It was quite a surprise to analysts used to seeing the Suzlon Energy stock being battered on the bourses every time the management said it would raise its bid for the German REpower. But on Friday, as the news of Tulsi Tanti finally bagging his prized catch filtered in, the markets gave a massive thumbs up.
The Suzlon stock soared about 18.9 per cent to Rs 1378.45. And while scepticism surrounded the bidding process earlier, it appears that the recent run up has partly compensated for the battering the scrip experienced at the bourses. In fact the scrip has appreciated about 9.5 per cent since February 8 when the bidding for REpower started.
"Well the deal structure has changed quite significantly from the time Suzlon made its first bid and hence the financial impact may not be as bad," says Mehul Mukhati, research analyst, Emkay Shares and Stock Brokers.
Under the most recent understanding, Areva, which has a 30 per cent stake in REpower, has backed out of the bidding process and will support Suzlon.
Suzlon, which currently holds a 7.7 per cent stake, also has an agreement with Martifer, which has 23 per cent stake. Under a put option clause however, Areva can sell its stake to Suzlon after one year while Martifer can do the same after two years.
Also, the price for Areva's stake would be at a fair market value to be determined by an "independent valuer". Areva and Martifer have also conceded voting rights under the understanding.
Financially, the Indian company will be required to bid for the remaining 36.9 per cent as against the earlier 75 per cent. Thus this would imply that Suzlon through this acquisition, gains management control without paying the entire cost upfront.
Moreover, the debt financing requirement has also, according to analysts, significantly reduced from over Euro 900 million earlier to about Euro 550 million. This would in turn imply that the debt-equity ratio which in absence of the agreement would have been in the range of 1.9-2 in FY08 would now stand at a more respectable 1.5 to 1.6 times from the current 0.9 times.
Thus in a case of bad being better than worse, it appears that markets are generally getting enthused at not only the spectre of the bidding power getting over, but also of the deal being through in better terms than expected. Moreover the management has $300 million through its FCCB issue and has tied up Euro 626 million as debt from ABN Amro. Given that it is expecting an initial investment of Euro 250 million, greater clarity has descended on the financial plan.
At the analysts call, the management exuded confidence at the future growth prospects of the company. As Tulsi Tanti, CMD, Suzlon Energy put it, "Both Suzlon and REpower would grow at more than 50 per cent y-o-y beating the industry growth of 25 per cent."
Several challenges however remain. Along with the massive capex plans of the company, the pressures of the deal would imply that there would be an impact of EPS in FY08 though the scenario for FY09 is much better.
Overall analysts are estimating the FY08 EPS to take a 2-2.5 per cent hit.
The tepid financials of REpower are also a drawback.The management has implied that it would take six to nine months for REpower's tepid margins to improve, but has indicated strong performance thenceforth.
For example in 2006, Repower was plagued by thin margins of 2.5 per cent as compared to Suzlon's current margins of 16.2 per cent. As Tanti puts it, "Our efforts will be to increase the margins to double digits within two years".
The company strongly believes that the margin growth will come on the back of economies of scale since the fixed costs, which are significant in this business, will get spread over larger capacity when the company scales up.
At the same time, REpower's high raw material cost component to the order of 82 per cent would also have to be a key focus and the management believes that margin improvement in FY09 will come due to lower material costs.
Besides, Suzlon's robust vertical integration especially its strong component manufacturing base should help tide over REpower's thin margins though it would take time. This is especially because the German company has only an assembly capability at present.
The acquisition would give the company a strong foothold into key European markets like Germany, France and UK where it had negligible presence earlier. Moreover the company would also get access to high niche technical expertise for variable speed and offshore technology - something which would have taken atleast four to five years to develop independently.
At the same time, REpower's present technical expertise as regards its product offering are applicable to specific developed markets and of little use to the high growth markets of Suzlon in developing countries like India and China.
Even REpower's much touted 5MW offshore turbine business where it has invested heavily is in a nascent stage. Large turbines (over 2.5MW) have just 5 per cent penetration, and these turbines are expected to start doing well only from 2009-10.
A key challenge would also include how Suzlon manages to increase REpower's share in its traditional German market. Though the latter has a 10 per cent market share and is the third largest turbine maker in the country, it has to take the might of Enercon and Vestas which together have a 68 per cent share of the German market.
Thus while much of the positives already appear to have been factored in, for the short term ie the next 8-9 months the deal does not bring in any intrinsic triggers for a significant upside. At the price of 150 Euros, the deal values REpower at an EV/EBITDA of 30-31 times which is expensive.
Moreover on an opportunity cost basis, analysts estimate that a greenfield plant of similar capacity would have an enterprise value of around Rs 0.5 crore (Rs billion) a MW in contrast to REpower's present EV/MW of Rs 9.5-9.6 crore (Rs billion) a MW.
Another key risk remains the absence of clarity on what the price for Areva's stake under the put option could be; especially since it is unrelated to the market price. Overall while short term challenges may remain, atleast investors can heave a sigh of relief that the aggressive bidding war is finally over and Suzlon can finally lay claim to the mantle of the fourth largest wind power company in the world.
