further clarity, an upper circuit refers to the price of a stock that cannot be traded beyond a specified limit on a particular day. After this update of acquisition of shares by Plutus Wealth, what we saw the next day was a further 5% rise in share prices of GMM Pfaudler, to Rs 4,012.

The Managing Director, Tarak Patel has addressed these allegations, stating that the company would help or assist any regulator who would investigate the serious claims. It is noteworthy that GMM Pfaudler’s insiders (or promoters) DBAG, would own roughly 32% stake and the Patel family would have 22% even after the offer for sale. The MD also stated that the promoters would remain with the company for a minimum of 3 years, and are not presently cashing out their stake. SEBI or other regulatory bodies would investigate the matter, and check for any irregularities in the company’s records.

An important takeaway of this whole situation as explained by experts is the fact that investors need to be very careful, and be aware of the risks involved when investing in a company whose valuations are very high. And when huge discounts are given for an Offer for Sale (OFS), it means that even the promoters don’t believe in the current valuation of the company. The stock currently trades below Rs 3,800 (as of 6 October).

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