When Apollo Tyres chairman Onkar S. Kanwar announced the acquisition of U.S.-based Cooper Tires on Wednesday, he described it as a “transformational transaction.” The last thing he expected was that Apollo would be transformed into a pariah on the Indian stock exchanges. In a single session of trading after the deal was disclosed, shares of Apollo Tyres plunged more than 25%. “We believe Apollo could have bitten off more than it can chew,” Surjit Arora, research analyst for institutional equities at brokerage firm Prabhudas Lilladher, wrote in a report to clients.
The takeover of Findlay, Ohio-based Cooper Tires is one of the biggest outbound deals involving an Indian company. At $2.5 billion, it is more than the $2.3 billion the Tatas paid for Jaguar Land Rover (JLR) in 2008. The deal creates the world’s seventh largest tire company with a footprint in the U.S., China, Europe and India. “Together, our two organizations have almost no geographic overlap and [there are] significant opportunities for growth,” Cooper chairman, CEO and president Roy Armes said in a statement.
Cooper had a turnover of $4.2 billion in 2012. Apollo is smaller; the combined entity had revenues of $6.6 billion last year. The Indian company has offered $35 per share, which is a 40% premium over the 30-day weighted average on the New York Stock Exchange (NYSE). Cooper will be delisted after the transaction is completed. The share is currently being traded at $33.82.
U.S. shareholders have a limited downside and have reason to be satisfied, particularly those who got in at the 52-week low of $15.25. They can take their money and make an exit. But Indian shareholders of Apollo — and analysts — have reason to worry. The principal problem is the funding. “We are concerned about the huge debt burden, which could strain the balance sheet of the combined entity,” Arora said in the client report.
The all-cash transaction will be funded mainly through debt. Apollo has been preparing for the deal: A few weeks ago, it agreed to sell its Durban-based unit — Apollo Tyres South Africa — to Sumitomo Rubber Industries for $60 million. But that still leaves a large gap that could put a burden of around $200 million a year on the company. The deal will be conducted through Apollo subsidiaries in the Netherlands and Mauritius. According to analysts, price cuts forced by the competitive marketplace and the rupee depreciation — the Indian currency has fallen more than 6% against the U.S. dollar in the past month — will add to the pressure.
The adverse reaction to the Apollo-Cooper deal has reignited the debate over the benefits of M&A. It is widely held that in the short term, such deals are negative for acquiring companies. When Tata Motors took over JLR, there was criticism that it was a trophy acquisition. It has, however, been a great success; today it is rescuing the balance sheet of a beleaguered Tata Motors. One cannot say the same of the Tata Steel takeover of British steelmaker Corus. In May this year, the Tatas announced a $1.6 billion goodwill impairment caused by Corus.
According to a study by the Massachusetts-based National Bureau of Economic Research (NBER), which looked at 12,023 acquisitions between 1980 to 2001, shareholders lost $218 billion when acquisitions were announced. When the target was a small company, however, the shareholders of the acquiring firms gained $8 billion. One conclusion: Mergers for size — and eventual gains through economies of scale — are counterproductive in the short term. Another conclusion from the NBER report: “Large firms that make acquisitions are the firms that signal that they have exhausted internal growth opportunities, so that firm value drops as a result of that signal rather than the acquisition.” Apollo management says the Cooper deal will create value of around $80 million to $120 million annually. But this will kick in fully only after three years.
That’s a historical perspective — but things may be changing. At an iGlobal M&A summit in February in New York, speakers noted that deals have become more attractive for acquirers recently. Companies have become lean and efficient and valuations no longer have a huge takeover premium. A recent study by Forbes found that of 55 deals in the past six months, 24 resulted in share price increases, 10 were flat and only 21 acquiring companies saw their share prices decline on the deal announcement. In India, merchant bankers have been advising their multinational clients to raise stakes in the subsidiaries now, as valuations are attractive.
S. Raghunath, dean of administration and professor of corporate strategy and policy at the Indian Institute of Management Bangalore, believes that the Cooper acquisition is a positive move by Apollo. “Organic growth would have been a real struggle for the company,” he points out. “This acquisition will put it in a different orbit altogether. Also, Apollo’s over-dependence on the domestic market will now come down substantially.”
However, Raghunath cautions that it is “a high-risk acquisition.” He says Indian companies looking at overseas acquisitions have to be extremely careful about how they project their future cash flows. “This is based on an assessment of what those customers and those markets look like and whether you can bring the required synergies. Managerial competence and resource utilization competence are extremely important.”