The merger of UPL and its associate company Advanta is a step in the right direction but it has left some questions unanswered, especially the earnings growth estimates that have been assumed while arriving at the deal valuations. To start with, on it is expected to be earnings-accretive for the merged entity, due to the cost savings and synergies across global markets and portfolios. To be completed in the next eight-odd months, it is estimated to save Rs 90 in annual costs, largely for Advanta, including savings on interest outgo and taxes. Operationally, too, there are visible gains. While the sales and marketing teams will remain separate, access to UPL’s wide distribution network and improved cross-selling should enhance Advanta’s reach and help the combined entity. UPL had in 2006 acquired a significant minority stake of 48.4 per cent in Advanta. On a fully diluted basis (considering the foreign currency convertible bonds and employee stock options issued), its stake is 38.9 per cent. Jai Shroff, Global CEO, UPL and Vice chairman of Advanta, said, “With this merger, UPL expands its product portfolio to cover the agri-value chain and provides UPL with an opportunity to engage directly with the farmers. Advanta benefits from the strong global distribution network of UPL and will be able to fast track its growth plans on the back of strong balance sheet of the combined entity”. With the merger of Advanta into UPL, shareholders of the former will get one equity share of the latter for each held in Advanta, as well as three preference shares which can be redeemed (only after 18 months) or converted (any time after being issued). The face value of the preference shares will be Rs 10 and the coupon rate is five per cent. If preference shareholders desire to convert their holding into equity, they will be entitled to one share in UPL for 47.1 preference shares. Meanwhile, Advanta’s global depository receipt (GDR) holders will get 1.06 of these in UPL for every one they hold. The deal, on the whole, will entail UPL issuing 77.45 million new equity shares (face value of Rs 2) and 181.83 mn new preference shares, based on the Advanta shareholding pattern as on last Friday (fully diluted basis). The basis of the share swap has been the discounted cash flow (DCF) analysis. This takes into account future cash flows and earnings, and the weighted (including volumes) average prices of the two stocks over the past two months.
The valuations have given more weightage to Advanta, expected to grow at 10-12 per cent annually in revenue over the next couple of years, with margin gains and savings on interest costs. Advanta’s fully-diluted earnings per share is estimated to be higher than that of UPL for calendar year (CY) 2016. However, not everyone agrees with the timing or the valuations for the merger, which is also reflecting in the street's reaction. The merger announcement, however, saw the UPL stock shed 3.5 per cent; Advanta ended marginally positive. An analyst at a domestic brokerage cited the movement in the two stocks. From its low in June, the Advanta scrip gained 47 per cent to its high in October, since correcting a bit, in line with other agricultural input peers. UPL in the period has fallen 20 per cent. For the deal valuations to justify, the net profit of Advanta is expected to nearly triple from the CY2014 level of Rs 86 crore to about Rs 240 crore (excluding the expected Rs 90 crore in savings). However, analysts say, they aren’t clear how the seeds business will be able to achieve a sharp jump in bottom line. What does stand in Advanta’s favour is the fact that globally, the seeds business does get a higher multiple than agri chemical companies (UPL in this case). The management indicated the seeds business is more sticky and, so, pricing power is higher. This is to be seen. At the current price, the UPL stock is trading at 14 times its FY16 earnings estimate. Given the muted near-term outlook, UPL’s stocks is likely to remain range-bound.