A stitch in time

PENNY WISE

Blackstone's open offer price for Gokaldas is attractive for an immediate exit but long term investors should remain invested.

Consolidation invariably result in stock price gains. Take for example the case of the low cost carrier Air Deccan which woke up from a long slumber only to touch all time high of Rs 175 when King Fisher announced its buy out.

One key reason for stock price appreciation of the acquired company, in the short run, is the premium the buyer is usually willing for the buy out which results in a temporary re-rating of the stock.

For the acquiring company, it is the considerations of cost and time savings as result of acquiring a business as against creating it afresh. The gains for both companies can last only if the deal actually renders better earnings power.

The stock price of India's largest apparel manufacturer, Gokaldas Exports zoomed 10 per cent to Rs 252 last Tuesday, after the private equity major Blackstone Group announced that it would buy a majority stake in the company and follow it up with an open offer to the public.

The stock is currently trading at Rs 251. Blackstone's huge investment in the company shows its confidence in the potential of the Indian apparel industry.

So the question is whether existing investors should exit at the open offer price or stay invested in the company?

Analysts opine that short term investors can take the exit route while investors having a one to two year perspective could remain invested as opportunities galore with Blackstone backing Gokaldas.

US based Blackstone Group, which manages $80 billion worth of assets world-wide, has bought 50 per cent stake in the company. According to Sebi guidelines, it will make an open offer for an additional 20 per cent stake at Rs 275 per share.

Thus, with the majority stake and open offer, Blackstone's investments in the company is pegged at $165 million (Rs 677.8 crore) out of which Rs 475 crore will go to the founders of the company.

Says Rajendra Hinduja, managing director, Gokaldas Exports, "Despite Blackstone buying a majority stake, there will be no change in the management of the company besides adding three persons from Blackstone on the board in addition to the current three promoters and three independent directors."

Gokaldas is India's largest apparel manufacturer with a capacity of roughly 30 million pieces per annum and operating through 46 manufacturing locations mostly concentrated in and around Bangalore. It is the one of the only Indian apparel manufacturer of a size and scale comparable to a Chinese company.

Currently most of the products manufactured are exported to global giants like Banana Republic, GAP and Old navy, Nike and Reebok while a small portion (10 per cent) is sold in the domestic market.

The promoters will be utilising a part of the money (approximately Rs 150 crore) to fund its SEZ (special economic zone) project near Bangalore wherein 50-60 textile companies would be setting up plants with a total investment of close to Rs 2500 crore.

Gokaldas Exports Apparel and Textile Park Private Limited, a promoter group company will be developing the SEZ while Gokaldas Exports will be setting up a factory in the SEZ with an investment of Rs 30-40 crore.

Besides this, its ongoing expansion project in Hyderabad is expected to be commissioned in October 2007. The company also has regular expansion plans in its existing plants in Bangalore.

Says S N Rangaiah, general manager (finance), "The private equity major has also invested in Chinese textile and apparel companies and see a lot of potential in the Indian apparel industry."

According to Hinduja, it has investments in some US textile and retail companies. Thus, Gokaldas can gain from huge orders or deals accruing from Blackstone's investments in apparel and textile companies across the globe.

Moreover, the buyout has revived the hopes of the much needed consolidation in the beleaguered Indian textile sector which has been facing the double whammy of rising rupee impacting exports and competition from other low cost producing countries. There could be many more deals in future as the potential of Indian textile sector is huge.

Says Deepak Seth, group chairman, House of Pearl Fashion, "There is bound to be consolidation as many smaller players in the industry don't have the size or scale to be globally competitive and huge orders are flowing from high cost centres such as Europe and US to low cost ones such as India and China."

Thus players like Gokaldas and other large companies can gain in future. Says Darshan Singh Bagga, analyst, Prime Securities, "Gokaldas' association with Blackstone is likely to give it the financial clout and international visibility, besides helping it achieve inorganic ambitions."

Financials
In the June 2007 quarter, net sales grew 18 per cent year-on-year to Rs 261 crore.

However, operating profit declined by 11 per cent to around Rs 20 crore, thanks to lower realisations (down 16 per cent) due to change in the product mix to the less profitable bottom-wear and impact of rupee appreciation and higher expenses (up by 21 per cent) mainly due to raw material and employee expenses.

Aggravated by higher interest, depreciation and taxation on account of ongoing expansion plans, net profits declined at double the rate as operating profit.

Going forward, the company targets to achieve a top line and bottom line growth of 15-20 per cent in FY08. It targets to achieve a net margin of 7 per cent unless the rupee appreciates rapidly.

However, the company expects the rupee to move in the band of Rs 39-42 levels versus the dollar. The recent rise of the rupee against the dollar and boom in the Indian retail industry has prompted the company to enhance its presence in the domestic market supplying to retailers like Shoppers Stop, Pantaloon, Wills Lifestyle and ITC.

Three years down the line, the company plans to take its share of the domestic market to 25 per cent of the total revenues. The product mix is unlikely to change going forward.

Currently, bottom-wear (like cargos and track pants) which constitutes half of sales, gives large volumes though margins are lower than outwear (like wind cheater and jackets) which contributes about 30-35 per cent. 
 

CONSISTENT GROWTH AHEAD
Financials (Rs crore)	Q1FY07	Q1FY08	% chg	FY08E	FY09E
Net sales	221.00	261.00	18.10	1175.00	1350.00
Operating profit	22.50	20.91	-7.07	120.00	135.00
OPM (%)	10.18	8.01		10.21	10.00
Net profit	13.50	10.53	-22.00	73.60	88.60
NPM (%)	6.11	4.03		6.26	6.56
Note: Analysts' estimates

Valuation
At Rs 251.55, the stock gives an upside of 9 per cent at the open offer price of Rs 275, which is not that attractive for investors looking to buy the stock for short term gains. However existing investors who were looking for a good price to exit, can accept the offer.

Says Neha Bubna, analyst from UTI Securities, "Though there is nothing to worry about the company's business, short term investors having three to six month perspective can exit the stock at the open offer price."

However long term and patient investors with a horizon of at least two years can remain invested in the company or can enter at the current levels as the benefits are immense in the long term. The stock trades at 10 times and 9 times its FY08 and FY09 estimated earnings respectively.