A day after power and retail giant CESC announced its plan to acquire 49.5 per cent stake in business process outsourcing (BPO) firm Firstsource Solutions for Rs 400 crore, the Street gave the move the thumbs down.
According to Bloomberg data for mergers and acquisitions in India since January 2008, for half the deals, shares of acquirer companies have taken a knock. On Friday, history repeated itself; the CESC stock closed 15.3 per cent below its previous close, owing to the acquisition announcement. The fall was the most seen by any acquiring company.
While the CESC deal has no synergies, as the company has diversified into an unrelated sector, markets have also punished deals with strong operational synergies. This is because of a host of concerns — from deal valuations to the funding source. Typically, markets do not favour deals involving high leverage for the acquirer company. In case of CESC, the higher leverage and the company’s unsuccessful ventures into new sectors were key factors behind the fall in the stock. Most brokerages downgraded the stock to ‘Sell’, citing the unrelated diversification was unwarranted.
“We downgrade CESC from ‘Buy’ to ‘Sell’, as this acquisition is unrelated. The track record of unrelated retail diversification has been poor and though the BPO business should not guzzle cash like the retail business, it could lead to higher leverage in the power business, as it has its own needs. We cut the target price to Rs 300 (Rs 345 earlier) and the target price/book value to 0.85 times (from 1.0 times),” said Citigroup’s Venkatesh Balasubramaniam and Atul Tiwari.
About 70 per cent of the total acquisition cost of about Rs 650 crore (assuming the open offer is fully subscribed) would be funded through additional debt on CESC’s book. While the deal would partly reduce Firstsource’s debt, it would strain CESC’s balance sheet and growth prospects, analysts say. Not surprisingly, the CESC stock on Friday tanked 18.6 per cent to hit the day's low of Rs 270 on the BSE. However, it recovered marginally to close at Rs 281.15 (down 15.3 per cent), against the Sensex’s 0.71 per cent fall. Owing to the open offer price of Rs 12.2 (14 per cent below Thursday’s closing price), the Firstsource stock fell 13.34 per cent to close at Rs 12.34.
Of the total proceeds, Rs 280-290 crore would be used to repay Firstsource's outstanding foreign currency convertible bonds (FCCBs). The BPO firm has a cash balance of Rs 680 crore and outstanding FCCBs of Rs 1,140 crore. After the deal, it is likely to repay about Rs 1,030 of FCCBs. The company would still be left with a net debt of Rs 1,200-1,400 crore, which would impact its margins.
| BIGGEST LOSERS | ||||
| Announcement date | Target | Acquirer | Value ($ mn) | % fall |
| Oct 25, ‘12 | Firstsource Solutions Ltd | CESC Ltd | 51.1 | -15.30 |
| Jan 31, ‘08 | Tata Chemicals North America Inc | Tata Chemicals Ltd | 1005.0 | -6.87 |
| Mar 17, ‘08 | Greenfield Mine | Reliance Power Ltd | 245.5 | -6.57 |
| Mar 7, ‘08 | Standard Chartered AMC, StanC trustee | IDFC Ltd | 205.0 | -6.45 |
| Sep 26, ‘08 | Axon Group Ltd | HCL Technologies Ltd | 731.1 | -5.31 |
| Oct 8, ‘08 | Citigroup Global Services Ltd | Tata Consultancy Services Ltd | 512.0 | -5.09 |
| Oct 22, ‘12 | Rutgers Belgium NV | Rain Commodities Ltd | 916.7 | -5.08 |
| May 26, ‘08 | Reliance Vanco Group Ltd | Reliance Communications Ltd | 76.9 | -5.03 |
| Sep 29, ‘08 | SE Forge Ltd | IDFC Ltd | 84.8 | -4.76 |
| Jul 16, ‘08 | Nanocity Haryana Infrastructure Ltd | Parsvnath Developers Ltd | 92.8 | -4.67 |
| Jun 10, ‘08 | Vikram Ispat | Welspun Corp Ltd | 239.2 | -4.54 |
| Jan 25, ‘10 | India Infoline Finance Ltd | India Infoline Ltd | 72.0 | -4.28 |
| Feb 4, ‘10 | DyStar Group | Kiri Industries Ltd | 68.8 | -3.84 |
| Jul 26, ‘10 | Hobi Kozmetik Imalat Sanayi Ve | Dabur India Ltd | 69.0 | -3.76 |
| Dec 23, ‘10 | JSW ISPAT Steel Ltd | JSW Steel Ltd | 1971.6 | -3.67 |
| May 3, ‘11 | Abbot Point X50 Coal Terminal | Adani Ports and SEZ | 1961.6 | -3.58 |
| Dec 1, ‘08 | Balaji Distilleries Ltd | United Spirits Ltd | 60.1 | -3.53 |
| Jul 13, ‘11 | Peguform Group | Motherson Sumi Systems Ltd | 454.9 | -3.53 |
| Jun 12, ‘09 | Elel Hotels And Investments Ltd | Indian Hotels Co Ltd | 142.8 | -3.40 |
| The list is representative, not comprehensive; % fall in acquirer shares post-deal announcement Compiled by BS Research Bureau Source: Bloomberg | ||||
Experts believe the deal valuations are not cheap. “The deal is valued at an enterprise value (EV) of Rs 1,900 crore, implying EV/earnings before interest, tax, depreciation and amortisation (Ebitda) of 10.4 times, a marginal discount to the current EV/Ebitda multiples of peers, such as Genpact (11.5 times EV/Ebitda), which operate at an Ebitda margin of 20 per cent. Given the general trend in clubbing the information technology and BPO sectors together, the competitive environment for standalone BPO firms remains tough,” said Amit Rustagi and Rahul Modi of Antique Stock Broking.
Analysts are sceptical about the benefits this deal would offer CESC. For the company, the deal would entail an immediate outgo of Rs 640-650 crore, about three quarters of the company’s standalone cash. This would lead to CESC resorting to additional borrowings to invest in Haldia and Chandrapur expansions. Also, most analysts view this unrelated diversification as totally unnecessary. Firstsource has been struggling since the past three years; it operates in the low-margin voice BPO business. The company has been struggling to grow amid the low scalability of its business and aggressive competition from Philippines-based BPO companies.