Forging ahead

Baba Kalyani

Auto component maker Bharat Forge is now focusing on the non-auto components sector. the strategist examines the shift in strategy.

It's the second-largest forging company in the world, making parts for the who's-who of the auto world. But that doesn't seem to be enough for Bharat Forge Limited (BFL).

The Pune-based, Rs 3,085-crore company manufactures components for engines and chassis for commercial vehicles and cars, for clients like General Motors, Toyota, Volvo and Caterpillar.

Chairman and Managing Director B N ("Baba") Kalyani has said often enough that BFL is aiming to become the No. 1 forging company in the world, on the back of its leadership in the Indian auto ancillary industry.

So where does a new-found interest in non-auto components fit in? BFL Executive Director Amit B Kalyani explains the new focus is as much to derisk the business model, currently skewed towards the auto industry, as it is to explore a new space. But there's more to the shift in strategy.

Go where the growth is
Strictly speaking, the non-auto components business isn't new. BFL has already been making parts for the hydrocarbons sector and last year, revenues from this line of business contributed 17 per cent to its consolidated revenues.

But now, the company wants to make forged components for sectors such as oil and gas, infrastructure, power, mining and aerospace. More importantly, by 2009-10, it wants non-auto components to account for at least 30 per cent of revenues (which, by then, should have crossed Rs 6,000 crore).

"We're beginning to see large investments in energy and infrastructure. And all the equipment will require forged components," says Baba Kalyani.

Son Amit explains the interest: "The addressable space runs into billions of dollars, so if we are able to get even a fraction of the business, it will be hugely rewarding."

Analysts, too, think the reorientation isn't a bad idea. "It's sensible to have a diversified portfolio because the auto sector has historically been cyclical. It makes sense to step on the gas now, when these spaces look promising," says Ernst & Young Partner Randhir Kochhar.

BFL is putting its money where its mouth is. It has invested Rs 350 crore "" funded with internal accruals "" in a new plant, to come up near its existing facility in Pune, to manufacture components for power plants, mining companies and so on.

The plant, which will have an annual capacity of 100,000 tonnes, will begin production in late 2008. The company already has orders for about 40 per cent of this capacity "" a tightlipped Kalyani declines to discuss client names and size of the orders.

BFL is counting on this segment bringing in Rs 2,000 crore by 2010, a four-fold increase from the present Rs 525 crore.

The new plant will account for about half of that target; meanwhile, Kalyani says BFL will scout around for inorganic growth avenues as well. Which means the balance revenue will probably come from acquisitions; and given BFL's track record, it may already have a target in sight.

Time to shop "" again?
BFL has a huge advantage: it is present in nine locations across six countries. Of course, that didn't happen by chance "" over the past several years, the company has carefully planned its organic growth, building capacities through geographies, bagging customers across the globe and improving its product mix through a string of acquisitions.

In 2005, BFL bought over Federal Forge in the US (now Bharat Forge America), Imatra Kista AB of Sweden and Germany's CDP Aluminumtechnik. Before that, in November 2003, it acquired German forgings company Carl Dan Peddinghaus GmbH (CDP); Aluminumtechnik was a subsidiary.

In December last year, the company also gained control of the forging division of First Automobile Works (FAW), China's largest vehicle manufacturer. The deal upped BFL's total capacity to 600,000 tonnes, making it the second-largest forging business in the world (next to Germany's Thyssen Krupp).

The geographical spread finds approval with most analysts, who believe the company should continue the strategy even with the non-auto components business, where BFL is now looking for potential mergers and/ or acquisitions.

"BFL is careful not to place all its eggs in one basket "" whether businesses or locations," says Prabhudas Lilladher's Mahantesh Sabarad, who tracks the auto ancillary sector at the investment firm.

Seeking synergies
Initially, to establish itself more firmly in the non-auto space, BFL will leverage its existing relationships.

Its client list includes companies such as Mahindra & Mahindra, Cummins, Dena, ZF, Caterpillar and Honda, which have interests beyond the auto sector.

Explains Amit Kalyani, "We have clients for whom we already make engine parts. We can use our expertise with steel to supply them with other parts too." He adds that BFL already has the technical skills required for making non-auto parts.

Comments Yezdi Nagporewalla, national industry director, industrial markets, KPMG, "Nowadays, technology needs to be upgraded much faster and the only way to do this is to work closely with customers, not just physically but also in the business sense."

Meanwhile, backward integration will also help the company's new venture "" group company Kalyani Steel produces forging-quality steel that can be used for manufacturing components for rail, power and engineering projects.

Capacity at Kalyani Steel is also being enhanced, points out Amit Kalyani "" in the next four or five years, capacity should cross 1 million tonnes per annum.

For aerospace projects, though, BFL will need to import raw materials "" Indian companies do not yet manufacture steel of the required quality.

The road ahead
The potential business opportunity isn't the only reason BFL is so keen on the non-auto component business. There's also the cyclicality in the auto ancillary industry.

India is still somewhat protected, but internationally, car and truck makers have been shifting to a lower gear for some time now as high fuel prices and rising interest rates take their toll on vehicle purchases.

As original equipment manufacturers (OEMs) struggle to sustain sales, component manufacturers can't remain unaffected for long. Almost half of BFL's revenues come from overseas markets, so the road ahead could get bumpy. De-risking the business model is clearly good strategy at such a time.

But how does the non-auto business compare with auto component manufacture?

Most analysts believe that margins in the non-auto sector won't be worse, at any rate, especially given the advantage of in-house steel supply: BFL's stand-alone operating profit margins in the September 2006 quarter were 26 per cent. But if the company decides to concentrate on contracts that do not require too much design and technology value-addition, its returns may be affected, fear analysts.

That's not likely to happen, according to BFL: "Many of these components will require a higher level of technology," says Amit Kalyani. "It may be better if BFL concentrates on its core business, because it can achieve better returns on investment there," says Sabarad.

Even if non-auto margins do turn out to be lower, they shouldn't be a big drag on the bottomline. "It's true that, apart from aerospace, margins from other products may not be very high. But it shouldn't deplete margins. On the contrary, pressure on auto component margins may continue," says E&Y's Kochhar.

"The OEMs will continue to squeeze vendors when the industry goes through bad times," agrees Nagporewalla. As long as the non-auto business grows, BFL should be able to drive through this business cycle, too.

How to hammer out a deal

Baba Kalyani is known to take his time when it comes to buying companies. Where other promoters may hurry to close deals after the basic due diligence, the senior Kalyani likes to spend time with the management of a "good buy", building a relationship.

Of course, he has the luxury of a leisurely approach only because of the sorry state of auto component companies in the US and Europe. Knowing they have to either file for Chapter Eleven or look around for potential suitors, the overseas promoters have little choice but to play ball.

"Bharat Forge's acquisitions are not usually brokered," says an investment banker. "The Kalyanis have probably missed out on a couple of deals because they take so much time, but nothing that really matters."

It's not just about time. Bharat Forge isn't extravagant in its purchases. Thanks to some clever structuring, four international acquisitions "" 260,000 tonnes of global forging capacity "" came its way for just Rs 190 crore.

BFL managed to stagger payments and also used the cash flows of the acquired company in some instances to pay off the promoters.

While promoters of European firms are hard up and not in a position to bargain, BFL has managed to negotiate a phased payment mechanism even for the Chinese acquisition (of the FAW group's forging division in December 2005), the consideration for which is to be paid in equal instalments over the next three years.

With the result that the consolidated entity is virtually debt-free after taking into account the foreign currency convertible bonds of Rs 360 crore raised earlier this year.