Bharati Shipyard Tebma acquisition – No near term benefits:: EMkay

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Bharati Shipyard

Tebma acquisition – No near term benefits

REDUCE

CMP: Rs 239                                       Target Price: Rs 196

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n     Bharati Shipyard plans to acquire controlling 51% stake in Tebma Shipyard at an investment of Rs757.5 mn

n     Tebma (an offshore vessel manufacturer) has order book of Rs7.5 bn. In FY10, it posted loss of Rs1.9bn, had a networth of Rs(-)0.5 bn and debt of Rs4.3 bn

n     Expect no positives from the above deal in near-to-medium term in view of (1) un-conducive business environment and (2) deteriorating financial health and (3) strained cash flows

n     Retain ‘Reduce’ rating for BSL with target of Rs196/Share (Core shipbuilding: Rs117 + Great Offshore Stake: Rs79); Only caveat is meaningful subsidy disbursement

The Event – Bharati Shipyard acquires 51% stake in Tebma Shipyard

Bharati Shipyard (BSL) plans to acquire controlling 51% stake in Tebma Shipyard at an

investment of Rs757.5 mn. The details of the deal are as follows:

¾ BSL plans to acquire 51% stake in Tebma through an investment of Rs757.5 mn

through fresh capital infusion. Under the deal, the total equity capital of Tebma is

expected to increase from Rs77.8 mn to Rs773.6 mn. Accordingly, BSL’s share

works out to 39.45 mn equity shares and an average price of Rs19.2/Share.

¾ Prior to the BSL’s acquisition, ICICI Ventures was the largest shareholder with 53%

share, followed by the public at 42% and promoters at 4.93%.

¾ ICICI Ventures will also receive additional 30.13 mn shares, valued at Rs0.57 bn

(@ BSL’s acquisition price of Rs19.2/Share) – post which ICICI Venture’s effective

shareholding will come down to 44.27%. The above shares currently stand as

‘Share Application Money’ in Tebma’s books.

¾ Tebma has a modern offshore yard at Malpe (66 kms from Mangalore) with a

capacity to manufacture 10-12 vessels and repair 4 vessels per annum. It also has

another small yard at Cochin. It manufactures OSVs, PSVs, MSVs, AHTSVs.

Geology Survey vessels, etc. for Indian Navy and domestic & international

customers. Tebma has delivered 115 vessels till date. Tebma has an order book of

Rs7.5 bn.

¾ In FY10, Tebma recorded revenues of Rs1.6 bn and posted a net loss of Rs1.86

bn. The net loss includes (1) provisions and write-offs worth Rs0.35 bn and (2)

upfront extraordinary expenses of Rs0.83 bn – details not ascertainable. It had a

negative net worth of Rs0.5 bn, accumulated losses of Rs1.3 bn and gross debt of

Rs4.3 bn as on Mar’10.

¾ In addition to fresh equity infusion, Tebma will also undergo debt restructuring to

improve its financial health and facilitate turn-around.

Our View – Near to medium term pain, But long term positive

We believe that the deal is likely to be beneficial for BSL in the long term in view of the good

quality assets acquired. While the deal appears lucrative on equity based valuations, it

appears less attractive on EV basis - with debt of Rs4.3 bn. In the near-to-medium term, we

give thumbs down to the acquisition. This is in view of (1) un-conducive business

environment and (2) deteriorating financial health and (3) strained cash flows for both.

¾ Tebma’s order book has come down from about Rs20 bn in FY08 to Rs7.5 bn currently.

Its annual revenue run rate has also come down from 4.4 bn in FY08 to Rs1.6 bn in

FY10. Above indicates under-utilization of capacities. Besides, BSL is also experiencing

gross under-utilization of own capacities. We believe such under-utilization does not

augur well for BSL, especially in view of our negative bias on the shipbuilding industry

and no immediate signs of revival therein.

¾ With high Debt of Rs4.3 bn (DER >10.0) and low order book cover, we believe that

Tebma is likely to witness strained cash flows over the next couple of years. Even in a

blue sky scenario – with annual revenue run rate of Rs4.0 bn (>0.5X order book), Tebma

will generate operating cash flows of about Rs0.8 bn (@ 20% EBITDA margins). After

paying interest costs of about Rs0.4 bn, Tebma will generate free cash flows of mere

Rs0.4 bn for debt repayment (8.6% of debt). This is likely to compound problems for

BSL, which itself has a DER of 2.3X.

Retain ‘Reduce’ recommendation

We believe that acquisition of Tebma does not offer any upsides in the near to medium

term, being a highly leveraged buy-out. We retain our ‘Reduce’ recommendation for BSL.

This is in view of (1) our negative bias on core shipbuilding business - however, given the

uptick in order inflows in global ship building industry, we will review our call post a reassessment

of the scenario (2) risks to earning estimates from slow execution of existing

order book with deteriorating cover at 1.25X revenues (3) impending debt repayment (4)

weak operating cash flow and (5) high DER resulting in need for equity dilution. The only

caveat is a meaningful subsidy disbursement in immediate future.