At Rs 464 crore, Tube Investments of India seems to have overpaid for the acquisition of a 70 per cent stake in Shanthi Gears (assuming full acceptance of 26 per cent open offer). Based on the acquisition price, Shanthi Gear’s valuation works out to around Rs 662 crore (for 100 per cent), which is close to four times its FY12 revenues and 9.5 times earnings before interest, taxes, depreciation and amortisation (Ebitda) and around 19 times FY13 estimated earnings at the open offer price of Rs 81 per share. This is the reason why Tube Investments’ stock has gained only 6.8 per cent while Shanthi Gear’s stock is up over 12 per cent post the announcement.
However, if one looks at the long-term business gains and the prospects of Shanthi Gears, Tube Investments has made a smart move. That’s even if one assumes that the company will fund this acquisition entirely from debt. The company not only gets immediate and a larger exposure to the non-auto sector (currently forming 25 per cent of its standalone revenues) as targeted, but also gets to improve its overall margins as Shanthi Gear’s operating profit margin stood at 39 per cent in FY12 compared to Tube’s 10.5 per cent.
Acquisition of Shanthi is the second after the flagship company of the $4.4-billion Murugappa group acquired 77 per cent stake in Financiere C10 SAS, the holding company of the French industrial chain manufacturing company, Sedis, two years ago, which strengthened its foothold in the industrial chains business.
|In Rs crore||Tube Investments||Shanti Gears|
|% change y-o-y||16.9||12.9||14.6||19.0|
|% change y-o-y||22.6||14.0||11.6||17.7|
|% change y-o-y||13.3||18.6||21.8||24.8|
|E: Estimates Tube Investments' financials are standalone
Source: Company, Bloomberg Estimates
Opportunistic move, good synergies
Since Shanthi Gears’ promoters were looking to sell their business and Tube wanted to increase the revenue share of its non-auto business, the acquisition is a logical step and an opportunistic move. Together, the duo can extract lot of synergies to propel growth.
Says M M Murugappan, chairman, Tube Investments, in the company’s press release, “Shanthi Gears is one of the largest organised players in India in the gears segment and its products profile is targeted towards niche products. We hope to leverage our understanding of the engineering space and customer relationships to help scale the business further.”
Adds L Ramkumar, managing director, “Addition of Shanthi’s product portfolio substantially enhances our ability to service other industry segments and reduce our reliance on the auto sector. It will also help expand our industrial power transmission business, which currently manufactures industrial chains.”
Over four decades old and India’s second largest industrial gear box maker, Shanthi is debt-free and had a cash balance of Rs 56 crore at end-FY12. Its variety of industrial power transmission products such as gears (standard and customised), gear boxes, geared motors and gear assemblies applicable in several industries (steel, textiles, cement, infra and power) fits well with Tube’s industrial chains business under the metal formed products division (25 per cent of total revenues).
There is also scope for improving capacity utilisation to 90 per cent in the next three years from the current 35-40 per cent as Shanthi Gears went slow on low-margin orders. This is probably why the acquisition price looks a bit high.
Shanthi Gears had plans to introduce gears for products like compressors and mining equipment, which now Tube can take forward. The downside risk is that the gear industry in India is highly import intensive (60 per cent), which can restrict margin expansion if cheaper products are dumped here. That apart, any sharp swing in commodity prices and further deceleration in domestic auto volumes could also hurt its performance.
While the company’s engineering and metal formed products businesses, which mainly cater to the Indian auto sector, are facing challenges like moderation in demand for automobiles following high interest rates, the bicycles business (including components, electric scooters and fitness equipment) is structurally well placed, thanks to improving consumption, led by increasing awareness about health and fitness. Its French subsidiary (Sedis) and financial services business are also doing well though the insurance business is still making losses.
Tube Investment’s stock looks fairly valued based on FY13 estimated earnings. However, based on FY14 estimates, which will be the first full year of consolidated operations and reflect synergies, valuations are cheap.
Meanwhile, given Shanthi’s free float of 56 per cent the acceptance ratio of the open offer is likely to be a minimum 46 per cent. In short, for every 100 shares tendered, at least 46 will be accepted. Given the offer price, investors with a short-term perspective could tender their shares.