Have the auto deals succeeded? :: Business Line

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When Tata Motors acquired Jaguar Land Rover (JLR) for a huge Rs 9,200 crore in March 2008, it was actually not an expensive deal. But the Jaguar brand wasn’t in great shape. The company was saddled with high costs, needed restructuring and additional investments. The burden of the $3-billion debt raised for the acquisition and the onset of the global economic crisis worsened things. From a consolidated net profit of Rs 2,168 crore in FY08, Tata Motors slipped into a loss of Rs 2,505 crore in 2008-09.

However, amid the gloom, Tata Motors succeeded in cutting working capital needs at JLR. Cost reductions were brought about by making engineering and capital spending more efficient. Fixed marketing and selling costs were pruned and labour costs trimmed by about 20 per cent. In the October-December 2009 quarter, as the global economy recovered, the JLR bottom-line showed profits. By March 2010, the company’s consolidated profits had shot up to Rs 2,571 crore, with its debt to equity ratio (automotive business) down from a precarious 4 to a more moderate 2.05. Now, debt to equity stands at a comfortable 0.24. The focus on emerging markets and the moving of a portion of the material and component sourcing and assembling of vehicles to low-cost countries such as India and China also helped the deal pay off.

Mixed bag for M&M

Being cash-rich, M&M never took on huge debt to fund its acquisitions. Punjab Tractors (Swaraj brand) was still profitable when M&M bought its 65 per cent stake for about Rs 1,500 crore. But poor management until then had led to its deterioration. M&M realigned priorities for the company, motivated employees and invested in product development. As a result, from less than 5 per cent in 2007-08, the Swaraj brand’s market share now stands at 12 per cent. Having fully integrated with M&M, these two brands are the market leaders today with a combined share of just over 40 per cent.

Ssangyong, however, is yet to turn around. M&M acquired the company in end-2010 for about Rs 2,110 crore. Two years hence, for the year ended December 2012, Ssangyong still sports a net loss. But the losses have been narrowing year after year. Improved efficiency in production and a revival in demand helped the company meet its sales target of 1.2 lakh units in 2012, showing a 7 per cent growth over the previous year.

M&M recently made a fresh capital infusion of Rs 400 crore into the company to aid product development. It is developing a shared platform for new products and engines. The first UV on this platform is expected to be out in 2015. As for two-wheelers, thanks to strong competition from companies such as Hero, Bajaj and Honda, M&M so far remains a marginal player in this segment. Despite several and periodic product launches, it has a market share of less than one per cent in this space.

Litmus test for Apollo

Apollo’s Vredestein buy has paid off in terms of improving its product mix, realisations and margins at the consolidated level. But Cooper may test its mettle further. At 4.8 times EV/EBITDA (2012 earnings), Cooper has not come cheap. Goodyear’s EV/EBITDA for example, stands at 4.2 for the same period. The 40 per cent premium to market price that Apollo paid may be justified considering Cooper’s strong presence in the US markets and its good hold over high-margin replacement markets. However, that Apollo is funding the entire deal through debt raises some concerns.

After the acquisition, the company’s net debt-to-equity ratio moves up to 1.9 times from the 0.7 times for the year-ended March 2013. The company expects the acquisition to add to Apollo’s EPS from year one onwards. But a debt burden becomes a challenge whenever rubber prices turn unfavourable for this raw-material intensive industry. This will hold the key to whether this buyout delivers.

Takeaways for investors

Given the experience with these companies, what should investors in auto/component stocks watch out for when their company acquires? For one, the mode of funding. Vehicle manufacturers, if not component makers are generally cash-rich but if the company is taking on too much debt, then it could be a red flag. More so, because the industry is both cyclical and raw material intensive.

A heavy interest burden at a time when vehicle sales are down or when raw material costs shoot up is inviting trouble.

Secondly, if the acquisition is not immediately earnings accretive, is the company in a position to infuse enough funds to aid volume growth/R&D/product development there, without affecting its existing operations?

Third, look for whether the acquisition will leave the company with a complementary mix of high-growth and high-margin products/markets.

This diversification will help the company survive tough times better.