Deflated expectations

Cooper-Apollo spat forces investors to pick lanes

Investors in Cooper Tire & Rubber are being forced to pick lanes. Legal wrangles have put Apollo Tyres' agreed $2.5 billion offer for its US rival in doubt, and tensions at its China joint venture have undermined Cooper's value. But a negotiated price reduction still looks possible. Cooper shares may be pricing in too much bad news.

Cooper shareholders must choose between four broad outcomes. The least likely is that the deal goes ahead on the agreed terms of $35 per share. Apollo has made it clear that it would like a lower price. Its lenders are also getting cold feet.

If the deal falls apart, Cooper shares might be expected to fall back to their pre-bid price of $24.50. But the wrangle with Apollo has exposed the US company's less-than-firm grip on its Chinese joint venture, which contributes around a quarter of its parent's revenue and earnings. Assume the subsidiary's value is reduced by 25 per cent, and Cooper's standalone value drops by $100 million, equivalent to $23 a share.

There is room for negotiation between these two extremes. One possibility is that Apollo adjusts Cooper's value to reflect the reduced value of the Chinese business and then applies the same 40 per cent premium as before. In that case, Cooper shareholders would receive around $32 a share.

Apollo might, however, seek to pay a lower premium. Say it offers just 20 per cent more than Cooper's reduced standalone value. Shareholders would then be presented with an offer worth just $28 a share.

Investors are taking a dim view. Take Cooper's closing share price of $25.81 on October 11. One way of interpreting that number is that investors think there is zero chance of the deal going ahead at the original price, a 60 per cent probability of failure, and just a 20 per cent possibility of either renegotiation scenario proving correct, according to a Breakingviews calculator.

The longer the dispute drags on, the greater the damage to Cooper's value. But that also makes it more likely that the US company renegotiates with Apollo - or finds another bidder. Cooper shareholders aren't attaching much probability to that lane providing an exit from the current mess.