Adverse newsflow can also be an opportunity

Recent headlines have focussed on the Rs 3,900-crore income tax demand on Idea Cellular. It is impossible to guess how long the tax demand will take to be legally resolved or the outcome. It will be logged as a contingent liability on the balance sheet and the case may drag on indefinitely.

Are such cases an overhang on long-term valuations? Perhaps not. Income tax and excise cases often run for decades. The companies involved can generate excellent returns for investors during this period.

Assuming the company has the money to fight the case and in the worst case scenario, pay the demand, the share could give good returns over the long-term.

There is a short-term adverse effect when the demand is first raised. Every so often, there will be some newsflow as the case winds through the legal system. The newsflow will have either negative or positive impact. The losing side will appeal; there will be more newsflow and so on.

ITC, for example, faced an excise demand for Rs 800 crore in 1987. The tobacco major paid Rs 350 crore and appealed and won at the Supreme Court in 2004.

The Excise department changed the laws via ordinance to allow retrospective claims. The case was settled out of court in 2005. The excise department dropped the claims and ITC agreed not to seek refund of the Rs 350 crore.

The specifics of the two cases are totally different, of course. But this example should give some idea of the time period that could lapse before closure on Idea. More recently, Vodafone, has challenged a tax demand for $2 billion equivalent on the $11-billion takeover when Vodafone bought out Hutchison's stake in 2007.

Vodafone won in the Supreme Court and then, the law was rewritten in the 2012-13 Budget to allow retrospective demand. The merger of Mahindra Satyam with Tech Mahindra is also held up over demands made by the income-tax department on the fraudulent accounts submitted by the erstwhile Satyam Computer Services Ltd.

Meanwhile through 1987-2005, ITC was one of the best market performers. Vodafone is unlisted but if it wants an Indian initial public offering, the case will be a factor in valuations. Satyam, of course, was a major scandal and there are also lots of pending criminal cases.

However, investors who bought into Mahindra Satyam after the scam have done well.

The Aditya Birla Group has deep enough pockets to bear the legal costs and in the worst case, pay the tax demand. So, this could be an opportunity.

Every time there is adverse newsflow, the trader gets a chance to short the stock. Of course, the telecom industry is also in a mess for reasons unconnected to the tax demand. Adverse newsflow can also be an opportunity to accumulate Idea at lower valuations for the long term, if the investor believes in the stock.

The author is a technical and equity analyst