All golden

Indian Billionaire Serves a Happy Meal to the Hedge Funds

Anil Agarwal's financing of Anglo stake is clever, but unsettling for the miner's investors.
The Sydney Morning Herald via Getty
As of 10:14 AM EDT
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Anil Agarwal is cementing his influence over Anglo American Plc. The resources magnate is set to become the largest shareholder in the mining giant after investing up to 1.5 billion pounds ($1.8 billion) in a cleverly structured deal. His aims remain unclear. That's becoming increasingly unhelpful for the company.

The latest move lifts Agarwal's stake from 12.4 percent to about 20 percent. That ought to move the Anglo share price sharply higher. But Agarwal, who's chairman of Indian-based miner Vedanta Resources Plc, has been cunning in minimizing the price impact from such a hefty trade. The Anglo shares had only risen by about 2 percent in early afternoon trade.

Buy The Dip, Buy The Spike

Anil Agarwal's second swoop on Anglo stock lacks the opportunism of the first strike in March

Source: Bloomberg

As with his initial investment, Agarwal is first issuing a bond that he has the right to repay in Anglo shares. These so-called exchangeables are attractive to hedge funds because they carry a tasty coupon, in this case 3.9 percent. The hedge funds don't want to end up owning the stock when the bond matures, so they borrow shares in the market and short-sell them. Agarwal steps up to buy this borrowed stock. If he repays the bond in shares, the hedge funds immediately cover their short positions. The whole package is known as a "happy meal".

The economics are such that Agarwal is fully protected from the downside if Anglo's shares go south. In return, he foregoes most of the upside if they rally.

Agarwal presents this as a personal investment in a familiar entity. He has said he doesn't want to do a takeover -- a promise that stays binding for six months under U.K. stock market rules.

Investors wonder if there may be more to it. For a family investment, it's a big exposure to a single entity. What's more, the structure can be seen as more than just a clever hedge. It's a way of giving Agarwal a chunky voting position without exposure to the share price. He gets influence but can escape the economic consequences.

Analysts suggest Agarwal may want to nudge the company to a breakup, or attempt to buy some assets. Having a big stake and possible board seat could help that.

Maybe this is just an investment with some in-built loss insurance. But having a dominant shareholder from the industry with unclear intentions has to be a worry for other investors. Agarwal, together with South African state shareholder PIC, could form a powerful block.

The board of Anglo has to do what's best for all shareholders, not just Agarwal. Chairman-designate Stuart Chambers may face some early tests of good governance.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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