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Kubota to hike stake via preferential allotment, open offer

Stake to rise to 53.5% | FY23E cash to increase to INR58.7b

ESC’s board on 18th Nov’21 approved sale of ~6.4% stake in the company to Japan’s Kubota Corp. for ~INR18.7b (at INR2,000/share), taking Kubota’s stake to ~16.4% (after the extinguishment of the first round of treasury shares). This will trigger an open offer by Kubota for a 26% stake in ESC. Assuming the successful open offer and cancellation of all treasury shares, Kubota’s stake in ESC will rise to 53.5%. Its stake will rise further as it is consolidating its Indian operations under ESC by merging two JVs in India with ESC. These transactions further strengthen its relationships, which was initiated in Dec’18 through a JV and transited to ~10% stake purchase in Mar’20. With ESC being the only vehicle for Kubota in India, we expect faster leveraging of synergies from the India operations, with easier access to: a) global product knowhow (in Tractors and implements), b) global distribution network, and c) global supply chain (by leveraging India’s cost base). Factoring in share capital, excluding treasury, would result in ~9% dilution and ~4% cut in its FY23E EPS. We are also not factoring in mergers of the two JVs with ESC. After the first acquisition of stake in ESC by Kubota, the stock got substantially re-rated (from pre-Kubota LPA P/E of ~11.5x to ~20x currently). With this anticipated event behind us, we expect the focus to shift back to fundamentals. We remain cautious on the Tractor cycle. We now value ESC at 18x (v/s 15x earlier; in line with our target PE multiple for MM’s Tractor business) and maintain our Neutral rating with a TP of INR1,700.

* Transaction details: ESC will issue ~9.36m shares (or ~6.4% stake) at ~INR2,000/share to Kubota for ~INR18.7b. Subsequently, Kubota will make an open offer to the public shareholders for 26% of ESC’s capital (after the proposed extinguishment of the first tranche of treasury shares). 

* Other proposals: The board has proposed: a) extinguishment of the remaining treasury shares (21.4m shares, or 16.3% stake), b) merger of the two JVs between ESC and Kubota (ESC’s stake at 40%) and Escort Finance, c) increase in the number of directors on ESC’s board as it plans to have four directors nominated by Kubota (from two currently), four nominated by the promoters, and eight independent directors, and d) change in the name of the company to ‘Escorts Kubota Ltd’.

* Kubota’s stake to increase to 53.5%: After the proposed allotment of shares, Kubota’s total stake in ESC would increase to ~16.39% (adjusted for extinguishment of the first phase of treasury shares). Its stake will increase to ~44.8% after the open offer. Post cancellation of the remaining treasury stake, it will increase to ~53.5%.

* No change in the executive management: Except for an additional two board seats for Kubota, there wouldn’t be any change in the executive positions of the company. Mr. Nikhil Nanda (promoter) will continue to remain the Chairman and MD.

* Five-year shareholding lock-in for both partners: As per the shareholders’ agreement between Kubota and the promoters, there would be a five-year lock-in equity holding. Mr. Nanda reiterated that they are fully committed to ESC and have no intention of selling any shares.

* The eventual holding of Kubota and other shareholders will depend on the share swap ratio for the merger of the two JVs and Escort Finance. The two JVs had a combined FY21 revenue/EBITDA/PAT of INR18.b/INR1.2b/INR0.6b.

* The management expects to complete the preferential allotment and open offer by Mar’22.

* Business level benefits: This transaction further fortifies its earlier announced synergies and consolidates the entire operations of Kubota in India into ESC (adding ~2.5% market share in India). With ESC being the only vehicle for Kubota in India, we expect faster leveraging of synergies from the India operations as well as much easier access to: a) global product knowhow (in Tractors and implements), b) global distribution network, and c) global supply chain (by leveraging India’s cost base). In the domestic market, ESC now would have an additional Tractor brand of Kubota, which will complement its two brands of Farmtrac and Powertrac. Kubota’s Tractors are more suited for the wetland/paddy crop.

* The mid-term plan (6-7 years) is being worked upon and will be ready by Jul’22. It would focus on: a) strengthening its Tractor portfolio for India and global markets, b) Agri-implements for India, c) Earthmoving Equipment (Kubota is a global leader in mini Excavators) for India, and d) component sourcing from India. It would also evaluate manufacturing engines in India to meet its global requirement.

* Cash increase and plans for deployment: Post this transaction, ESC’s cash balance on its books will rise to ~INR59b as of Mar’23 (~25% of its current mcap). The management said it would finalize its cash deployment plans on completion of its mid-term plan, which may require investments in newer opportunities.

Valuation and view

* For this transaction, we are factoring in an equity stake sale in ESC and cancellation of treasury shares only. Due to limited clarity on various aspects of the partnership, we are not yet factoring in any contribution from this partnership. We are also not factoring in mergers of the two JVs with ESC. Factoring in share capital, excluding treasury, would result in ~9% dilution and ~4% cut in its FY23E EPS.

* Kubota plans to acquire majority stake in ESC lends credence to its commitment to this partnership. It has scope to cover additional areas like implements, Construction Equipment, and component sourcing from India. It has the potential to structurally improve ESC’s growth trajectory in the medium to long term.

* After the first acquisition of stake in ESC by Kubota, the stock got substantially re-rated (from pre-Kubota LPA P/E of ~11.5x to ~20x currently). With this anticipated event behind us, we expect the focus to shift back to fundamentals. We remain cautious on the Tractor cycle. We now value ESC at 18x (v/s 15x earlier; in line with our target PE multiple for MM’s Tractor business) and maintain our Neutral rating with a TP of INR1,700.

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