Rains' Rutgers buy: Viable proposition?

Management remains confident, Street feels acquisition price is expensive and would impact earnings

Rain Commodities’ acquisition of Belgium-based Rutgers, a coal tar pitch manufacturer, has failed to excite the market. The Rain Commodities stock plunged about nine per cent in the last two trading sessions, accompanied by heavy volumes after the announcement. The company’s acquisition of Rutgers for Rs 4,900 crore (deal value euro 720 million) values the latter at 7-7.8 times its operating profit, which analysts believe is expensive.

Earlier, Indian companies like Himdari Chemicals had dropped plans to acquire Rutgers, while other international players, too, weren’t interested in buying the business, even at euro 600 million, analysts said. The acquisition, carried out through a competitive bidding process (Rain emerged the highest bidder), is worrying analysts, as they believe the company is paying too much.

However, the company doesn’t agree. “The valuations we are paying are in line with global benchmarks,” says T Srinivasa Rao, chief financial officer, Rain Commodities, a company which earlier, too, made big acquisitions, compared to its size.
 

DIM OUTLOOK
In Rs crore	2011	2012E
Sales	5,630	5,359
Ebitda	1,320	1,288
Ebitda (%)	23.5	24.0
Net profit	664	626
EPS (Rs)	19.0	18.2
PE (x)	2.1	2.2
E: Estimates                  Estimates as on May 2012 Source: Motilal Oswal Securities

The acquisition is proposed to be funded through debt and internal accruals. Given its cash position (in June, cash on its books stood at about Rs 1,200 crore), the company would need to raise debt of Rs 3,700 crore.

The question is: Can Rain sustain the current high return on equity (RoE) levels of 30 per cent for the combined Rain-Rutgers business? The Street feels this is a key valuation parameter.

A positive aspect is the debt for the acquisition would be raised in the US subsidiary, at about eight per cent a year. So, the cost of funds is likely to remain low. And, if the acquired company can earn an additional two to four per cent over the cost of funds, it would directly add to the RoE. But the company believes it may not be possible to maintain 30 per cent RoE levels.

The acquisition immediately adds to the company’s scale. After the transaction, the consolidated annual revenue of Rain Commodities would more-than-double from the current Rs 5,600 crore to Rs 11,600 crore. But it is unlikely to add to the profitability commensurately; Rutgers’ earnings before interest, depreciation, taxes and amortisation margins are projected at 11-12 per cent, against Rain Commodities’ 24 per cent.

Also, the high leverage the additional debt would bring to the company is likely to weigh on the stock. After the deal, Rain’s consolidated debt is estimated to rise from Rs 3,600 crore in FY12 to Rs 7,380 crore — very high for a company with a market capitalisation of Rs 1,373 crore. Turn to Page 8 >

However, Rain Commodities’ chief financial officer says the transaction would be earnings per share-accretive and the company hopes to create long-term value for shareholders. He also suggests one should wait for a few quarters before assessing the actual performance of the target company.

Logically, Rs 1,200 crore (cash to buy Rutgers) would earn about Rs 110 crore annually. Given the Rs 6,000-crore revenue of Rutgers, at 12 per cent margins, it would earn Rs 720 crore. Half of this would go towards acquisition-based debt servicing. After tax, Rain would still have Rs 200-250 crore (Rs 5-7 per share). But the impact on valuations (given the debt and lower RoE) could mean limited gains, as analysts await further clarity on the deal.

Looking at the synergies, there is scope of better performance in the coming years. Rutgers is one of the leading producers of coal tar chemicals with presence in Europe, Russia, Americas and West Asian markets. With this acquisition, Rain Commodities can leverage its footprint and expand product offerings to its existing markets and clients. The company’s management said Rutgers and Rain Commodities had complementary products and geographic presence. Together, both companies would have a large and well-balanced product portfolio, as well as better international reach. It is also likely operational efficiencies can be achieved by leveraging the companies’ resources in international markets.