Cooper looks too big for Apollo Tyres to digest: Quant

Basudeb Banerjee, Equity Research - Auto Ancillary & IT Services at Quant Capital is of the opinion that Apollo Tyres's acquistion of US-based Cooper Tire & Rubber Company, in an all-cash transaction of Rs 14,500 crore is too large for the company to digest.

However, he does not expect the stock to see a massive correction from current levels. He expects the stock to stabilise somewhere around Rs 65-70. Post acquisition, Apollo will become the seventh largest tyre manufacturer in the world. The acquisition will give Apollo access to higher margin markets, Banerjee adds. Also read: Apollo Tyres buys Cooper Tire for Rs 14,500cr; stk sinks Below is the verbatim transcript of his interview on CNBC-TV18 Q: What have you made of the deal that they have struck for themselves and what kind of implications does it have for their balance sheet? A: If one looks at the size of the deal compared to the Tata-Jaguar Land Rover (JLR) deal of USD 2.3 billion, this deal is even more than that and new for Indian tyre industry. However, going through the fully leveraged route the size of the acquisition is too big for the existing Apollo to digest. If one looks at the valuation premium which they are paying compared to what Cooper Tire was trading at, is also very much on the higher side adjusted enterprise value (EV)/ earnings before interest, taxes, depreciation and amortisation (EBITDA) of somewhere around five times after factoring in pension liabilities. Cooper was trading at 3.5 times EV/EBITDA. So, this Rs 15,000 crore of debt is very big for Apollo's books and debt to equity will reach around three times. Therefore, a knee jerk reaction on the stock price was expected. Q: Do you see the stock stabilising at current levels, that is 20 percent lower because it has lost fifth of its marketcap already. What price would factor in this kind of enhanced balance sheet risk? A: Factoring in four times EV/EBITDA for Cooper and 4.5 times for existing Apollo business, our ballpark number comes out around Rs 80. However, whenever this kind of costly acquisition come, the stock trades near to the fair value. So, there is a probability of trading at a steep discount to fair value is also there and that is why one saw this 20 percent cut today. Broadly, one should not expect massive correction from these levels now on and stabilising levels should be somewhere around Rs 65-70 before which any element of buying interest can emerge. If one looks at the drivers for this acquisition then definitely since commodities are in a bad shape and with the raw material basket being in the favour of Cooper and Vredestein, free cash flow generation will continue from a consolidated perspective and that will help them to gradually repay the debt around Rs 1,200-1,400 crore every year. As we see more visibility that Apollo consolidated is repaying back debt, positivity will come back into the stock. Currently looking at the domestic business with the demand is not in a great shape; rupee weakening impacting the cost of acquisition of raw material, Vredestein for the past two quarters suffering from the European downtrend etc under along with this high risk profile acquisition, the stock has suffered today. On the positive side, Cooper revenues has been more or less stable, the element of volatility in Copper is not much only plus-minus 3 percent and Copper will also give Apollo access to the high margin markets of Eastern Europe and China, which Apollo was looking out to expand for so many years. So, Apollo will stop their existing capex plans at Thailand and Eastern Europe.