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Maruti IPO: Should you wait or take the bait?
Sunil Nayanar | May 19, 2003
With Maruti Udyog Ltd filing a draft red herring prospectus with the Securities and Exchange Board of India, the Indian IPO market is set to awake from slumber.
The issue is unique for several reasons: It will be the first time the IPO market will see a market leader in cars offer shares to the public. The offer is one of the largest in recent times: Rs 830 crore (Rs 8.30 billion).
The IPO takes forward the government's divestment programme and puts Suzuki firmly in the driver's seat at Maruti; after the sale, the government's stake will fall to 20.8 per cent.
The issue, to be managed through the book-building route, has been underwritten by Suzuki Motor at a price of Rs 115 a share on a face value of Rs 5.
The critical question: Should investors hop onto the Maruti bandwagon?
Analysts are not so sure. For one thing, the money raised will not go to the company, but into the government's coffers. The public issue is coming from the 25 per cent government holding that is being put on the block.
The draft prospectus, filed in April, says that 7.22 crore (7.2 million) shares of Rs 5 each will be offered in the domestic market through the book-building route.
While there is a provision for oversubscription of 10 per cent, once the offer for sale goes through, the government's stake will fall to 20.8 per cent.
As per Sebi norms, a maximum of 60 per cent of the offer will be reserved for institutions such as FIIs, mutual funds and banks while 25 per cent will be reserved for retail bidders.
Kotak Mahindra is the lead manager of the offer while ICICI Securities acts as the joint lead manager.
Though there are a few optimists among analysts - who commend the fact that this is the first major opportunity for investors to buy into a profitable player in the fast-growing car sector - others are less impressed.
They point out that the offer comes at a time when Maruti is consolidating financially after a dismal FY01 when it reported a net loss of Rs 269.40 crore (Rs 2.694 billion).
Cost-cutting measures, and better capacity utilisation have led to a revival in fortunes in FY02, with the company posting a net profit of Rs 104.5 crore (Rs 1.045 billion) on total sales of Rs 9,080.9 crore (Rs 90.809 billion).
FY03 figures for the first nine months ended December 31, 2002, looked promising, with the net profit at Rs 92.9 crore (Rs 929 million) (before adjustments) on the back of sales of Rs 6,366.7 crore (Rs 63.667 billion), yielding a net margin of 1.46 per cent.
A brief look at the financials of other players in the automobile sector should set that performance in perspective.
While Tata Engineering (Telco) posted a nine-month profit of Rs 218.06 crore (Rs 2.180 billion) on total sales of Rs 7,248.74 crore (Rs 72.487 billion), the net profit of Mahindra & Mahindra stood at Rs 96.96 crore (Rs 969.6 million) for the same period on revenues of Rs 2,828.07 crore (Rs 28.280 billion).
Two-wheeler majors Bajaj Auto and Hero Honda enjoyed a good ride during the period, posting net profits of Rs 387.81 crore (Rs 3.878 billion) and Rs 430.90 crore (Rs billion) on sales of Rs 3,682.09 crore (Rs 3.682 billion) and Rs 3,886.31 crore (Rs 3.886 billion), respectively.
Overall, for prominent players in the auto sector, the profitability margin ranges between 3 per cent and 10 per cent for commercial vehicle manufacturers and two-wheeler makers respectively. Maruti's margins are clearly thinner.
But there are pluses to the Maruti offer too. Thanks to cheap financing and the availability of many new models, the passenger car industry is the fastest-growing segment in the Indian automobile industry.
According to figures released by the Society of Indian Automobile Manufacturers, for the period between April 2002 and April 2003, cars have outpaced other segments by a considerable margin.
Cars recorded a growth rate of 28 per cent for the period as compared to an overall industry growth rate of 0.78 per cent.
Other major segments have been left far behind with commercial vehicles lagging at a paltry 3.92 per cent while the motorcycle segment could manage only a 6.1 per cent growth during the period.
The future is not without worries, though, given the sharpening of competition. Maruti's market share has taken a bit of a knock during the last few years as rivals ate into the company's premier position in the industry.
The delicensing of the passenger car industry in 1993 has seen Maruti's dominance of the domestic markets erode significantly.
The company's overall marketshare in passenger cars declined from 83.1 per cent in FY98 to 57.6 per cent in FY01, though things did look up in FY02 with the percentage improving to 58.6 per cent.
However, more than 86 per cent of sales volumes in the Indian passenger car market in FY02 came from the price sensitive A and B segments (cars priced below Rs 500,000), which constitutes Maruti's core focus.
In fact, the company is the only manufacturer in India to produce passenger cars in the A segment (priced below Rs 300,000), which contributed approximately 60 per cent to its domestic sales volumes in FY02.
Maruti's marketshare for passenger cars in the B segment (priced between Rs 300,000 and Rs 500,000), declined to 36.9 per cent in FY01 from 67.3 per cent in FY98.
The company's dependence on the A and B segments is so much that it constituted 95.4 per cent of Maruti's domestic sales volume in FY02.
This has given rise to apprehensions, since the big proportion of Maruti revenues come from these low-margin segments, unlike its competitors.
More worries are in store with Tata Engineering announcing its intention to launch a Rs 100,000 four-seater car which few industry watchers believe possible at the moment.
But there was equal skepticism about the Indica too earlier. At the upper end of the small car segment, competition could intensify with Honda announcing its intention to launch a small car sometime in the near future.
While Maruti's big advantage is a depreciated plant and ability to cut costs to the bone - which helped turn things around to a large extent in FYO2 - there's no doubt that much more needs to be done to sustain its position in an increasingly competitive car market.
Though its share in the small car segment is not under any immediate threat, the company needs to strengthen its position in the C segment, where it has a much smaller penetration.
As compared to the A and B segments, the C segment (which has cars priced between Rs 500,000 and Rs 1 million) comprised only 4.2 per cent of Maruti's domestic sales volumes during FY02.
Maruti currently has three cars in the C segment, Esteem, Versa and Baleno, of which the latter two have failed to make a mark.
Keeping in mind the steady growth of the C segment in the Indian market, which is more fragmented, Maruti is toying with ideas to address the imbalance.
These include launching mid-sized saloons originally built by Korean car manufacturer Daewoo Motors, which now belongs to Maruti's parent Suzuki, following its investment in the former last year along with General Motors.
Coming to more hardcore numbers, some analysts believe that at a price of Rs 115 (the underwriting price indicated by Suzuki), Maruti will be the highest priced automaker in the country.
At estimated FY03 earnings of Rs 140 crore (Rs 1.40 billion), the P/E would be around 30x -- too high compared to its peer group even for a market leader. Tata Engineering (Telco) is ruling at 15x, while others like Mahindra & Mahindra, Hero Honda and Bajaj Auto are keeping below 8x levels.
The global scenario is not much different, with most leading carmakers enjoying single-digit P/Es. "I think the P/E is very high and it will be very difficult for the offer to scrape through," says Sachin Kasera, analyst with domestic securities firm, Pioneer Intermediaries.
Some fund managers with a longer-term view feel that the price must be seen against future prospects, and not only the recent P/E.
Says one fund manager with a leading domestic fund: "While the offer at current P/E levels might seem high, on a forward basis it is likely to be less so."
Quite possible, considering that the company's net profit is expected to almost double in FY04 after Suzuki agreed to waive royalty and provide a 10 per cent discount on knocked down components for this fiscal.
With the government's divestment programme running into rough weather several times in the past, Maruti's case was no different.
The initial deadline for the sale of a 25 per cent government stake in the company has now been revised to July 31, 2003 from the previous deadline of March 31, while a rights issue is planned by March 31, 2004.
To ensure widespread public participation, the company recently reduced the face value of its shares to Rs 5 per share from Rs 100 through a stock split.
Moreover, the book-building process is likely to start at Suzuki Motor's underwritten price of Rs 115 per share. In May 2002, the government had yielded a controlling stake in Maruti by giving up its share in a Rs 400 crore (Rs 4 billion) rights issue to Suzuki for a control premium of Rs 1,000 crore (Rs 10 billion).
This works out to over 21 per cent of the company's total valuation, based on the rights issue price of Rs 3,280 per share, considerably higher than the normal control premium range between 10-25 per cent of the market value of a company.
After the rights issue, Suzuki's stake is now 54 per cent. If any part of the public issue devolves, its stake may rise further.
"While the government is assured of its booty, considering that Suzuki has underwritten the offer, there's nothing much in the IPO for the general investor."
"It has nothing to do with the company's future prospects, which is bright by all means, but the question is whether investors will be willing to pay a premium which is more than double that of industry leaders like Tata Engineering. Considering the circumstances, it will be prudent to wait for the scrip to get listed before investing," says Kasera.
According to Manish Turakhia, an equity fund manager with Gandhi Securities, the offer should be able to create enough demand.
"Maruti being a purely car play, investors might look for opportunities in the sector. Its too early to comment about the price because the fundamentals of the manufacturing sector differ from that of a software firm," says Turakhia.
Kasera agrees, noting that Maruti's unique position offers investors exposure to an hitherto unexplored segment.
But if exposure to cars is all one wants, there could be others on the way. "Considering Hyundai's emerging status in the Indian market and the lack of government involvement, it could turn out to be a better pick than Maruti," notes Kasera.
In sum, what analysts are saying is simple: Maruti is a great company, but the public offer may not be coming at a great price.