Bajaj Auto de-merger: A jolt for stocks
May 21, 2007 13:29 IST
With the Bajaj Auto de-merger turning out to be a damp squib, there appears to be limited room for upside in the near term.
It's a tale told quite often in stock markets -- splits are good for shareholders. It does not matter if it happened because of a family feud or due to a well calibrated strategic initiative.
Recently, we have seen it happening in the case of India's largest private enterprise Reliance Industries and also several other medium sized companies.
In the case of Bajaj Auto however it has turned out to be otherwise. Even a high powered performance by Rahul Bajaj at the packed press conference and analyst meet at the Oberoi Hilton in down-town Mumbai couldn't stop the stock from sliding on the bourses.
On Thursday when the demerger was announced, the Bajaj Auto stock plummeted 6.7 per cent as leery investors got stumped by an earlier undisclosed call option googly. The stock lost another 8.5 per cent to Rs 2,287 on Friday ending the week with losses of nearly 16 per cent.
"A demerger is fundamentally a move towards value unlocking, but the call option disclosure has made the deal appear value destructive," says Amitabh Chakraborty, President (equities), Religare Securities.
"For investors who were expecting insurance value discovery through the demerger as the key trigger for the stock, the prospect of Allianz exercising a call option at a nominal price was truly a let down," exclaims Umesh Karne, Senior research analyst, Emkay Shares and Stock Brokers.
By all measures, the structure of the demerger proved to be quite a surprise. While the holding company Bajaj Holding and Investments Limited would hold a lion's share of the cash and cash equivalents, to the tune of around Rs 6,000 crore (Rs 60 billion), out of Rs 8,600 crore (Rs 86 billion) that exists in Bajaj Auto's coffers, it would also hold a 30 per cent stake in the two new entities viz the new automobile manufacturing entity Bajaj Auto Limited and Bajaj Finserv Limited which will house the wind power, insurance and consumer finance businesses.
The reaction of brokerage houses has also been, with a few significant exceptions, negative. Citigroup revised its price target from Rs 2,886 to Rs 2,600 due to a downward revision in its core valuations as also a massive cut in the insurance per share value.
Similarly, Morgan Stanley downgraded the stock to equal weight "essentially reflecting concerns on the core implied automotive operations." Most other domestic broking firms aren't really enthused by the event either.
Although the stock market has given its verdict for the time being, how should investors play the stock till the listing of the new entities? And what should be their long term strategy with respect to the stocks post listing? Here is a low-down.
The insurance tangle
If the Bajaj Auto stock was, in recent times, trading at a premium to peers, one of the key reasons was its financial services exposure primarily represented by Bajaj Allianz General Insurance and Bajaj Allianz Life Insurance.
Besides, its huge investments with a market value of Rs 8,600 crore served as a cushion to its potential downside.
In fact, before the details of the demerger were known, various analysts pegged the value of the insurance business at anywhere between Rs 600-1000 per share. Now however they are cutting the fair value of the share by Rs 300-500.
And the reason is not far to fathom. Much depended on the price Bajaj Auto would get by selling its shares in its insurance business to its foreign partner Allianz whenever the regulators raise the foreign direct investment limit. Allianz SE holds 26 per cent stake in Bajaj Allianz General Insurance and Bajaj Allianz Life Insurance.
Now under the recently disclosed call option clause, in the event of policy changes Allianz could increase its stake in the general insurance entity to 50 per cent at Rs 10 per share and life insurance at Rs 5.42 per share, plus interest at 16 per cent per annum compounded since April 2001 in both the cases.
This stipulation would last till 2016. Thus, the prospect of profiting through a stake sale to the foreign partner, whenever it happens, at near market value considering the potential of the insurance business have been virtually quashed.
While both the entities are currently at the number two position among private general insurance companies, they have experienced robust growth in the last fiscal.
While the gross written premium for life insurance has shown an increase of 40 per cent over the previous year, for the general insurance entity, the gross written premium showed an increase of 69 per cent. And the losses in the life insurance, typically a back-ended business, have reduced to Rs 71 crore (Rs 710 million) this year from Rs 98 crore in the previous
year.
And with the insurance market looking set for attractive growth given the low insurance penetration and the rising demand for financial services, this is bound to increase in future. Given the strong prospects, the Allianz agreement seems a total dampener as far as shareholders are concerned.
The two wheeler story
Given that the embedded value in insurance is unlikely to be realised in full, the performance of its core business would be keenly watched over the next 6-7 months. And the news isn't great on this front either. Rising interest rates, raw material pressures and fierce competition have put tremendous pressure on margins.
The tepid Q4 figures already have plenty of bad news. The stand alone turnover has crawled by a measly 8.9 per cent while net profits have actually fallen by 11 per cent to Rs 308 crore (Rs 3.08 billion).
Similarly, while operating margins for the quarter have plummeted by about 550 basis points to 14.5 per cent, on an annual basis, operating margins have fallen about 190 basis points to 15 per cent.
There appears to be a deeper problem emerging. While overall sales volumes have grown by a tepid 1.5 per cent in Q4, there are signs that Bajaj Auto may be losing market share in the crucial motorcycle segment to its competitor, Hero Honda.
Over the last quarter, Bajaj Auto's overall market share is down 360 basis points to 31 per cent mainly losing in the 100cc and 125cc segment.
In contrast, Hero Honda powered by its recent launches like CD-Deluxe, Glamour, CBZ X-treme has expanded its market share.
Moreover while the company remains on a strong wicket in the 150cc segment with its Pulsar series, competition is expected to get more fierce here.
Even the most optimistic scenario suggests a sales growth of 10 per cent for FY08. The company too admits that the next 4-5 months could be challenging. In such a scenario, the next few months do not seem to hold any exceptional trigger for the stock.
At the same time analysts feel that after a short correction the price could stabilise at around Rs 2,100. As Ambrish Mishra, research analyst, Man financial services puts it, "Investors could consider getting into the stock at Rs 2100-2150 levels with a longer term perspective."
On the positive side, the continued expansion of the Pulsar series towards higher cc bikes and a proposed innovative upgraded product, which is believed to straddle the entry and value segments and expected to hit the market in mid 2008, should stand it in good stead.
While the two wheeler story hasn't been too inspiring, the three wheeler segment hasn't had much to show either. Sales growth has been tepid at best at 2.2 per cent and 3.5 per cent in the months of March and April respectively.
The only significant trigger could be exports which should support volumes going ahead. Already in FY07 exports have risen by a whopping 88 per cent to Rs 1,694 crore (Rs 16.94 billion) and with the company strengthening its presence in South-east Asia, Africa and Latin America, this should be a key positive going ahead, albeit it wouldn't be able to counteract the negative pressures in the short to medium term.
The tripartite division
"We believe that we can complete the entire process including the listing of the companies before the end of this calendar year," says Sanjiv Bajaj, executive director, Bajaj Auto.
While the auto entity has been assigned Rs 1,500 crore (Rs 15 billion) of the existing cash and cash equivalents, the finance entity would get around Rs 800 crore (Rs 8 billion).
The holding company would provide any further assistance to the two entities at arm's length. While some analysts feel that Rs 1,500 crore (Rs 15 billion) would be insufficient given the needs of increasing product launches, some others feel that the arrangement wouldn't really create any major problem.
"In fact the parking of funds with a central entity would not only provided greater flexibility in meeting the needs of both businesses but also secure funds for new business opportunities," says a senior company official.
Overall a key upside for shareholders would be that, on listing, they would have the flexibility to get out of any one of the three scrips or remain invested in either of the three.
"Generally with the holding companies valuations expected to remain unattractive at around one time book value, investors could consider reducing their exposure to the stock," says Emaky's Karne.
The final word...
The signs of a slowdown in the two-wheeler industry in general and the company in particular would mean that the scope for significant upside in the short to medium term remain limited. The stock is avoidable at this point.
