Case 053Event-driven and merger arbitrageCore
Ushvin Industries, worth Rs 10,000 crore, will spin off Ushvin Chemicals, with EBITDA of Rs 300 crore against peers at 12x. Index funds holding the parent must sell the new shares. How do you trade the spin-off?
1The situation
Ushvin Industries, a diversified industrial group with a market value of Rs 10,000 crore, announces that it will demerge its speciality chemicals arm into a separately listed company, Ushvin Chemicals. Shareholders will receive Chemicals shares in proportion to their Ushvin holdings. Chemicals has EBITDA of Rs 300 crore and no debt; listed chemicals peers trade at 12x EBITDA.
Index funds own 20% of the parent. Chemicals will be too small for the parent's index, so after listing those funds must sell what they receive. Brokers expect Chemicals to trade about Rs 50 crore a day. As a standalone company, Chemicals will need its own board, finance team and systems, which the parent estimates will cost Rs 30 crore a year.
2Your task
What is Chemicals worth, how large and how long is the forced selling, when would you enter, and what could make the cheap price deserved?
Quick check
Where is the better entry point for a long position in Chemicals?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
At peer multiples Chemicals is worth about Rs 3,600 crore, but forced index selling can push it toward Rs 3,000 crore, so the entry is after listing, once the selling is done. Index funds must sell about Rs 600 crore, roughly 48 trading days of pressure at a quarter of volume. Net of Rs 30 crore of standalone costs, fair value is closer to Rs 3,240 crore, so the real gap is about 8%, not 20%.
Step 1What is Chemicals worth on its own?
Start with the peer multiple, then correct it. Rs 300 crore of EBITDA at 12x is Rs 3,600 crore, and with no debt that is also the equity value. But a spun-off business loses the head office it used to share, and those dis-synergiesCosts a business takes on when it separates from a group: its own board, audit, treasury, IT and listing costs that the parent used to spread across all its divisions. come straight off EBITDA. Rs 30 crore a year of standalone cost takes EBITDA to Rs 270 crore, worth Rs 3,240 crore at the same multiple. That is the number to hold, not the headline Rs 3,600 crore.
Step 2Why would anyone sell a business below its value?
Because some holders must sell whatever the price. Think of a family that inherits a flat in a city where no one wants to live: they sell quickly to whoever is buying, and the buyer gets a discount for being there. Index funds owning 20% of Ushvin will receive Chemicals shares they are not allowed to keep, about Rs 600 crore at a Rs 3,000 crore valuation. At Rs 50 crore of daily trading, if they sell a quarter of each day's volume to avoid crushing the price, that is Rs 12.5 crore a day, about 48 trading days, or more than two months of steady supply. Active holders who bought Ushvin for its engineering business and never wanted a chemicals company add to it.
Step 3How do you structure the trade?
Buy Chemicals after the forced selling fades, and hedge what you do not want to own. At Rs 3,000 crore the gap to peer value is 20%, but the honest gap after standalone costs is about 8%. To keep only the mispricing, short a basket of listed chemicals peers against the long, so a fall in the whole sector does not swamp the gap closing. Watch daily volume against the estimated remaining supply; when volume stays high and the price stops falling, the sellers are nearly done.
| Step | Number | Working |
|---|---|---|
| Peer value | Rs 3,600 cr | 300 x 12 |
| Less standalone costs | Rs 3,240 cr | (300 - 30) x 12 |
| Forced supply | Rs 600 cr | 20% of Rs 3,000 cr |
| Days to clear | about 48 | 600 / (50 x 25%) |
| Gap from 10x entry | 8% to 20% | 3,240 or 3,600 over 3,000 |
Index providers have their own rules for demerged companies, including whether the new company enters the index for a few days and when it is removed; those dates decide when the selling starts, so read the current methodology rather than assuming. The parent stub is the mirror trade: at peer value the rest of Ushvin is worth Rs 6,400 crore, and if the parent trades well below that before listing, the parent can be the cheaper way in, which you would hedge with the same peer basket.
Close with what would make the discount deserved. Chemicals may be sub-scale against its peers, it has no record as a standalone company, and the parent may have loaded it with contracts or debt it would rather not keep. If the first standalone results show margins below the segment numbers the parent used to report, the 10x price was right and the peers were the wrong comparison.
Where candidates lose it
The frequent mistake is buying the parent before the record date to get Chemicals. That is a position in the whole group, with the chemicals arm a third of it, and it puts you on the same side as the forced sellers once listing comes.
The second is valuing Chemicals at the full peer multiple on segment EBITDA. A newly separate company carries costs the segment never showed, and ignoring them turns a 8% gap into a 20% one.
What the interviewer asks next
- The parent will keep 20% of Chemicals and sell it in two years. How does that overhang change your entry?
- How would you estimate the daily volume of a company that has never traded?
- Chemicals is added to a smaller-company index at the next review. How do you position for that inclusion?
Company names and figures are illustrative.