Welspun Corp -Comfort emerges after PE deal ::Macquarie Research,

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Welspun Corp
Comfort emerges after PE deal
Event
 Welspun Corp announced an Rs13bn private equity (PE) investment by
Apollo Global Management, for a ~21-22% stake in WLCO and 87.5% stake
buyout in Welspun Maxsteel Limited (a promoter group company engaged in
steel manufacturing) for a consideration of ~Rs8bn. This is likely to remove
certain regulatory issues that emerged in 2010. Reiterate Outperform.
Impact
 Deal to infuse Rs5bn of cash in WLCO. Two tier PE investments involve
Apollo infusing Rs13bn of fresh equity into WLCO through 1) Rs7.9bn of
fully/compulsorily convertible debentures with 5% coupon, and 2) non-voting
GDR of Rs5.2bn. Both debenture conversion price and GDR issuance price is
fixed at Rs225/share and will results into a 21-22% stake for Apollo. The
second part of the deal involves WLCO and Apollo acquiring 87.5% and
12.5% stakes in promoter owned steel manufacturing company Welspun
Maxsteel for sums of Rs8bn and Rs1.4bn, respectively.        
 WLCO to become an integrated steel company. The Maxsteel acquisition
will place WLCO as an integrated steel manufacturing company with
presences from sponge iron, steel slab, plate/coils to pipe. This, we believe,
makes WLCO sensitive to commodity prices from current cost pass through
structure.  
 US$1bn of capex over next three years in Maxsteel. Maxsteel is planning a
capex of ~US$1bn over the next three years to set up 1.5m tonnes of high
end steel slab manufacturing and expand its existing sponge iron facility to
1.7m tonnes from current 0.9m tonne. We believe this will help the company
to capture better margin at the each end of value chain in the long term.
 Deal to dispel regulatory overhang. We believe a large stake of a PE player
as well as the Maxsteel deal is likely to alleviate investor concerns and
regulatory overhang as these should take care of the emergence of potential
transfer pricing issues.  
 Value neutral transaction. As detailed financials on Maxsteel have not yet
been disclosed, preliminary data points to the deal being value neutral due to
~20% equity dilution post investments by Apollo.    
Earnings and target price revision
 No change.
Price catalyst
 12-month price target: Rs250.00 based on a PER methodology.
 Catalyst: Announcement of fresh large pipe order.
Action and recommendation
 Outperform maintained. WLCO is currently trading at 5x its FY12E earnings,
over a 50% discount to its long-term average. The company also has a
healthy order book position of ~US$1bn. With entry of a large PE investor and
management’s focus to integrate along the value chain, the company has
tried to address recent regulatory overhang on the stock.