Related-party transactions return to haunt APSEZ shareholders

  • In market cap terms, APSEZ lost more than 6,100 crore in value, which seems like an overreaction
  • Acquisition rekindled investors’ worries that the group is piggybacking on APSEZ’s financial strength

Shares of Adani Ports and Special Economic Zone Ltd (APSEZ) plunged 8.4% on Monday after the company said it will purchase Adani Agri Logistics Ltd from Adani Enterprises Ltd for 945 crore. In market cap terms, APSEZ lost more than 6,100 crore in value, which seems like an overreaction, given the size of the transaction that triggered the fall.

However, the acquisition rekindled investors’ worries that the group is piggybacking on APSEZ’s financial strength.

The transaction has precedence. The sharp rise in loans and advances (purportedly to related parties) undermined APSEZ’s shares in FY16, so much so that the company was valued at a notable discount to its smaller competitor Gujarat Pipavav Port Ltd. The company addressed these investor concerns by eventually pulling back those advances, narrowing the valuation gap.

Subsequently, the stock outperformed the broader markets over the past three years. As capital expenditure peaked, the management alluded to its focus on cash flow generation. Even as losses mounted at its group firm Adani Power Ltd, it ruled out any bailout. The transfer of the liquefied natural gas terminals to a joint venture firm is also expected to strengthen its balance sheet.

Against that backdrop, the latest acquisition brings the situation back to square one. Not because APSEZ is paying a premium, or that the acquisition can push up debt levels. However, as analysts at two broking firms pointed out, the transaction with group entities deepens investor scepticism about the usage of funds. “Timing-wise, we think this deal may be viewed with suspicion as Adani Ports’ intention to reward minority shareholders versus group companies with its cash flows will likely be questioned, especially given the market sentiment," analysts at Jefferies India Pvt. Ltd said in a note.

The acquisition pegs the FY20 enterprise value to Ebitda (Earnings before interest, tax, depreciation and amortization) at 16.8 times, higher than Container Corporation of India Ltd’s 15 times. The current profitability estimates peg the return on capital employed of the target company at sub-10%, which is significantly lower than the 16-18% APSEZ is estimated to generate in the coming two years, showed calculations by Antique Stock Broking Ltd.

Even so, given its small size, the acquisition is expected to have only a marginal impact on APSEZ’s finances. “Our FY20E-21 earnings per share (estimate) sees a marginal downward revision of 1% and return on equity moves lower from 16.9% to 16.7% in FY20E, and from 17.5% to 17.4% in FY21E," said Jefferies India. “Net debt equity moves to 0.54 times from 0.48 times in FY20E and to 0.38 times from 0.32 times in FY21E."

However, as the steep fall in the share price indicates, investors are attaching little importance to the actual financial impact right now. The faster the company moves to rebuild investor confidence the better. “We find the transaction bit overpriced and, that too, with a related party. This will bother investors and can weigh on the stock in near term," said analysts at Antique Stock Broking.