Suzlon: Against the wind

Suzlon's bid for REpower at 25 times estimated FY07 earnings is high.

Suzlon's bid for REpower Systems, Germany's third-largest wind turbine company, at an equity value of ¤ 1 billion appears aggressive, considering that it is at 20 per cent premium to Areva's offer price of ¤105.

Areva's offer price was at about 17 per cent higher than the prevailing market price. Compared with the three-month average price before Areva's bid, the price is 73 per cent higher.

That REpower's business is improving is clear. After a negative EBIT margin in 2004 and 2005, its results for the nine months to September 2006 were good.

Analysts expect its EPS to improve from an estimated ¤ 0.75 in 2006 to around ¤ 3 in 2007 and over ¤ 5 in 2008. On an EV/EBITDA basis, analysts estimate Suzlon's bid value for REpower at about 25 times estimated FY07 earnings, which they say is high.

Suzlon's estimated FY07 EV/EBITDA is 23 times. It is fully integrated with a foothold in the two high-growth markets "� China and the US.

On the other hand, REpower operates in Europe, which has 45 per cent share of wind power facilities globally, though it is growing slow. While Suzlon is also fully integrated, REpower outsources its components.

There is a strategic fit between the two companies. Suzlon will make further inroads into Europe (it had acquired Belgium's Hansen in March 2006). The company also plans to improve the supply chain at REpower and bring about economies of scale.

According to the Suzlon management, there will also be synergies in marketing, design and R&D between the two companies. Besides, Suzlon will benefit from REpower's offshore turbine technology, though only in the long term, say analysts.

The company has lined up credit for the acquisition, so funding is not as much a problem as the impending decline in margin is, because if the deal goes through Suzlon's debt will increase substantially.

At the end of December 2006, the wind turbine maker had debt of Rs 3,198 crore and net worth of Rs 3,316 crore. Since the bidding is being made by a 75:25 SPV between Suzlon and Portugal's Martifer, the burden on Suzlon will be limited to that extent.

Also, it will depend on how many shares the combine is able to garner in the bidding. Also, Martifer owns 25.4 per cent in REpower, while Areva has 29.9 per cent stake.

What happens next is going to be interesting. Areva could increase its offer price and Suzlon could raise it further, making the deal more expensive.