Shareholders holding on to the shares from now on will be living in hope that Unilever wants to delist HUL and will revise its buyback or open offer price from time to time

On 30 April 2013, Hindustan Unilever’s parent company, Unilever Plc, announced an open offer to buy roughly 487 million shares, or 22.52% of the share capital, of  HUL, at 20% above the previous day’s closing market price (i.e. 29 April 2013). The open offer stipulates that Unilever Plc intends to buy back HUL shares, voluntarily, at a price of Rs600 per share. At the moment, Unilever Plc holds roughly 794 million shares in HUL, which forms 36.75% of the latter’s share capital. This means, if Unilever Plc intends acquire the 22.52% of the shares outstanding, it will take its total shareholding to 59.27%.
 

If you are a shareholder what should you do? Tender your shares? Or hold on for more gains?
 

Long-term shareholders will find it hard to make this decision. While HUL is a well-managed company with exceptional return on capital, Rs600 is way above the fair value currently. On the other hand, there is the possibility of Unilever Plc taking complete control (i.e. 100% ownership) in which case the price will head higher.
 

On the negative side, Unilever finds great value in HUL and mines it regularly. Recently, HUL and Unilever Plc signed a ‘New Agreement’ under which HUL will pay higher royalty costs at an increasing rate till 31 March 2018. It will be 0.5% of turnover till March 2014, and thereafter in a range of 0.3% to 0.7% of turnover in each financial year, leading up to a total estimated royalty cost increase of 1.75% of turnover compared to existing arrangement, till 31 March 2018. This means, HUL will have less to distribute to shareholders or reinvest from the pie.
 

Recently, Hindustan Unilever had announced good March quarter results. We had covered it over here (Hindustan Unilever reports robust results; net profit up 14.65%). Both its return on networth and return on capital employed are stupendous at 108% and 123% respectively. The valuations are at a premium though, with market capitalisation at 26.30 times operating profit.
 

In our view, investors are taking a gamble if they hold on to the shares. Three factors will decide the movement of shares: rising earnings, more and more extraction of value by Unilever and possibility of a higher buyback price. Of these three, a shareholder, as an outsider, has a sense of only the first factor. It is impossible to get a sense of the other two. And based on that first factor of earnings, HUL is currently overvalued. The price of Rs600 will act as a magnet and HUL shares will not fall but the upside looks limited. Shareholders holding on to the shares from now on will be living in hope that Unilever wants to delist HUL and will be interested in revising its buyback or open offer price from time to time. Meanwhile, if performance slows down even a little bit, the stock will stay flat or even fall.