Graphic: Mint
Graphic: Mint

Business gains, not just cost efficiencies, to determine UPL’s Arysta acquisition success

The Arysta LifeScience acquisition will catapult UPL into the big league, boosting its revenue by 72%

UPL Ltd’s $4.2 billion Arysta LifeScience Inc. acquisition comes as the company’s earnings have hit a soft patch and its large Latin American business is being weighed down by currency volatility. The purchase will catapult UPL into the big league, boosting its revenue by 72%. But for earnings-focused investors, the acquisition adds to the uncertainties. The worry is a rise in finance costs due to acquisition-related borrowings could suppress UPL’s earnings, at least till the benefits from the acquisition are realized.

Analysts’ estimates vary. But their calculations indicate a negative impact in the near term. “Net earnings of UPL in FY19E is expected to be higher by 2% YoY (10% lower than pre-acquisition FY19E estimated earnings) while in FY20E the real gain will materialise with earnings growth of 41% (5% higher than FY20E pre-acquisition earnings)," analysts at Dolat Capital Market Pvt. Ltd said in a note.

Motilal Oswal Securities Ltd projects a notable rise in debt and finance costs. “Based on our calculations, a debt of $3 billion at an assumed interest cost of 4.5% would not only shrink EPS by ~8% to Rs51.1 in FY20 (compared to our prior estimate of Rs55.6), but also inflate net D/E to 1.5 (prior estimate: 0.1). This, in turn, would impact the return ratios," the broker said in a note while reducing its profit estimate for FY20.

D/E is debt-equity ratio. EPS is earnings per share.

Earnings cuts, of course, are anathema for equity markets. Thankfully news reports about the impending acquisition had forewarned investors. The UPL stock is down 15% in the past month compared to a small rise in the Sensex.

On the positive side, UPL is not paying excessively for the acquisition. UPL will be buying Arysta at 9.9 times EV/Ebitda multiple compared to UPL’s 9.1 times core FY18 EV/Ebitda, according to Dolat Capital Market. EV is enterprise value.

Also, the management is quite confident about efficiencies and synergy gains.

Given that Arysta outsources much of their production, UPL with a strong manufacturing base sees good scope for cost reduction through in-sourcing. Then there are economies of scale, which gives scope for cost rationalization. And finally, there is the benefit to the product portfolio and to market reach, where UPL and Arysta can build on each other strengths.

UPL expects to see the benefits flowing from the first full year of acquisition itself, or in FY20.

As usual, much depends on execution. Beyond the cost savings through business integration, much will depend on how the management delivers on market share gains.

Arysta by itself is not growing much—constant currency sales were up 3% in 2017 and are projected to grow 3-4% in organic terms in 2018.

The faster the management achieves revenue momentum the earlier the company will be able reduce the acquisition debt.

This will not only address the Street concerns about leverage but will also fast-track the payback period.

“We could upgrade UPL Corp. if faster-than-expected revenue growth and profitability post-acquisition results in sustainably lower leverage at the parent level," S&P Global Ratings said after revising its outlook on the company to stable from positive citing rising leverage.

UPL Corp. is the international business unit of UPL through which the Arysta acquisition is being done.

UPL does have a strong acquisition track-record to boast of, with more than 25 acquisitions successfully integrated in the past 20 years. But none of them have been as large as Arysta.