MCF likely to turn into a winner's curse

Suitors giving higher valuation to Mangalore Chemicals than their respective companies despite the latter struggling to grow

With both Deepak Fertilisers and The Adventz Group crossing swords over the takeover of Mangalore Chemicals and Fertilizers (MCF), analysts say the Vijay Mallya company might well turn out to be a winner's curse, due to the high valuation offered by both the companies in terms of price to earnings multiples and litigation and labour issues faced by the company.

Adventz' Saroj Poddar is valuing MCF around 12 times its net profit in FY14 and 1.5 times its book value. In comparison, Adventz group's flagship company, Zuari Agro Chemicals, is currently trading at a discount to its book value. Zuari Agro reported net losses in FY14 making P/E comparison meaningless.

Sailesh Mehta of Deepak Fertilisers is willing to acquire MCF at 10 times its net profit, nearly twice the current price to earnings multiple enjoyed by his company. He is offering such a rich valuation despite the notoriously poor growth and profitability record of fertiliser industries. In the past five years, MCF revenues and profits have grown at a compound annual growth rate (CAGR) of six per cent. In contrast, Deepak Fertlisers revenues nearly tripled during the period and net profit grew at a compounded annual rate of 12 per cent. At such rich valuations, it would be tough for the acquirer to earn adequate returns on the acquisition, leading to value destruction for the shareholders of Zuari and Deepak.

"The winner will be in for a long haul to revive the company. There are issues related to litigation and labour, apart from late payments of subsidies by the government," said an industry source, asking not to be named.

"There is also the issue of gas supply for the plant which is faced by the company and is reducing its productivity."

A UB group spokesperson said there were no issues with litigation or with labour unions.

Both, Deepak and Adventz have made bids for MCF. The takeover battle started after Deepak picked up 24 per cent stake from the market and recently made an open offer for the company. Taken aback, Mallya has roped in Poddar as a joint venture partner to retain his control.

Analysts also said global fertiliser prices were continuing to decline due to a demand-supply mismatch and could play an important factor when both companies finalise their bids. Global di-ammonium phosphate (DAP) prices are, on an average, quoting at $368/million tonnes (mt) as compared to $475/mt in July 2013. Ammonia prices have corrected to $490/mt currently due to improvement in supply over the last few months. Besides, potash prices are currently ruling at $380/mt and are expected to slide further post the break-up of the joint venture between Uralkali and Belaruskali abroad.

With global fertiliser prices continuing their downward trend, it is likely that farmgate prices of complex fertilisers might be reduced. Analysts said such a reduction in prices would be beneficial for the sector and help to spur agri-input consumption. Further, even after the reduction in prices, companies would be able to maintain their margins. However, delay in subsidy receivables remains a key risk for the sector.

MCF is part of the UB Group and the only fertiliser manufacturer in Karnataka. The main products are urea, DAP, ammonium bi-carbonate, sulphuric acid, specialty fertilisers, nutrient products and an industrial product called sulphonated naphthalene formaldehyde, used in the construction industry. MCF has annual urea and non-urea capacity of 0.38mt and 0.26mt, respectively.