CESC?s wholly owned subsidiary, Spen Liq, is entering into an agreement with Firstsource Solutions (FSL) to subscribe to 34.5% of FSL?s expanded paid-up share capital.
SpenLiq is also executing a separate share-purchase agreement with three of FSL?s existing shareholders to purchase, collectively, 15% of FSL?s total expanded share capital from them. Further, the company has also made an open offer for 26% from the public shareholders of FSL. Assuming 100% acceptance in the open offer, the entire transaction would cost CESC R640 crore.
Acquisition valuations are trailing EV/sales of 0.85x and EV/Ebitda of 10.3x. Valuations look cheap on EV/sales vis-?-vis other BPO players (EXL Services at 2.4x and WNS Holdings at 1.4x), but don?t look cheap on EV/Ebitda (EXL Services at 13.2x and WNS Holdings at 7.7x), adjusted for scale of operations.
CESC parent has generated average CFO of R550 crore and done average capex of R760 crore in the last five years and not generated any FCF. This implies the acquisition would increase standalone parent leverage, which could depress profits. Further, CESC is spending ~15% of its current market capitalisation on this unrelated diversification.
Spencer?s Retail merger led to issuance of 31 million shares in FY08, which was a 37% dilution of shares. Spencer?s Retail booked losses of R980 crore over FY08-12. Other subsidiaries of Spencer?s Retail, Au Bon Pain Caf? (80%) and Music World (100% subsidiary), have contributed R 66.4 crore of losses over FY08-12.
We downgrade the stock to ?sell? as this acquisition is unrelated; past track record of unrelated retail diversification has been poor; and though the BPO business should not guzzle cash like the retail business, it could lead to higher leverage in the power business as it has its own needs.
We cut target price to R300 (from R345) as we cut target P/BV to 0.85x (1.0x) and roll forward multiple to Mar14E (December 13E). We remove CESC from our India Electric Utility top picks, which now include PGCIL and JP Power now.