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Tube Inv.-Shanthi Gears deal: Our view - Views on News from Equitymaster
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Tube Inv.-Shanthi Gears deal: Our view
Jul 18, 2012

The management of Tube Investments of India Ltd (TII) has confirmed that it intends to buy the 44% stake of promoters of leading gearbox company Shanthi Gears. We shall take a look at the terms of the deal and our view on the same.

About TII

Tube Investments of India Ltd was formed in 1959 when the erstwhile TI Cycles of India Ltd (which commenced bicycles manufacturing in 1949) merged with Tube Products of India Ltd (formed in 1955 as a backward integration initiative). The company has three business segments notably Bicycles (which includes cycles and electric scooters), Engineering (welded tubes and strips) and Metal Formed Products (doorframes, chains and railway wagon sets). The company has two financial subsidiaries which are Cholamandalam Finance (54.5% stake) and Cholamandalam MS General Insurance (74% stake). The company also acquired 77% stake in an industrial chain company in France called Financiere C10 (holding company of Sedis) in 2010. In the period FY06-12, the company's sales and operating profits grew at compounded annual growth rates of 15% and 12% respectively. The company's average operating margins over the last five years stood at around 9%.

About Shanthi Gears

SGL is a Coimbatore based industrial gear manufacturing company and is in existence for more than 3 decades. The company, which earlier had a forte in manufacturing gears for textile machinery is now producing gears for industries as wide as process, power, steel, cement, sugar and aviation. The product range extends from gears for simple applications such as hand-driven jacks to high-tech gears for supersonic jet aircraft. The company makes a range of power transmission products including gears, gearboxes, geared motors and gear assemblies. Its product range includes worm gear boxes, helical and bevel helical gear boxes, geared motors, custom-built gear boxes, mill gear boxes, open gearing, products for the textile industries, and CNC machine tools. Besides, the company also offers consultancy services for engineering design.

Most importantly, SGL has the capacity to design as per the customer's requirements. Customised products contribute around 60% of its revenues. It has its own wind mills with capacity of 5.16 MW, which makes it almost self sufficient in its power requirements. The company has upgraded its manufacturing capabilities to high-end gear boxes for windmills, gear boxes for rolling mills, gears for aviation and defense helicopters. The company's sales and profits have grown at compounded growth rates of 30% plus in the past and average operating margins have also been 30% plus.

Rationale for the deal

The business of TII comprises of 3 segments notably bicycles, engineering and metal formed products. The auto sector accounts for a significant chunk of its revenues of the latter 2 segments. For instance, in the engineering division, the auto sector accounts for 81% of the division's sales. As far as the metal formed products division is concerned, auto forms around 62% of the division's sales. Thus, the company's performance depends a lot on the how the auto sector performs, which is cyclical. As a result, the company has been making efforts to foray into non auto applications as well. In this the company so far had a presence in railway wagon sets and industrial chains. Hence in a bid to move up the value chain, the acquisition of stake in Shanthi Gears will give TII a share of the industrial power transmission products. This is also in line with TII's strategy of diversifying from auto. Further, the consolidated business of Tube Investments could see its operating margins ramp up given that Shanthi Gears' margins are way superior to those of TII's.

What to expect?

TII has bought out the promoters' share at Rs 81 per share for a 44.1% stake which comes to around Rs 2.9 bn. The price of Rs 81 is at a premium of 21% to Shanthi Gears' current stock price of Rs 67. Further, TII will have to make an open offer to the extent of 26% and if there is a full response, the total outgo for TII will be to the tune of Rs 4.6 bn assuming that the offer price is the same at Rs 81 per share. Given that the synergistic benefits of the deal could take some time to materialize, so far the deal appears value neutral to TII. Thus, as of now, we do not feel the need to change our target price for TII. The stock of TII is up 13.6% since the time we recommended it and we recommend investors to 'Hold' on to the same.

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