Diluting deal

Eicher Ltd shareholders stand to gain more from the merger move, it seems

Eicher Ltd (EL), has decided to transfer all its manufacturing businesses to group company, Eicher Motors Ltd (EML). EL manufactures tractors, two-wheelers, gears and engines; while EML is in the much more lucrative commercial vehicles (largely LCV) segment. EL shareholders, according to the merger deal, get two shares of EML for every five shares held by them.

Essentially, EL shareholders will get close to 80 lakh shares in EML, which means the manufacturing division of EL has been valued at close to Rs 160 crore, based on EML's share price before the merger ratio was announced.

In comparison, EL's total market capitalisation was at Rs 190 crore. But looking at EL's market capitalisation doesn't really make sense since it has more than doubled since October, probably in anticipation of this deal.

What matters is the enterprise value of EL works out to Rs 360 crore (debt of around Rs 200 crore as on March 2003), or around 13 times the forecasted EBITDA for FY04. Needless to say, an EV/EBITDA of 13 times is a pretty rich valuation, especially for a company that has been in losses, and has an ROCE that is in low single-digits.

A merger ratio in favour of EL works to the advantage of the promoters since they hold 77 per cent in EL. As a result, their stake in EML would increase from the current 48 per cent to 56 per cent in the consolidated entity.

EML, in stark contrast, has an ROCE of 38 per cent and a double-digit operating margin. Clearly, the merger will dilute the financial performance of EML. Besides, while EML enjoys leadership in the light commercial vehicles segment, EL is not a dominant player in both the tractor and two-wheeler businesses.

Tractors could increase the risk of seasonality in the business, and since the company offers niche products in the two-wheeler segment, it can't be expected to drive growth for the consolidated entity.

Based on results for the six months ended September, two-wheelers would account for 12.5 per cent of revenues, tractors 24 per cent and CVs 58 per cent.

The few positives of the deal are that the consolidated entity will benefit on the tax front because of EL's losses, and also the advantage of size and scale.

In summary though, the two companies are a strange fit, what with some extremely low-margin businesses being merged with a highly profitable and high-return business. What's more, that merger ratio also seems to favour EL shareholders. But what's surprising really is that the EML stock price has reacted very positively to the deal.

Exide Industries

Exide Industries' plans to revive the setting up of a lead manufacturing plant in India will go a long way in lowering its raw material costs, since lead forms around 65-70 per cent of its total raw material costs.

Exide expects to reuse around 15-20 per cent of lead used in batteries produced through the reclamation process. This helps a lot, since otherwise around 80 per cent of its lead requirement is imported.

With the auto industry on an upswing, the bottomline will be boosted due to both volume growth as well as lower cost of production. However, there are still some hurdles to be cleared. But first, the sustainability of the lead prices will have to be ascertained, since a fall in lead prices will lower the cost advantage of producing domestically against importing lead.

Secondly, setting up a plant will imply a gestation period of around a year at the very least. Hence, any benefit of domestic production of lead will take that much time.

Further, Exide has ridden the bull wave in automobiles, not just in India, but in the export market too. Exports of industrial batteries grew 62 per cent year-on-year in the first half of FY04, while exports of automotive batteries grew 14 per cent.

Operating margins have been improving on a sustained basis, but the risk of higher lead prices remains. As around half of its requirement of lead is on long-term contracts, the higher prices may impact in the ensuing quarters as new contracts will be signed at higher prices.

Exide's presence in the export market will be strengthened further if the company is able to finalise a deal with Rover (UK) for supplying lead acid batteries for its automobiles. Earnings have jumped significantly in recent times and the Rover deal will only add to the bottomline.

With contributions by Mobis Philipose and Sameer Ranade