Restructuring could be win-win for all
Expect value unlocking for TTCH’s shareholders
* Media reports indicate that the Tata group is evaluating the separation of Tata Chemicals’ (TTCH) salt and branded lentils businesses and merging them into Tata Global Beverages (TBGL). The group is also considering the merger of Tata Coffee (TCO), which owns coffee plantations and tea gardens, with TGBL.
* While there is no certainty on if and when the aforementioned strategy would be executed, we have evaluated the possibilities of execution of such a strategy and the effect it could have on the existing shareholders of TTCH as per current scenario.
Expected deal scenario: Equity swap or part-cash-part equity transaction
We believe that the speculated deal would either be a complete equity swap or a part-cash-part-equity transaction. We value TTCH’s consumer business at 22x FY18 EBITDA (~30% premium to its trading EV/EBITDA), and TCO at 15x FY18 EBITDA (~15% premium to its trading EV/EBITDA). For an equity swap, we estimate that TGBL would have to issue 320.9m shares for TTCH’s consumer business and 146.7m shares for TCO. However, for a ‘50% equity - 50% cash’ deal, the additional shares to be issued would be 160.5m for TTCH’s consumer business and 73.3m for TCO. Additionally, for ‘50% equity - 50% cash’ deal, TGBL would have to raise debt of INR43.4b for TTCH’s consumer business and INR19.8b for TCO.
Win-win for all
Tata Global Beverages (TGBL)
* TGBL to bag a re-rating business:
TTCH’s consumer business contributes ~41% to the overall revenue of the standalone entity and ~14% to consolidated revenue. At EBITDA level, the contribution to standalone entity stands at ~42%, while the contribution to consolidated EBITDA stands at ~18%. As per our estimates, the market values consumer business at ~17x FY18 EV/EBITDA, at ~10% discount to TGBL and over 50% discount to other FMCG giants. However, given the high margin (~28%), high RoCE nature of the consumer business, we believe the business deserves valuations comparable to its peers, which is not being realized, as it is being consolidated with TTCH’s commodities business. Merger with TGBL will unleash its full value potential.
* Enhanced EPS despite dilution:
In FY18, TGBL’s adjusted earnings were INR5,115m, while the earnings of TTCH’s consumer business were INR2,995m (as per our estimates). If the deal is a complete equity swap, the number of shares of the combined entity would rise to 952m, while the combined earnings would be INR8,111m. This would result in an increase of 5% in EPS to INR8.5.
However, if TTCH’s consumer business as well as TCO are merged into TGBL, the number of shares of the combined entity would rise to 1,098.7m as per our estimates, while the combined earnings would stand at INR9,270m. This would result in an increase of 4% in EPS to INR8.4.
If the deal is 50% equity – 50% cash, the total debt of the combined entity would increase and so would the interest cost. If TTCH’s consumer business is merged into TGBL, the number of shares of the combined entity would rise to 791.5m as per our estimates; however, the EPS would shrink by 20% to INR6.5 (refer exhibit 6) considering interest rate of 9% for incremental debt. If we assume interest rate at TGBL’s existing interest rate (4%), EPS would rise 6% to INR8.6. If TTCH’s consumer business as well as TCO are merged into TGBL, the number of shares of the combined entity would rise to 864.9m as per our estimates; however, EPS would shrink by 32% to INR5.5 (refer exhibit 8) considering interest rate of 9% for incremental debt. Assuming interest rate at TGBL’s existing interest rate (4%), EPS would increase 3% to INR8.4.
Tata Chemicals (TTCH)
* Value unlocking for TTCH’s existing shareholders:
While TTCH would lose its high-margin, high-RoCE consumer business, as well as an estimated 33% of its EV in FY18, the existing shareholders of TTCH would get 320.9m shares of TGBL in case of equity swap and 160.4m shares of TGBL at ‘50% equity - 50% cash’. The total equity value of TTCH at present stands at INR179.6b. Post the deal, at complete equity swap, the total equity value of TTCH would shrink to INR109.1b. However, the additional 320.9m shares of TGBL would provide additional value of INR86.7b. The collective value for the existing shareholders of TTCH would be 9% higher than now. Similarly, for ‘50% equity - 50% cash’ deal, TTCH would get additional cash of INR43.4b and its total equity value would shrink to INR152.4b. However, the 160.4m shares of TGBL would provide additional value of INR43.4b. The collective value, hence, would again increase by 9%.
Valuation and view
The speculated restructuring is expected to unleash value for TTCH’s consumer business and generate an additional value of 9% for the existing shareholders in the worst case (as per current scenario without taking into account synergy benefits). Once the consumer business de-merges from TTCH, the company would no longer remain a re-rating candidate for the mid-term. However, going forward, its foray into specialty products of HDS and Nutraceuticals would drive growth and re-rating, as TTCH invests free cash flows generated from commodities into high RoCE businesses. We largely maintain our estimates and value TTCH on SOTP basis, arriving at a TP of INR959 (36% upside). Maintain Buy
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