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M&M-Ssangyong deal: Our View - Views on News from Equitymaster
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M&M-Ssangyong deal: Our View
Aug 19, 2010

On the face of it, acquisition of a controlling stake in Korean SUV (sports utility vehicle) maker Ssangyong Motor Company (SMC) seems like a good fit for Mahindra and Mahindra (M&M). The reason we say this is because it will help M&M achieve its long term ambition - being a globally recognized SUV and utility vehicles player.

On acquisition, M&M will get access to SMC's global distribution network. It is reported that the company has over 1,300 distributors outside its home turf. SMC has presence in about 98 countries. Within Korea it has about 140 dealers.

About Ssangyong

Established in 1962, SMC is a Korean SUV manufacturer having a product basket of 7 models under 5 brands. These models include two large sized sedans, four SUVs and one multi-purpose vehicle (MPV). The company has sold over 1.3 m vehicles from 1990 to 2009. It also manufactures gasoline and diesel engines as well as axles. SMC has a strong presence in markets outside of Korea. It exports vehicles to geographies such as Europe, Russia, South America, the Middle East, Africa and Asia. It is believed that SMC has a market share of about 14% in the Korean SUV market. However, prior to the phase when their problems began, the company had a market share of 25%.

SMC has two manufacturing plants in South Korea with a combined annual installed capacity of 270,000 units. One plant is located in Pyeongtaek and the other in Changwon.

SMC has been going through a rough phase over the past few years, with it running in losses over the past two years. However, it managed to turn EBIDTA positive in quarter ended June 2010 (after a gap of nearly two years). A leading business daily has reported that SMC is expecting its operations to improve significantly on the back of higher sales volumes. The same were impacted on account of two reasons - a labour strike and the overall slowdown. However, at the net level, it is still in the red.

SMC is believed to have piled on a huge debt of about US$ 630 m (about Rs 28 bn). The company has a market cap of about US$ 310 m.

Why is SMC a good fit for M&M?

First and foremost, it gives M&M a strong leap in terms of expanding its distribution network globally. The auto sector in India is witnessing strong competition. Several international players have entered the market in recent times, thereby giving the old timers something to worry about. As such, SMC's acquisition will give the company a fillip in terms of boosting its export volumes as well as diversifying to newer geographies. But this would be the case in the long run and comes with its own set of risks and concerns. A lot will depend on how fast the company will be able to make this happen.

Back home in India M&M is still the leader in the SUV segment. However, it lacks presence in the premium SUV category, where sales volumes are still picking up. M&Ms management has indicated that it plans to launch SMC's vehicles in India over time. This will strengthen its portfolio as SMC produces premium SUVs.

Thirdly, similar to Tata Motors' motive of the Jaguar and Land Rover buyout - technology, M&M would get access to SMC technological and R&D expertise. However, it seems though that this aspect has not really been emphasized by M&M's management. As far as the idea of jointly developing a product is concerned, the company's management has stated that it is too early to discuss anything.

In a recent interview with a leading business daily, M&M's Vice-Chairman and Managing Director, Mr. Anand Mahindra stated that M&M will provide financial stability to SMC. This is something that will allow SMC to improve its health in the long run. As for improving sales, launching vehicles in emerging markets (such as India; discussed above) is one of the many plans on the cards. It may be noted that Mr. Mahindra has clearly stated that he intends to maintain SMC as an independent company with a local person running the firm.

In addition to financial stability, the company intends to also help SMC by providing some strategic support. The key would be of improving its standing in the global markets. Some of the efforts that the company has in mind include the various engine developments and entrance into new areas (product launches) with the acquisition of Reva.

What could possibly go wrong?

It may seem that M&M would be looking at fast growing markets such as India to boost SMC's sales volumes. But, considering that 'Ssangyong' is relatively not a very popular brand in this part of the world, it would require some strong marketing efforts on part of the company. In addition, it would be competing with the popular premium SUV brands of auto majors such as Toyota, GM, Hyundai, Nissan, Ford and Honda. These companies are quite well established in the Indian markets. The price points at which the company is planning to enter is again in the Rs 1.5m to 2 m (Rs 15 to 20 lakh) range. This price points fall under the premium SUV range, an area where M&M does not really have much experience.

With more and more global auto manufacturers looking to indigenize (source local components) their vehicles, the prices of their vehicles could come down in the future as well (not that this is not an option for M&M as well). Keeping all this under consideration, we believe M&M has enough work cut out for itself. On the flipside, the company will save a lot of time and money on product development by bring products to the Indian market quickly.

Secondly, with M&M acquiring controlling stake in SMC, the latter's numbers will be consolidated with the overall M&M Group's numbers. Considering that the company is still making losses and has a huge debt piled up on its books there will be some amount of strain in its balance sheet. While there are reports of M&M planning to retire a portion of the debt, the details relating to the structure are still not fully disclosed. However, a possibility of some strain on the balance sheet cannot be ruled out. But to counter this, it must be noted that M&M has a healthy balance sheet (standalone). However, on a consolidated basis, M&M's debt-equity ratio stands at little over one time.

Another issue that would be quite obvious in acquiring an ailing company is of the turnaround not going as expected. While M&M would have a game plan in mind, this factor must not be ruled out. Aspects such as cost cutting, slowdown in sales volumes, debt repayment are some key examples.

Further, SMC is believed to have labour union issues. The most recent was a two and a half month labour strike, which hampered its operating performance. While the scenario in this area seems to have improved now, the likelihood of this recurring is always there. It is believed that M&M has not held talks with the labour union directly, but SCM's management has been in talks with the union, which is supporting the acquisition.

Apart from these issues, forex related issues cannot be ruled out considering that SCM exports its vehicles to a number of countries. And finally, with all acquisition, one concern that could crop up is of pending litigation processes.

Conclusion

As far as the impact of the buyout will have on M&M's balance sheet, we do not see that as much of a problem. The company has cash balance of about Rs 27 bn (about US$ 600 m; consolidated). However, we would get more clarity as things progress.

It may be noted that the due diligence process has to be undergone and the deal is scheduled to be closed by November this year. Until and unless the ink is dry on the agreement, one cannot say the deal is done.

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