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Safest bet there was

The Recanati family is mad. Kardan's Grunfeld can afford to smile

Oudi Recanati is mad and Leon Recanati is mad ¿ in fact, many people in the Recanati family are mad, and they are mad at Joseph Grunfeld, controlling shareholder in Kardan (TASE: KRDN ), who ducked out of the IDB Holding Corporation (TASE: IDBH ) takeover deal at the last possible minute. Kardan, with its Australian partners the Lowy family, was supposed to buy $312 million in IDB shares.

Oudi Recanati and the rest of the family thought they were going to sell their shares for lots of cold hard cash and now they are stuck with shares it is doubtful they will be able to sell at the high price set in the original deal.

Leon Recanati, who was to acquire control of IDB with Grunfeld, thought he was already in the driver's seat and could start the much-needed restructuring of the company. Now he is back where he was a year ago: back in partnership with his cousin Oudi, and everyone can see they don¿t want to be in business together, leaving IDB's future hazy.

And now the Recanatis will have another reason to get mad when Kardan publishes its 2001 financials. It will then be clear that Grunfeld didn't just ditch them on their way to the altar, but that doing so was the best deal he's made his entire life.

It all begins and ends with Kardan¿s decision not to take too many financial chances and "hedge", take out financial insurance on the IDB takeover deal. Since the price of the IDB acquisition was set in dollars, Kardan took out insurance against a rapid dollar revaluation since shekel devaluation would raise IDB's price for them, while it was not clear that the value of the asset would increase accordingly.

In August and September of last year, Kardan bought $250 million in futures and options on the dollar from the banks. The insurance policy was bigger than Kardan's portion of the deal, because Kardan originally was slated to buy a bigger stake. When Kardan brought in billionaire Frank Lowy, its stake dropped to $210 million, but it still had $250 million in options and futures.

December arrived and with it Bank of Israel governor David Klein's fateful meeting with the prime minister, after which he slashed interest rates by 2%, rocking the foreign currency market. Since the beginning of December, the dollar has gained 13% on the shekel.

While most of the business sector is stressed out by the devaluation, Grunfeld and his Kardan friends are sleeping well nights. Their decision to take out insurance against a sky-rocketing dollar turned out ot be conservative and wise. Otherwise, they would have found the price of the deal inflated by 12% while IDB¿s market cap has slumped over the past two months.

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Since Kardan's dollar insurance policy was more than its exposure to the IDB deal, Grunfeld allowed himself to close some positions on the futures and options markets in the past few weeks. That has meant profit-taking and capital gains as the dollar went through the roof.

The profit from the position isn't strictly profit ¿ since against the profits from the futures market Kardan has dollar liablities on the IDB shares. Therefore, the $25 million profit is set off against the "loss" created by the inflated price of the acquisition. According to generally accepted accounting practices, "profits" from the hedge are not listed on the profit and loss report, just deducted from the cost of acquiring the shares on the balance sheet.

However, last Thursday the deadline for closing the IDB deal passed without appropriate regulatory approval, and Grunfeld, for his own reasons, decided not to extend the deadline, withdrawing from the deal. At that moment, he freed himself of the dollar liability and was left only with his dollar asset ¿ the insurance policy.

The financial significance is that Kardan's strategy in the IDB deal, insurance until the end of last week, became a speculative bet on the dollar. And not just any bet, but one we already know paid off at $25 million.

The acounting significance is that the moment Kardan backed out of the IDB deal ¿ its options and futures positions became profits to report in Q4 2001 and Q1 2002 financials. The exact scope of the profits won't be known until Kardan exercises all of the positions, but it can be estimated at $20-30 million.

$25 million may look piddly next to the size of the IDB deal, nonetheless, it is a lot more money than Kardan is used to making. Kardan's shareholders equity is less than $40 million according to accounting procedures, and if we look at the company's activity in the past decade we won't find many deals that even came close to the profitability of the non-deal in IDB.

Kardan is a public company and will have to report the exact profit it made off canceling the IDB deal. Its interesting to wonder if Leon Recanati and the Carasso family also bought "insurance" against the dollar.

If they did, the result of the whole story is that the prospective buyers were left with $50 million profits ¿ while the sellers, namely Oudi Recanati, were left holding shares it is doubtful they will be able to sell for the original dollar price.