Apollo deal an ‘overambitious move’ – LKP Securities
Shares in Cooper Tire & Rubber have fared well since news of the tyre maker’s impending acquisition was announced. When the NYSE closed on 13 June the share price stood at US$33.80, an increase of some 38 per cent on the start of the week. Future owner Apollo Tyres has not enjoyed such a positive reaction to the news, however. By midday on 14 June (Indian standard time), shares in Apollo Tyres were trading at Rs 67.75, down more than 26 per cent since the deal was made public.
The current share price reflects concerns over the debt Apollo is taking on to fund the deal. As is already known, the Indian tyre maker will finance its acquisition of Cooper Tire & Rubber entirely through debt. US$2.1 billion, or around 85 per cent of the total acquisition price, will be serviced by a holding entity housing Cooper and Apollo’s Netherlands-based business, Vredestein. Following the Cooper acquisition, Apollo’s net debt/EBITA ratio will expand to 3.8x and the consolidated net debt to equity ratio will move up from 0.53x to 1.35x.
The acquisition has raised a few eyebrows amongst financial boffins in Apollo’s homeland. In a special report published 13 June, financial services group LKP Securities opined that the tyre maker is making an “overambitious move” considering current global demand. “Although the management has mentioned that this move will be earnings per share accretive right from the first year of operations, we have our reservations on it viewing the limitations on the topline growth and profitability at the EBITDA front considering the challenges both Apollo and Cooper are facing currently,” states LKP research analyst Ashwin Patil. “In FY 12, Cooper has posted its peak margins, and given the competitive intensity in the US from Chinese and Japanese players, we remain concerned over the pricing stability over there. In India too, given the falling commercial vehicle industry growth (which accounts for around 70% of Apollo’s business), earning incremental cash flows to pay off the debt seems difficult.”
In light of volatile demand and the raw material situation around the world, LKP also believes execution to be a key to earning stable margins. Patil notes that in 2009, when Apollo took on Vredestein’s operations, they were “acquired from a loss making company at reasonable valuations, which paid off well for Apollo.” He points out that “though Cooper seems like a good strategic fit, Apollo is paying a huge price for it (the debt raised for the acquisition is more than three times greater than Apollo’s market capitalisation), and hence gaining synergies and the timeline of achieving it is important.
“We also await more visibility on the complex funding structure and approval process in the next few months,” Patil continues. “Despite the 20 per cent fall in the stock price today, we believe there will be an overhang on the stock due to the complexity of the deal and expectations of investors from the deal going forward. We need to wait and watch over the next few quarters, as in how the synergies of this deal shape up.”