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To buy 19% stake in HLFL, incl. 12% from promoters… …
with objective of simplifying shareholding for pursuing future growth
Ashok Leyland’s (AL) management addressed investors on its proposed acquisition of ~19% stake in its subsidiary Hinduja Leyland Finance (HLFL). AL would acquire ~7% stake from the existing private equity investor Everstone and ~12% from promoter owned entity. This would entail investment of INR11-12b. Management tried to address key investor concerns about (a) rationale to buy partial stake of the promoters (residual stake at ~18.6%), (b) valuation of the deal and (c) timing of acquisition given the need to conserve cash. The rationale given by management of simplifying shareholding structure for HLFL to pursue future growth plans (incl. M&A) was ambiguous. This has raised concern about easing of tight leash on capital allocation which AL had displayed since FY14.
Deal details: AL will buy 19% stake in its subsidiary HLFL for INR11-12b. This includes 7% stake purchase from PE investor Everstone (announced on 7th Feb) and ~12% from the promoters (announced on 18th March). Both the stakes are to be purchased at ~INR119/share (~2x Mar’19 book value), based on valuations finalized in Feb’20. AL’s stake in HLFL would go up to ~81% post this acquisition.
* Everstone had bought ~14% stake in 2013. In Nov’17, it had sold ~7% stake at INR110/sh. Second tranche of ~7% was supposed to be sold by May’20.
* Valuation of the deal: While valuations at ~1.8x FY20E P/B are at premium to current valuations (in context of the difference in the RoE profile) of vehicle financiers like CIFC, SHTF and MMFS (0.8x-1.8x), these valuations were agreed upon with Everstone a few months back. The purchase of promoter stake is at same valuation as of Everstone. We are not too perturbed by valuation premium as it was based on a pre-determined agreement with Everstone (and before market crash happened) and strategic premium is not unusual.
* Why buy stake from the promoters? There was need to simplify shareholding structure of HLFL for it to pursue future growth opportunities like getting another PE investor, acquisition/merger and going global. Also, AL having sizeable stake is important because at some point in time HLFL will go for IPO and at that point it would like to show some value release for AL. Note that AL would like to have minimum 51% stake in the company.
* HLFL is of strategic importance to AL as it has 15% market share of CV financing and 50% of book from CV financing. In 9MFY20, HLFL had ~INR2.2b PAT (~34% contribution to AL’s 9MFY20 consol. PAT). Also, HLFL would play key part in AL’s export aspirations in Nepal, Bangladesh, ME and Africa.
* Acquisition by AL would not put stress on its balance sheet, as its net debt as of Dec’19 was ~INR14b (net of ICDs). With a reduction in inventory, Mar’20 ending net debt would be negligible (estimated at ~INR1.7b).
* Update on coronavirus: AL sources tools and & EFI parts from China. For BS6 and Modular Business Program, there would have been a challenge if China would not have started operations. However, the situation in China is improving and hence AL does not expect it to be a big challenge.
* BS4 inventory: Total inventory at 600 units including dealer and AL, from 27,500 units at peak.
Valuation and view:
We have lowered our FY21/22 S/A EPS estimate by 25%/20% to factor in the near-term volume weakness due to the impact of BS6 transition and coronavirus, as well as higher debt as we factor in the HLFL stake purchase. Unlike in the previous cycles, AL is on a very strong footing (lean cost structure & negligible debt) and focused on adding new revenue/profit pools. However, this stake purchase from the promoters does raise questions on dilution in tight discipline on capital allocation practiced since FY14. We will closely monitor for any further evidence on the same. Post recent correction in the stock price, valuations are very attractive at 12.2x FY22E S/A EPS and ~6.5x EV/EBITDA and do not fully reflect for AL’s focus on adding new revenue and profit pools. We do lower our target multiples for both S/A business (from 10x to 9x) and HLFL (from 1.5x to 1x) to factor in any potential risk of dilution in capital allocation discipline and sharp erosion in valuations of peer vehicle financiers. Maintain Buy with TP of ~INR72 [9x Dec-21 EV/EBITDA (compared to ~11x 10-year median EV/EBITDA) + INR9/sh of HLFL @ 1x P/B].
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