Vertical demerger a better option for execution of global deal with Hitachi; downgraded to ‘Hold’ on stock price run-up.
ABB Ltd, ABB India’s Swiss-based parent, has announced diversion of its Power sely to be valued at a similar multiple, as minority shareholders will not approve given the stronger growth prospects and better margin profile.
In our view, two possible scenarios can play out: (i) cash buyout of India business by parent at a higher valuation. While this is feasible, it may lead to contention on right valuation as well as higher tax outgo due to capital gains; (ii) vertical demerger of India PG business as a listed entity with majority stake transferred to Hitachi. This would be more tax efficient while allowing the market to discover the price of the PG business. We believe the latter to be in the interest of shareholders and likely to be strongly considered by the board.
Corporate governance record to ensure minority shareholders are protected
The transaction would require the approval of a majority of minority shareholders who are unlikely to accept the same valuation as for the global PG business. ABB India historically has strong corporate governance track record vis-à-vis its MNC peers with absence of conflicting business interests, fewer related party loans, more transparency in disclosures of royalty, etc. Given this background, we expect the transaction to be more amenable to minority shareholders.
Vertical demerger a more amenable alternative
Given the strong growth outlook and higher margin in India PG business, we expect a higher multiple for this business vis-à-vis global. A cash buyout at high valuation would entail significant capital gains tax (@20%) as well DDT#. A vertically demerged entity listed separately would be more tax efficient while allowing market discovery of fair value of business, which would be more acceptable to shareholders.
Estimates unchanged, downgrade to HOLD on stock price run-up
We keep CY19/20 EPS estimate unchanged at Rs 33.6/37.1. Target price maintained at Rs 1,410 (42x CY19e). We will review our estimates and target price once we get further clarity on details of the transaction.
PG business sale to drive focus on digitisation opportunities: ABB aims to exclusively focus on emerging opportunities in digital solutions for industries given the higher growth, improved profitability and its strong capabilities in the area. The sale would also help reduce earnings volatility as well as improve the balance sheet.
Organisational structure to be simplified further to reduce costs, and improve operational efficiency. The new structure would comprise four business verticals (ex. Power Grid)—Electrification, Industrial Automation, Robotics and Discrete Automation and Motion.