Why Hindalco's Aleris deal details should calm nerves in the market

Deal valuation, likely operating profit of $360 mn better than expectations

The Street’s nervousness over Hindalco’s expected acquisition of US-based Aleris was reflecting in its stock price volatility during the last one week. Though Hindalco’s intension to acquire Aleris through its US-subsidiary Novelis were known ever since it had bid for the business, and the enterprise value of close to $2.5 billion too was expected — the Street was worried over the deal valuation. 

Since Aleris had earned adjusted Ebitda (operating profit) of $200 million in calendar year (CY) 2017 and had a net debt of $1.68 billion, it was seen as an expensive deal. 

But, with Hindalco’s announcement now pegging the enterprise value/Ebitda valuation multiple at 7.2x (at an expected Ebitda of $360 million), and given the additional synergy benefits that are estimated to flow going ahead, most of the concerns should get addressed.

The projected Ebitda by Hindalco is now close to what analysts were expecting. For CY19, Kotak Institutional Equities had said that Aleris has the potential to increase adjusted Ebitda to $310-325 million. On Thursday, Hindalco said that it expects potential synergies of $150 million on integration of Asia operations (supply chain, selling and general expenses). 

Notably, Novelis doubled its auto products capacity in China to 200,000 tonnes, which is close to Aleris’ newly commissioned capacities. 

Further, while Novelis can grow its automotive products business, the Aleris acquisition adds to product diversification. 

Novelis — a downstream aluminium player with capacity to convert 3.3 million tonnes (MT) of aluminium into value-added products — will see its capacity grow by 1 MT after the acquisition, as it gets entry into new product segments such as aerospace, building and construction and truck trailers. 

This will increase its share of high-margin products besides improving its competitive position in America, Europe and Asia.

Goutam Chakraborty at Emkay Research says that while initially the Street was worried on deal valuations, their perception could change once they understand the long-term synchronisation and synergy benefits. 

Another analyst who did not want to be named felt that 7.2x valuations are attractive and the stock could now rebound.

On leverage, net debt to Ebitda — which at close of the deal is expected to be slightly less than 4x for Novelis-Aleris (less than 3.5x for Hindalco) — is expected to fall to 3x levels for Novelis-Aleris over two years, Hindalco said. 

Analysts say that Hindalco’s consolidated net-debt/Ebitda will initially increase to 3.7x from 2.8x, but is expected to decline to back to 2.5-3.0x over two years given the company’s strong free cash flows.