Hero Honda - Honda to buy out Hero? Edelweiss

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n  Honda to Buy out Hero?

Newspaper reports (Economic Times) indicate that there is a possibility of Honda acquiring the Hero group’s 26% stake in the Hero Honda. We note that for the past few months there had been constant speculation of a vice versa deal i.e Hero buying out Honda’s stake in the joint venture. (please refer to our note, Honda to offload stake?, dated July 26, 2010). Reports indicate that Honda’s offer might be at a premium to the current market price. A final decision is expected in the next few weeks.

n  Prefer Honda over the Hero Group

We believe that between the Hero group and Honda, the latter’s control would be more beneficial for the company on two counts.

·         Technology development: Hero Honda has little indigenous technology and a non renewal of the technological pact with Honda that expires in 2014 would force the Hero Group to develop new products – a long, arduous and expensive process.  A takeover by Honda would on the other hand lead to continuity in product development/ launches.

·         A more aggressive competitor: Currently, there seems to an agreement between Honda’s 100% subsidiary (HMSI) and Hero Honda restricting the former’s entry in core commuter motorcycle segments. We note HMSI has not launched a product in this segment that is pivotal to Hero Honda’s profitability. Incase, Hero group acquires Honda’s stake, we could expect the HMSI to launch new products more aggressively in the market.

n  Honda’s takeover could lead to a potential re-rating

The uncertainty regarding the deal has been an overhang on the stock, with the company underperforming the Nifty by ~15% over the past 6 months. Hero Honda currently trades at a ~10% discount to Bajaj Auto, which can be partially attributed to the uncertainty.

A takeover by Honda would lead to a potential re-rating of the stock. Just indicatively, at a peak PE multiple of 18xFY12 the stock would trade at INR 2,280; at a premium PE multiple of 20x, the valuation would be INR 2,550 (a 30% upside from current levels). Pending clarity we maintain ‘BUY’.