Havells-Lloyd deal: Why are investors unimpressed?

Even as Havells has paid relatively cheap valuations, Lloyd’s low margin profile is understandably a cause of worry


Lloyd’s vast distribution network of more than 10,000 direct and indirect dealers is a positive, with Havells getting access to ready infrastructure and a platform to enter the fast growing air conditioner market.
Lloyd’s vast distribution network of more than 10,000 direct and indirect dealers is a positive, with Havells getting access to ready infrastructure and a platform to enter the fast growing air conditioner market.

Investors weren’t impressed with the Rs1,600 crore deal between Havells India Ltd and Lloyd Electric and Engineering Ltd. Shares of both companies fell on Monday—Lloyd’s shares dropped as much as 17.1% and Havells’s shares fell 3.2%. Cumulatively, their market capitalization fell by more than Rs1,000 crore.

What gives?

For starters, Havells hasn’t really got itself a bad deal as its shares suggest. The enterprise value (EV) of Rs1,600 crore for Lloyd’s consumer durables business translates into a valuation of 14.5 times estimated Ebitda for fiscal year 2016-17. This compares favourably with peers such as Voltas Ltd and Blue Star Ltd, which trade at an EV/Ebitda ratio of 22.9 and 23.7 times, according to an Ambit Capital Pvt. Ltd report on 20 February. Of course, Lloyd’s consumer durables business enjoys lower margins compared to these firms, although that seems to be factored in the valuations. Ebitda is short for earnings before interest, tax, depreciation and amortization.

But one man’s gain is another man’s loss and the Lloyd stock seems to be mirroring that sentiment. The Street clearly expected Lloyd to fetch better valuations from the sale. In fact, the stock had risen by around 25% year-till-date until last week in anticipation of the sale.

As a part of the deal, Lloyd will get Rs1,550 crore, with the balance going to group company Fedders Lloyd Corp. Ltd. At the end of September, debt stood at about Rs720 crore, according to analysts. Assuming the company uses the proceeds to retire its entire debt, that leaves it with net proceeds of Rs830 crore.

For perspective, its market capitalization on Monday was less than Rs1,100 crore. What this means is that the deal values Lloyd’s retained non-consumer durables business at about 2.4 times FY17 annualized earnings before interest and tax (Ebit) or, in other words, next to nothing.

Of course, one can argue that the retained business largely consists of the unexciting supply to original equipment manufacturers, where margins tends to be low and working capital needs tend to be high. Even so, valuing the business at less than three times earnings net of cash suggests extremely low expectations from the company. Lloyd would do well to communicate to investors what it intends to do with the large inflow.

Meanwhile, even as Havells has paid relatively cheap valuations, Lloyd’s low margin profile is understandably a cause of worry. The consumer durables business’ Ebit margin for the nine months ended December is only 7%. Compare that to Havells’s electrical consumer durables business, which enjoyed 25% margin for the same period. According to an analyst with a domestic institutional brokerage firm, the competitive intensity for Havells will increase with this deal, as it will now face competition from MNCs and Chinese firms.

To be sure, Lloyd’s vast distribution network of more than 10,000 direct and indirect dealers is a positive. Havells will get access to ready infrastructure and a platform to enter the fast growing air conditioner market. But investors will watch out for improvement in margins and a pickup in growth. Else, Havells would have been better off with its money in the bank.

Lloyd’s consumer durables business is expected to generate an Ebitda of Rs110 crore for FY17. Ambit Capital says that this would roughly amount to the interest income Havells could have earned on the Rs1,600 crore consideration paid to Lloyd.

In that backdrop, the stock’s reaction is not totally surprising.

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