JLR deal will take time to give stellar results

JLR deal will take time to give stellar results: Experts

2008-01-04 11:56:27 Source : CNBC-TV18​

In and exclusive interview with CNBC-TV18, Sanju Verma, ED & Head-Institutional Business, HDFC Securities said that Tata Motors FY09 EPS may be cut to Rs 28 from the earlier estimate of Rs 57. This EPS cut is based on a 1:1 debt equity for financing the deal she added. According to Verma, the JLR deal will not be EPS neutral or accretive for 2-3 years. She added that they continue to have an outperformer on Tata Motors with a target of Rs 920. Verma warned [COLOR=#0000FF ! important][COLOR=#0000FF ! important]investors[/COLOR][/COLOR] not to expect very high returns from Tata Motors before FY10.

Meanwhile, Ashutosh Goel of Edelweiss Capital said that a 1:1 debt-equity would mean a 15% dilution for Tata Motors. According to him, assuming the deal to be a USD 2 billion valuation and assuming that JLR will see profits of USD 150 million in FY09, it will be an earnings neutral for Tata Motors.

According to Hormazd Sorbajee, Editor, AutoCar India the JLR deal will bring in high-end products and open global markets. “The JLR deal makes strategic sense for the Tatas,” Sorabajee said adding that though the Tatas Rs 1 lakh care has high potential, quality will be the key. According to him, Tatas are losing the share of the car market due to quality and product development cycle.

Excerpts from the exclusive interview with Sanju Verma, Hormazd Sorbajee and Ashutosh Goel:

Q: How do you think this deal might be valued? What Tata Motors might have to take on by way of debt or losses and how it might impact the financial of Tata Motors as a [COLOR=#0000FF ! important][COLOR=#0000FF ! important]stock[/COLOR][/COLOR]?

Goel: The valuation of the deal is already been talked about at USD 2 billion; it could be plus or minus 5% from that depending on their final financial due diligence that Tata Motors will be undertaking now. As far as the impact on the financials of Tata Motors is concerned, it will be about 15-20% dilution for the equity of Tata Motors and about a billion dollars of additional debt, assuming 1:1 debt equity ratio for the funding of the USD 2 billion.

They have net worth currently of about USD 2 billion and debt of another USD 1.5 billion. So their balance sheet is not heavily leveraged as of now. So raising that additional debt should not be a big issue and in addition to that, they might look at additional funding support from the group the way they did in some of the earlier acquisitions.

At that assumed level of 1:1 debt equity and a USD 2 billion equation, my estimate is that on FY09 earnings of Tata Motors will be close to USD 650-700 million and assuming that Land Rover, Jaguar combined put out a profit of about USD 150 million in FY09, it will be earnings neutral for Tata motors for FY09.

From whatever little financial information we have about Land Rover, Jaguar it seems that they started turning in a small profit in Q3 of calendar 2007 and in the last couple of years, their financial performance has been improving a bit and besides that the actual financial performance of the two-combined entities is not known in precise details.

Q: What’s your sense of the deal and so far the stock market reaction has been quite lukewarm. Do you expect that to continue?

Verma: The Tata Motors [COLOR=#0000FF ! important][COLOR=#0000FF ! important]stock [COLOR=#0000FF ! important]price[/COLOR][/COLOR][/COLOR] has had a very insipid performance in the last couple of months, barring the last three-four trading sessions where it has gone up from Rs 790 to more than Rs 805 today. But the run-up in the last three-four trading sessions has more to do with the Rs 1 lakh car being unveiled at the Auto Expo on 10th January this year.

As far as the possible Land Rover, Jaguar deal coming into Tata Motors kitty goes, we have done an analysis at our end obviously like any deal when it is a global alliance or global M&A you basically make an acquisition. For the acquirer, there are three things, which the acquirer looks at, that is access to technology, access to global market and a global customer base. So if Tata Motors were to acquire Land Rover, Jaguar, then of course it gets an access to all these three given that today Land Rover has a presence in 147 countries, Jaguar has a presence in more than 80 countries and more than anything else I think this is perhaps as good a time as any for Tata Motors to make a transition from being an India centric player to becoming a serious player in the global scheme of things within the automobile space.

Now the question is that what price? While Land Rover makes small amount of money; it makes profit but together Land Rover and Jaguar is a loss-making proposition and the combined losses of the two brands could be well in the vicinity of USD 200 million. What if the Tata acquires these two brands for USD 2 billion assuming there is a fair mix of debt and equity and assuming that they have to write off USD 200 million worth of losses in FY09. One will be surprise to know that the numbers don’t look flattering.

We were earlier talking of an EPS of Rs 57 for Tata Motors for FY09. But if Tata Motors were to get this deal for USD 2 billion and finance it in the ratio of 50:50 debt and equity, it would mean 9% equity dilution. It would more than anything else also mean that Rs 57 EPS which you were talking of that actually comes down to just about Rs 28; a staggering fall of more than 51%. So the financials don’t look flattering.

My personal sense is there is also a brand-positioning mismatch. The Tata have been having their finger in the mass segment, the popular segment. So while it is great to have these two brands, which mean that, they will also start catering to the premium and super premium brand. The point to be noted is that they will have to work hard and get their teeth into the deal to actually get brand synergies out of this acquisition which I think is not going to be an easy task.

So my personal sense is that the deal has its own share of positives and negatives, but it is certainly not going to be EPS neutral or EPS accretive for at least another two years and I think the Tata’s will have to be willing to sit through a period of pain for at least another two-three years before they can start making money on this deal.


Q: Is this truly a global step for Tata Motors because a couple of people watching the deal have made the comment that perhaps the brand should be kept separate, they should not be viewed as ‘Tata Jaguar’. Will it impact Tata Motors as a global foray or a global space now?

Sorbajee: I am sure that they are going to keep the brand separate. I don’t think there would be any question of linking Tata with Jaguar Land Rover. Volkswagen is considered a mass-market brand in Europe but they bought marks like Lamborghini and even Bugatti and have managed it quite well.

But I think the point over here, which has not been talked upon, is product. In the car business, product is king and if you have seen what Jaguar have recently launched the ‘XF Saloon’ -its been launched to rave reviews from the automotive press. Our sister magazine AutoCar UK have just done a comparison with 5 series BMW and after 20 years its actually beaten the 5 series which has been the standard in that class and this is one reason why Tata’s have been quite excited. They have seen what’s in the product pipeline, they have had a preview of it, which a lot of us don’t know, and there is a lot of exciting new products in this XF saloon. Land Rover has just shown the LRX Concept and the potential of that platform is also phenomenal.

So I think it’s a question of exciting products coming in. Fiat; a company, has been driven to the bankruptcy but it has bounced back on the strength of products like Grande Punto. So I think products are going to play a big role and there is access to global markets like Russia, China, which are just waiting to be tapped. Finally enough India isn’t such big market for these cars but there is a huge potential for the new range of products from Land Rover and Jaguar and I think that’s what is going to make the difference

 

[kartik]

Q: So, you are saying that if you look beyond the near-term financials, it actually makes a lot of strategic sense for the Tatas?



Sorabjee: Absolutely, they have got some great products there. Obviously they have had problems in the past for historical reasons. And I think the new owners are coming in at a time when there is a kind of rejuvenation in the product pipeline. So, I think in terms of timing, it is good.



Obviously there are going to be challenges. One is of managerial bandwidth in Bombay House. There is so much to be done even in the domestic market and Tata Motors’ other global ambitions. So, there are definitely going to be challenges, there is going to be an issue on investment in technology especially in environment technology because these cars have to meet certain CO2 emission requirements. So, all those challenges are there. But fundamentally if you have got great products, I think that is really the bedrock of any automotive company.



Q: Just one word on Tata Motors and its performance on the passenger vehicles segment, because even in the domestic market, Maruti has cleaned them out in several categories or segments?



Goel: Taking off from what Hormazd was saying earlier, the product is king. So, Tata Motors’ Indica is now almost 9 years old. So, no wonder that Maruti with a much younger fleet is gaining market share both in that segment and in the compact car segment. So, on that point, the hope is really on the success of the small car as well as the Indica replacement, which is expected to come out later this year.



That is the reason really on the car business side, Tata Motors has been not only losing market share, but the sales of Indica has been lagging the industry by at least 10-12 percentage points. So, really they are pinning their hopes on three new model launches that they are going to have in this year.





Q: At this point from a stock perspective at Rs 800, what would you do with Tata Motors?



Verma: We had released a report on the 26th of October 2007 at a price of Rs 793 where we had recommended an outperformer rating on that stock with a price target of Rs 920, and we continue to have that recommendation at this point in time as things stand now. Of course, as the deal goes through, we will have to closely evaluate the pros and cons, and like I said it could be a great deal from a product perspective, but certainly from a brand positioning, getting the cultural synergies together and more importantly putting the various pieces of the jigsaw puzzle into place is what will make or break the deal.



Had it been just another deal by the Tatas, I would have said great, I would have perhaps agreed with Hormazd. But let us not forget that the Tatas have spread themselves too thin, they have got to make Corus work out, TCS has been making acquisitions and trying to get a global footprint for itself. Now of course, Tata Motors has gone ahead and followed suit. So, I think for Tatas as a house, they have their finger in too many pies and the important thing is to look at this deal as part of larger scheme of things that the Tatas are trying to do for themselves in terms of becoming a global brand entity. It is not just about Tata Motors or Tisco or TCS, the Tatas as a house will have to get their act together to pull off this deal, just like they have decided to perhaps go and stretch themselves that extra mile with respect to a Corus or what have you.



As things stand now, of course, we continue to believe that there is an 18-20% upside from these levels. But like I said, this is clearly a story for somebody who is willing to bet on the strategic shift that the Tatas are making with respect to their branding and their geographical mix, and with respect to the perception that they wish to drive about themselves being a serious global player. So, if you are willing to bet on all of that, please go ahead and buy Tata Motors, but do not expect sterling returns till until FY10-11. For somebody who is more shortsighted and wants to look at their profit and loss position six months down the line, perhaps at Rs 920, the stock would be more or less full valued given that you are not talking of more than a compounded 10% growth in earnings for the company over the next 2 years.





Q: What do you think the Rs 1 lakh car can do to Tata Motors as a stock? What’s your own gut feeling?



Sorabjee:: I think there is a lot of potential for it. We are going to see it on 10th January but from what I understand, it looks absolutely stunning, it well packaged and frankly it is politically correct car in terms of space, price and fuel consumption. The potential is phenomenal for such a car. And the one thing which I think is a big challenge for Tata is they always get their concepts right even the Indica is a great concept even their SUV. It’s really the quality, which the company needs to focus on.



I think this is also one reason why they have been losing market share right now and as rightly said, I think the product development cycles has to be a lot faster with Tata Motors. It’s been ten years since the Indica whereas Honda in that period would have come out with two-three new models. So they got to accelerate their product development cycle and 2008 is going to be a very crucial year for Tata Motors. They have got so much happening and a lot riding on them this year. So potential is great but there are lots of challenges ahead as well