Investors want Apollo Tyres to rethink Cooper Tire acquisition

Concerned by the highly-leveraged acquisition of Cooper Tire, institutional investors of Apollo Tyres BSE 0.48 % are in dialogue with the management seeking a rethink on the $2.5-billion all-cash deal. The investors believe that the company is "over-paying" for synergies that will be difficult to achieve and they believe that the value-destructive deal is already been reflected in the sharp decline of Apollo shares, that destroyed about Rs 1,500 crore of shareholder value in the aftermath of the deal announcement. Among leading institutional investors holding sizeable stakes in Apollo Tyres are ICICI Prudential Life (5.24%), Franklin Templeton (3.54%), Skagen Kon-Tiki Verdipapirfond (2.64%), CLSA Mauritius (5.66%), among others.

ET could not independently verify with the institutional investors whether they had approached the Apollo Tyres management, as some of the investors cited "compliance issues" to decline comment.

Responding to a questionnaire, Suman Sarkar, chief financial officer, Apollo Tyres, said: "We are in continual engagement with our shareholders at all times and have been proactively reaching out to them post deal announcement to explain the strategic rationale, the financing structure and the benefits to shareholders." The investor grouse is related to the high leverage, which the investors fear may become a value destroyer. Amit Tandon, managing director, IIAS, says if it had gone to shareholders to vote, we would have said to vote against the deal. To be sure, no shareholders consent is required for an all-cash deal.

The investors also believe that the big-ticket acquisition will change the character of the company. To be sure the shares have recouped losses, when the share touched a 52-week low of 54.60 a share on 21 June. It has since recovered to Rs 63.15, a share on Tuesday, but still way lower than its 52-week high of Rs 102.45, a share.

According to an analyst, rarely does a tyre-maker make such highly-leveraged acquisitions, as margins of tyre companies rest on the highly-volatile rubber prices. Rubber prices are currently treading lower ground, but could bounce back in the future, thus thinning profit margins substantially.

The company, however, is betting on what some analysts are talking about the "end of the commodity super-cycle and going forward commodities in general are expected to be moderate."

"Rubber, specifically, is likely to see a lot of additional supply coming on stream in the next few years, and this is expected to keep prices soft. The leverage taken is split across entities that have the cash-flows to service the debt and no one operating entity is inordinately burdened," Sarkar explained.

Analysts aver that Apollo Tyres is guiding to $80-100 million cost synergies from the deal. However, given the heavy dependence on raw materials in the cost of production, this may be difficult to achieve. Soon after the deal was announced, Crisil downgraded the long-term credit rating on the bank facilities and other debt programmes of the company to "CRISIL A" from "CRISIL AA" and short-term rating to "CRISIL A1" from "CRISIL A1+". It also revised the rating outlook to 'negative' from 'stable.' For the acquisition, Apollo Tyres would set up a new holding company, which will be financed entirely through debt, of which about Rs 2,700 crore, or $450 million, will be serviced by cash flows of Apollo Tyres.

The company is of the view that this is not a big risk, when one looks at the big picture. "Only 18% of the financing for the deal has any link to the rupee," Apollo's CFO explains. "Our exposure on this will be fully-hedged against any further change in value of the Rupee. On the other hand, one of the great strategic benefits of this transaction is that Apollo's revenues and profits will be diversified to a whole basket of currencies and Rupee revenues will be only about 20% of the consolidated entity," he added.

This, according to the company, will help the company avoid a potential slowdown in the Indian market and serve as a safe-guard against a weak Rupee. Another grouse against the acquisition is that Cooper is a supplier of tyres to retail chains under private labels and hardly has any visibility in the developed markets. There is a fear also that US, which had imposed anti-dumping duty against Chinese tyre-makers has lapsed, thus leading to Chinese tyre-makers competing against Cooper for the US market.

"The US anti-dumping tariffs lapsed in September of 2012 and there has been no upsurge of imports since then. In fact, imports into the US have not dropped even in the years since the tariffs were imposed, so there is unlikely to be any change in valuations going forward," Sarkar reasoned.