Mahindra-Ssangyong: offers value, but successful integration is key

Mahindra-Ssangyong: offers value, but successful integration is key

Mahindra and Mahindra Ltd (M&M) scored an important win by sealing the acquisition of Ssangyong Motor Co., three months after it emerged as the preferred bidder for acquiring the Korean utility vehicle maker.

M&M will pay $463 million (about 2,100 crore), split into an equity investment of $378 million, which will be used to repay the company’s debt, and the balance $85 million will be in the form of corporate bonds. In return, M&M gets a 70% stake in Ssangyong and a global automobile business with a product portfolio comprising a luxury sedan, four sport utility vehicles and one multipurpose vehicle.

M&M’s shareholders will be closely watching how this acquisition affects their company. The company’s shares have outperformed the Bombay Stock Exchange’s benchmark Sensex in this fiscal, and their immediate concern will be whether the acquisition is going to be earnings accretive or a drain on earnings and weigh down its balance sheet.

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M&M’s rock-steady performance in the past few quarters has translated into liquid assets of about 2,500 crore. An earlier report by Motilal Oswal Securities Ltd estimates M&M’s net cash for fiscal 2011 at $340 million.

Thus, the firm can fund the acquisition through internal accruals comfortably. Even if it were to raise debt for the purpose, its low gearing of about 0.4 times in fiscal 2010 (estimated to be even lower at 0.2 times in fiscal 2011) will ensure that its balance sheet will not get stretched by the acquisition. The management is likely to use an optimal mix of debt and internal accruals to fund the acquisition.

The good news from Ssangyong is that the firm has been making operating profits since the first quarter of 2010. Compared with 35,000 vehicles sold in 2008, the firm is now selling vehicles at a monthly run rate of 7,000 units, implying annual sales of about 84,000 vehicles in 2010.

Bloomberg reports say that in the third quarter, the firm posted a net profit of $58 million, but this was by virtue of exceptional items, in the absence of which it would have incurred a loss. But the company has been rationalizing costs as well—the workforce at 4,400, for example, is down to 37% of its original strength.

M&M will get access to Ssangyong’s strong research and development capabilities. But M&M may have to invest in developing new models as the beleaguered state of the firm had hampered new product development since 2003.

M&M intends to focus on better management for Ssangyong and harness the 1,300-strong dealer network across 98 countries to market both Ssangyong and M&M brands. It would look for synergies in manufacturing platforms and processes for both firms. Over the longer term, Ssangyong’s edge in premium segment utility vehicles, where M&M is not present, could be used to expand its product profile.

Shares of M&M closed lower by 0.87% at 759.70, perhaps as the announcement did not spring any positive surprises. Besides, equity markets fell, too. Financially, the Mahindra-Ssangyong deal is not expected to negatively impact M&M at the operating profit level, as Ssangyong is profitable at this level.

M&M has a healthy operating profit margin (OPM), too, with an OPM of 16.5% and net profit margin of 13.5% for the September quarter—among the best in the industry. Ssangyong’s losses will be lower, to the extent debt repayment lowers its interest costs. Whether that helps it turn the corner will become evident after a few quarters.

In the longer run, the success of such acquisitions depends on how the two companies integrate, and feed off each other’s strengths. And that will determine if the acquisition can contribute substantially to M&M’s financial performance.