Apollo-Cooper deal: Renegotiate or cancel?

Unless the courts give an adverse opinion, any change in original terms will be a near-term positive for shareholders of Apollo Tyres

With Apollo Tyres dragging its feet and Cooper Tire taking the legal route, the $2.5-billion deal between the two to form the world’s seventh-largest firm is far from being done and dusted. In fact, both accuse each other of backtracking on their original deal. Cooper in its report to the US Securities and Exchange Commission as well as in its suit at a local US court has accused Apollo of delaying the merger. Apollo, on the other hand, says the US company has not disclosed key information and wage negotiations would entail higher costs justifying a lower valuation.

While any outcome that keeps the original terms of the deal will be a setback for Apollo, the stock went up five per cent in trade on Monday on hopes that the deal price of $35 a share will be renegotiated or it may fall through.  Apollo has accused Cooper of misrepresenting facts about its Chinese joint venture and is also unwilling to give concessions to the United Steel Workers union to take the deal forward. Cooper Tire has acknowledged to Apollo that some price reduction is warranted. The key concern for the Street, which had given a thumbs down to the deal, was the increase in leverage, as well as the ability of Cooper Tire to maintain its margins.

Speaking on the development, S P Tulsian of SP Tulsian.com said for now it is a case of wait and watch.  “Given the sharp negative reaction from the market, it is not clear whether the company wants to go ahead. Also, since Cooper Tire has accepted that some price reduction is warranted, then how much reduction it is open to and what will be the substantial reduction that Apollo is looking for is difficult to quantify at present,” he adds.

Rohan Korde at Anand Rathi, too, did not want to comment till further clarity arises. He feels the hangover of the deal has led the stock prices to correct to attractive levels.

Yaresh Kothari at Angel broking feels despite Apollo doing well in the domestic segment, the stock has been beaten down severely due to the hangover of the deal. During the June quarter, Apollo Tyres had reported strong consolidated performance. Though top-line grew just 0.8 per cent over the June 2012 quarter, it was up five per cent sequentially to Rs 3,190 crore. The growth in European revenues was robust at 11 per cent y-o-y. Ebitda margins expanded 62 bps sequentially (123bps y-o-y) to 12.3 per cent. Profits grew 19 per cent y-o-y to Rs 165 crore.

Given the market sentiment, in case the deal falls apart, it will be a positive for Apollo Tyres shareholders in the near term. However, Apollo was looking at long-term gains from the deal as the acquisition would have led to an expansion of its its geographical presence. Hence the falling apart of deal would mean the company will have to re-work the strategy and decide on how to increase its geographical presence (through a greenfield route or will look at some other acquisition). Also, it is not clear what the financial implications ie whether the company will have to pay a penalty for cancellation of deal. Kothari feels that since looking at the issues raised it is difficult to say whether the penalty for cancellation will be applicable. Tulsian says that Apollo will look at cost benefit ratio of whether reduction of valuation of the deal is in favour or let the deal fall through and pay the penalty.

The $ 2.5-billion acquisition was planned to be funded by foreign currency debt (bonds) with seven-eight years t enure, the cost of which would have been slightly under 10 per cent, according to analysts. Even the management expected that post the consolidation, the consolidated net debt to equity ratio would jump sharply to two times from existing 0.6 times. After the announcement of the deal, rating agency CRISIL had downgraded ratings on Apollo Tyres debt from ‘AA’ to ‘A’, as fully debt funded acquisition of US-based Cooper Tires would have hit the financial profile of Indian tyre company.

The other concerns included the management’s ability to successfully integrate the operations of such a large company and maintaining the margins at which the company is operating. Gaurant Dadwal at Nirmal Bang had observed that the deal is likely to add around 110bps towards the margins of Apollo and was believed to be marginally EPS accretive for the company, given the higher margins at Cooper Tire and the size of its business. Cooper Tire is almost twice in terms of revenues and 5.5 times in terms of profits compared to Apollo Tyres.