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M&Mís acquisition of Jeco Holdings: Our view - Views on News from Equitymaster

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M&Mís acquisition of Jeco Holdings: Our view

Oct 3, 2006

M&M, Indiaís largest producer of tractors and MUVs recently announced the acquisition of 68% stake in Jeco Holdings AG, one of the top five forging companies in Germany. This is the latest in a series of acquisitions by prominent Indian companies in a bid to expand their operations, move up the value chain and become not just a supplier of low value-add components but become a partner across the entire value chain (right from design and development to engineering, manufacturing and testing and validation services). Jeco Holding AG is primarily focused on the truck, bus and trailer markets. Its major products include gearboxes, engine and axle parts, hubs, gears and piston heads. The company has a forging production capacity of 100,000 TPA (tonnes per annum) and revenues of Euro 180 m for CY05 (US$ 230 m approx or 11% of M&Mís FY06 consolidated revenues). It is believed to be among the top 10 German profitable forging companies. Its top customers include Daimler Chrysler Group, ZF Group, MAN Nutzfahrzeuge, Volvo, Linde, Renault, Agco, Kessler and Kolbenschmidt. Scholz AG currently holds 90% in Jeco Holding AG with the remaining 10% held by the management.

Although the acquisition would be through the Mauritius based subsidiary of M&M, eventually Jeco holdings would be merged with the recently listed Mahindra Automotive Steel, which is a part of M&Mís systems and technologies division and which supplies products and services to the auto component industry.

Surge in domestic auto demand and emergence of India as a low cost supplier to the global automotive industry has led to both the domestic as well as exports market growing at a CAGR of 20% and 25% respectively between 2000 and 2005. With the industry showing no signs of slowing down, domestic sales for the auto component industry is likely to touch US$ 40 bn by 2014, translating into a CAGR of 17% from 2005 levels. Exports are expected to clock growth rates of almost 2 times the domestic market growth rate and reach a total value of US$ 25 bn by 2014 from the 2005 level of US$ 2 bn.

Source: ACMA

This kind of growth will not be achieved from merely producing low-cost components and shipping them to the auto companies. Global automotive industry is going through a structural shift. Most of the OEMs are focusing on new product innovation, design and marketing and leaving the job of component manufacturing to strategic vendors. Secondly, their margins are getting squeezed and hence, the need for low-cost suppliers. Hence, sooner or later, auto manufacturers will demand high-value added services like design and engineering from their Indian vendors and would also derive a great sense of comfort if there were geographical proximity between them and their vendors.

This explains the current frenzy among Indian auto component manufacturers to snap up technologically advanced forging capacities in developed locations like the US and Europe. Thus, the current acquisition by M&M is a part of its strategy of building a global auto component business, serving OEMs across geographies. Just like any other leading Indian auto component player, Systech (System and technology division of M&M) has positioned itself as an 'art to part' auto component player with capability in design & engineering that perfectly complement its capability in the auto component space by adding value for its stakeholders.

Now let us analyse the economics of the deal. While the deal size has not been given, as per a leading daily, the enterprise value of the company is estimated to be in the region of Rs 8.2 bn. If one considers the Rs 10 bn topline of the company during 2005 then the EV to sales multiple works out to be less than one, which is not a bad multiple for a deal of this size. Further, if one assumes that the companyís EBIT margin is in the region of 10%, the pre-tax earnings yield works out to be between 13% and 15%, which is attractive considering that enough synergies remain to be exploited (CDP, a German based forging manufacturer that was acquired by Bharat Forge, had PBT margins of 8.1% in FY06). However, it should be borne in mind that the above numbers are not company confirmed and hence may distort the entire picture if the actual numbers turn out to be different.

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