Cautious coverage view on Crompton Greaves; Deal for sale of overseas T&D biz a shot in the arm for CG

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Updated: March 14, 2016 3:57:51 PM

Good riddance: The offer for sale of Crompton Greaves’s overseas product transmission and distribution business meets its key demands of (i) payout sufficient to pay its Rs 9 bn of consolidated net debt, (ii) no incremental liabilities beyond deal closure, and (iii) limited impact on the business prospects of its residual business.

F&O, F&O expiry, BSE Sensex, NSE Nifty, stocks in news, stocks in focus, quick heal, nmdcThe company is in discussions for technology tie-ups in the domestic T&D business.

Good riddance: The offer for sale of Crompton Greaves’s overseas product transmission and distribution business meets its key demands of (i) payout sufficient to pay its Rs 9 bn of consolidated net debt, (ii) no incremental liabilities beyond deal closure, and (iii) limited impact on the business prospects of its residual business. CG also shared plans to limit overseas portfolio to the profitable drives business with the impending sale/closure of its solutions business and proposed sale of the ZIV business. We build in the impact of a positive EV with fair value estimate at Rs 170.

Overseas business likely to get limited to the profitable motors and drives business in FY2018

Loss-making overseas business (~85% of FY2015 revenues; over 90% of loss): CG has accepted the revised offer from First Reserve (US PE fund) for sale of its overseas T&D product businesses for an EV (enterprise value) of 115 million euros (Rs 8.5 bn). CG will use the funds to pay down R5 bn of long-term debt. It is also on the verge of selling/closing down its solutions business. On a combined basis, the overseas T&D business led to a loss of Rs 4.9 bn in FY2015 (against R5.1 bn of overseas loss) and loss of Rs 3.5 bn in 9MFY16 (against Rs 3.6 bn of overseas loss). Over the period of the deal closure and eventual sale/closure of the solutions business, CG expects limited losses from such businesses.

ZIV (14% of FY2015 revenues): CG has appointed investment bankers for the sale of the ZIV business, which is expected to be concluded over the next one year or so. From FY2018, the overseas business (~800 million euros in FY2015) will likely get limited to the drives and large rotating machines businesses (50 million euros revenues at present with healthy profitability).

Revised offer for the product business meets CG’s considerations

The current offer from First Reserve for the overseas T&D product business meets key considerations of Crompton Greaves: (i) significant debt reduction in CG (zero net debt targeted for the remaining consolidated business, (ii) absence of any further losses in the overseas business (no incremental liabilities related to present contracts), and (iii) CG being in a position to grow exports without too many constraints.

Sale has limited impact on growth prospects of remaining businesses

CG’s domestic business had limited dependence on the overseas business, both from a technology (most technology absorbed; ZIV’s technology superior for Indian needs) and market perspective (limited overlap of its export markets with those of businesses getting sold). The company is in discussions for technology tie-ups in the domestic T&D business. For the retained B2B business, the company expects Rs 65 bn of revenues, Rs 4.5-4.7 bn of Ebitda and Rs 3.5 bn of PAT in the first year post deal closure. This is significantly ahead of our estimates.

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Key takeaways from conference call
* Broad contours of the deal: Crompton Greaves highlighted that they have accepted the offer received from First Reserve Int. (US private equity)  to buy the overseas T&D business. Its overseas holding company would get 85 mn euros cash at the time of deal closure (expected over 5-6 months given regulatory approvals) and the remaining 30 million euros over a period of 18 months from the deal closure.
* Yet to decide usage of funds left after paying long-term debt: Against a net debt of R9 bn at CG consolidated, the deal proceeds would be used to repay R5 bn of long-term debt. The company is yet to decide the usage of the remaining funds. We note that the company has an overall exposure of about ~R13 bn to the businesses included in the perimeter of the deal.
* Loss-making overseas solutions businesses to also get closed/sold: The solutions business  is the other overseas business that would cease to contribute to financials incrementally (R2.1 bn of loss in FY2015). Essentially some plants have been or are in process of getting closed down (Brazil, UK) and others would be sold (US).
* Impact on financials: For the businesses included in the deal, the contribution to key financial metrics in FY2015 was as follows: (i) R43 bn of revenues, (ii) Ebitda loss of R0.93 bn, (iii) depreciation of R1.1 bn, interest cost of R0.32 bn and tax outgo of R0.4 bn. This led to a significant PAT loss of R2.77 bn for the businesses covered in the deal for FY2015. In addition, the solutions business has accounted for Rs 2.1 bn of loss in FY2015. Over the next few quarters before consummation of current deal and eventual closure of the solutions business, CG expects positive cash flows from the product businesses and limited incremental losses (2-3 million euros) from the solutions business.
* ZIV may get incrementally sold: What would remain as part of the overseas portfolio would be (i) the automation business in ZIV, (ii) the drives business and (iii) the large rotating machines business. ZIV business (110 mn euros revenues, positive Ebitda) may incrementally get sold in FY2017 (banker appointed). After its potential sale, the overseas business  would be a 50 million euros revenue business having an 8-9% Ebitda margin.
* The deal is unlikely to impact the growth prospects of the remaining business: From a technology perspective, the domestic business of Crompton Greaves was getting limited support from the businesses getting sold to First Reserve. From an export perspective, there is limited overlap of the markets the Indian business serves with that of the businesses getting sold.
* Financial target post deal closure: For the retained B2B business, the company expects R65 bn of revenues,
R4.5-4.7 bn of Ebitda and R3.5 bn of PAT in the first year post deal closure.
* Active discussion for technology tie-ups: The company is in active discussions for technology tie-ups in the domestic power systems business. It has been successful in buying the platform and then absorbing the 765 kV transformer and reactor technology. It intends  to follow a similar strategy in plugging gaps in its switchgear offering.
* Domestic T&D business running at around 80% capacity utilisation: The issue of deferred delivery would continue to impact financials of the domestic power systems business in Q4FY16, post which the margin should normalise. There is potential to grow the current business scale given 78-80% capacity utilisation averaged over key product lines in the segment.
* Good order prospects from railways: The company highlighted good set of orders won from Indian Railways for traction motors. It has now got approval from Indian Railways for supply of tractions electronics as well, which would enhance its positioning for incremental awards from the transporter.

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