SamvardhanaMotherson Finance Limited (SMFL) is tapping the capital markets with its IPO which opens on Wednesday the 2nd of May and closes on Friday the 4th of May. The issue comprises of a fresh issue of Rs 1,344 crs and an offer for sale of Rs 321 crs. The price band is Rs 113-118. The company has completed an anchor allocation of 193.06 lac shares at Rs 115.

Business
The company SMFL is in the business of providing design and manufacturing solutions mainly to the automotive industry. The company has a number of subsidiaries and joint ventures with partners in the relevant fields. The principal focus is the automotive industry and the company derives about 75% of its revenues from overseas. For the nine month period ended December 2011, the total revenue from overseas was 76.6% and from within the country was 22.5%. The company has a global footprint with presence in 25 countries and 120 manufacturing facilities. The company is the holding company for listed entity MothersonSumi Systems Limited (MSSL) where SMFL owns 36.12% share. The reported revenues for MothersonSumi in 2011 fiscal on a consolidated basis were Rs 8,371 crs and the net profit Rs 390.08 crs. The EPS for the year was Rs 10.12. In the current nine month period ended December 2011, the company has reported revenues of Rs 8,479.62 crs and a net profit of Rs 64.81 crs.

SMFL as on 31st December has 18 subsidiaries, 19 joint ventures, and 86 other consolidated entities. The group through its one listed entity and the company going public reported combined revenues of Rs 14,500 crs in the nine months ended December 2011. SMFL has acquired Peguform in November 2011 and this company reported revenues of Rs 8,107 crs in calendar year 2010. This company is a key supplier to the Volkswagen group and is located in Europe, Brazil and China.

There are two interesting angles to the Motherson group. One is every joint venture that the company or group has irrespective of the holding or interest in the JV, the management of the JV is always with Motherson. Second is, that some of the recent acquisitions have been at the behest of the customers and have been prompted and supported by the vehicle manufacturers. These two facts assure the group of continued business and support in future ventures.

The group acquired Visiocorp in 2009 and this was a turning point in the company. This acquisition helped the company prove its capability in turning around sick companies and made it a large player in the exterior rear view vision systems in the light vehicles segment and having a market share of about 22%.

The company has a diverse product portfolio and manufactures various products used in the automotive space. It supplies products like wire harness, elastomer products, rear view mirrors, cutting tools, Bus AC’s, Cabins for off-highway applications, transport refrigeration systems and so on. The company has plenty on its plate and needs to consolidate the acquisition done this year in the form of Peguform to consolidate its business.

There is one major advantage in the automobile industry where any developmental work done with a manufacturer assures the developer/vendor of assured business for that product wherever the car is manufactured globally. The auto industry particularly the premium segment is doing extremely well and one is aware of the growth in high end cars like BMW’s, Audi’s and Mercedes Benz in countries like India and China. This would be a key growth area and demand driver for SMFL going forward.

Objects of the Issue
The company’s IPO consists of a fresh issue of shares of Rs 1,344 crs and an offer for sale of Rs 321 crs. The proceeds of the fresh issue would be used for the following objects: –

Financials
SMFL owns 36.12% of listed entity MSSL. The standalone results of the company are no comparison simply because the number of subsidiaries, joint ventures and consolidated entities is huge. The company reported revenues of Rs 5,716.5 crs for the year ended March 2011 and the same in the nine months ended December 2011 has increased significantly to 6024.52 crs. The company made a net profit of Rs 192.24 crs in fiscal 11 and a net loss of Rs 152.79 crs in the nine month period. There are two one-off items which have impacted the results adversely. There was a loss on account of foreign exchange translation of Rs 70.87 crs, and transaction cost of Peguform acquisition of Rs 67.17 crs. Besides this there were start-up costs due to new facilities in Brazil and Hungary.

The company has been growing consistently and the two large acquisitions will keep the momentum going and the business growing for the next couple of years. The financials will also see improvement as Peguform business stabilises and the new units which have been set up in Brazil and Hungary are ramped up and start delivery and slowly reach capacity utilisation. The production plants of auto ancillaries have to be ready before the automobile company begins production and there is always a start-up cost incurred in the short term. The margins of the company have yet to stabilise as the business mix has changed dramatically and the additions through acquisitions have been large. The EBITDA margin in FY11 was 8.8% which had improved from the previous year’s 7.5%, In the case of net margins the same was 3.4% which had improved from 1.5% in the previous year. In the current nine month period the EBITDA margins have halved to 4.4% while the net margins have turned negative.

In terms of EPS the company had an EPS of Rs 4.06 for FY11 which translates into a PE of 27.84 times at the lower end and 29.07 times at the upper end of the price band. These ratios are on the basis of pre-money IPO and based on historical numbers for FY11. As mentioned earlier the current nine month period ended December 2011 saw net losses and there is no way that the net loss after nine months could get reversed in the last quarter.

The next year is likely to see significant growth and improvement in margins as Peguform stabilises and the new production facilities start delivering. The benefits of the Peguform acquisition would be seen in the topline from Q4 of year ending March 2012 and effect on the bottomline from Q1 of FY13. Peguform was acquired for a total value of approximately Rs 1,000 crs and loans were taken for the acquisition and also for working capital loans. The object of the issue includes repayment of Rs 966 crs of debt. This would reflect in lower interest costs and also higher margins. On a rough cut basis it would be fair to assume that the revenues of Peguform would cross the Rs 2,500 crs in a quarter and would continue to increase as the business ramps up.

Track record of Merchant Bankers

Standard Chartered Securities (India) Limited
The banker has handled one issue prior to SMFL and that was the IDR issue of Standard Chartered PLC. The issue was trading at a premium at the end of the 30th trading day after listing. The issue as of close of trading on Friday the 27th of April was trading at a discount to the issue price.

J P Morgan India Private Limited
This banker has in the last three years handled 5 issues. Of these 5 issues as many as 4 issues were trading at a premium on the 30th calendar day from listing. The situation changes completely if one takes the closing prices as of Friday the 27th of April into consideration. 4 out of five issues are trading at a discount.

Comparisons
The company has chosen to compare itself with companies like Bharat Forge Limited, Bosch Limited, Exide Industries and MothersonSumi Systems Limited. I believe the first three names are not comparable simply because the nature of business is different. Bharat Forge is more into forged components which is in no way any speciality of SMFL. Secondly Bosch is more with spark plugs, filters and components connected with the engine of automobiles. Exide Industries is more to do with storage batteries and SMFL is in no way connected with this activity. The best comparable for SMFL is MothersonSumi and these two companies have a lot in common, besides being owned and part of the same group.

The company MSSL reported an EPS of Rs 10.12 for the year ended March 2011. In the current nine months ended December 2011 there have been one time provisions on various counts of Rs 155.91 crs. I believe that the best comparison for SMFL is its own associate company MSSL and the comparison should be made with this company. The valuation of SMFL versus MSSL makes the former look expensive compared to MSSL. The key to the difference in valuation is the last two acquisitions which have been made in the form of Visiocorp and Peguform. Both these companies are multi location, across geographies and add substantially to the revenues of the company. The holding of these companies is in both the companies i.e. SMFL and MSSL and the benefit to SMFL would be larger on consolidation as it would consolidate its own revenue and bottom line and also 36.12% of MSSL.

There is confusion about the structure of ownership which is through a maze of companies that the SamvardhanaMotherson group operates. It is the same in the case of MSSL and SMFL.

Valuations
The valuation of SMFL based on an EPS of Rs 4.06 for the year ended March 2011. The PE ratio based on this EPS is 27.84 times at the lower end of the price band of Rs 113 and 29.07 times at the upper end of the price band of Rs 118. Anchor investors have put in money at Rs 115 and subscribed to shares worth Rs 222 crs. In the nine month period ended December 2011, though the company’s revenues have grown from Rs 5,716.5 crs in 12 months to 6,024.52 crs, the profit was impacted due to one off items as explained earlier. The growth in revenues on an annualised basis would be in the region of 40%. The profits would come in the year 2012-13. The asking price looks extremely expensive considering that there was a loss in the nine month period and effectively there is no PE for a loss making company.

The growth in business and opportunities in this sector seem tremendous. Consolidation in the business is happening and globally car manufacturers are looking at dealing with lesser number of vendors or partner suppliers. It is this opportunity that the Samvardhana group is exploiting.

Concerns
The biggest concern with the group is the complex structure that the company does its business through. There are as many as 18 subsidiaries, 19 joint ventures, and 86 other consolidated entities in SMFL. Secondly all new businesses are split in terms of ownership between the two companies namely SMFL and MSSL in a ratio which could be 49:51, 50:50 or 51:49. This ratio gets further skewed in favour of SMFL which owns 36.12% of MSSL which means effectively even a 50:50 split on a consolidated basis is actually 68.04:31.96. The second concern is that 75% of the revenues of the company at a consolidated basis come from outside the country. Globally currencies are extremely volatile and could cause the balance sheet to get impacted on translation losses/gains which are not a part of the regular business. This situation in terms of local to overseas ratio of sale is unlikely to change significantly in the near future due to the nature of business and the location of plants and customers. The third concern is that the group has no previous experience of turning around a sick company and whatever little experience is in the form of Visiocorp which is in the process of turnaround. The ability to successfully turn around Peguformwould be tested and the success or failure would determine the growth of SMFL.

Conclusion
There is risk in investing and with the high valuations demanded by SMFL the risk reward ratio is not in favour of the risk taker. It makes better sense to buy shares and make investment in the listed entity MSSL which has a 19 year track record. Once SMFL is listed and performs one could switch from MSSL to SMFL. At the current market price of MSSL and price band of SMFL the switch would give you 1.5 shares per share of MSSL making the investment that much more worthwhile. Very clearly it appears merchant bankers and promoters are not leaving that little bit on the table to attract investors and make investment in primary markets attractive.

SEBI Disclaimer: – I do not intend to subscribe to the above issue.