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St slams midcaps for unrelated M&A moves

Saturday, 27 October 2012 - 8:04am IST | Place: Mumbai | Agency: dna

Recent moves by several midcap companies to grow their business inorganically have failed to enthuse the Street.

Recent moves by several midcap companies to grow their business inorganically have failed to enthuse the Street.

In fact, three companies which announced plans to acquire unrelated or new businesses have seen their share prices plunge 5-19% following the announcements.

The stock of CESC tanked 18.67% in intraday trade on Friday after it announced that it is acquiring a minimum of 49.5% stake in Firstsource Solutions, a company engaged in business process outsourcing, for Rs395 crore. The RP-Sanjiv Goenka Group led company closed the day at Rs281.15 a share, down 15.32% – its steepest fall in the last six years.

Similarly, the stock of Sun TV Network slipped a further 7.25%, on top of a 3.46% fall witnessed after the company won the bid for Hyderabad IPL T20 cricket league franchise for Rs85.1 crore a year, to be paid for five years.

The stock of Rain Commodities has also been under pressure, shedding nearly 12% in the last four sessions, since it announced 100% acquisition of Rutgers NV, a Belgium-based coal tar pitch manufacturing company. The Rain group, engaged in production and sale of calcined petroleum coke, cement and co generation of energy, would be paying a gross enterprise value of €720 million to gain geographical and product diversification.

Analysts, too, have slammed the companies for these unrelated diversification deals.

Citigroup downgraded the stock of CESC to ‘sell’ from ‘buy’, saying another unrelated acquisition post its retail diversification through Spencer Retail could lead to higher leverage in the power business.

“The acquisition multiples look cheap on enterprise value (EV) to sales parameter but look expensive on EV/Ebitda multiple vis-a-vis other BPO players such as EXL Services and WNS Holdings, adjusted for scale of operations. CESC parent has generated average CFO (cash flow from operations) of `550 crore and done average capex of `760 crore in the last five years, which implies it has not generated any FCF (free cash-flows) over the last five years. This implies the acquisition would increase standalone parent leverage, which could depress profits.

Further, the company is spending almost 15% of its current market capitalisation on this unrelated diversification,” Venkatesh Balasubramaniam, Atul Tiwari, Deepal Delivala and Vaishnavi G, analysts at Citigroup Global Markets, said in a note dated October 26.

The analysts at Motilal Oswal Securities too see CESC’s intent of venturing into an unrelated business as negative.

Analysts are less critical of Sun TV’s move but feel its valuation multiple may suffer.

“While we expect earnings impact to be insignificant, relatively unrelated diversification into IPL could be an additional overhang and impact the valuation multiple,” Shobhit Khare, analyst at Motilal Oswal Securities, said in a note on Thursday.

The stock of Rain Commodities may also remain under pressure because of higher leverage and impact on its cash flow metrics, believe experts.

“We believe the acquisition could weaken company’s credit measures such that its debt-to-Ebitda remains in range of 3.5-4X over next two years as compared to the current 2.5X. Also, the leverage and cash-flow metrics are likely to be stretched immediately after the acquisition,” wrote the analysts at Standard & Poor’s Rating Services.

Clearly, unrelated diversification is not taken well by investors unless the company is cash-rich and large-faced, with limited growth opportunities in its core business.


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