Motherson Sumi Rejig: Why Analysts See It As Two Steps Forward, One Step Backwards

Analysts had questioned the valuations used, saying that these were not favourable to minority shareholders. It’s also expected to increase its leverage in the short-term.

The two-step restructuring process announced last month is aimed at making the group structure simpler, consolidating the group’s automotive component and allied businesses into listed entities. It’s expected to be completed by June 2021.

The revised structure also takes care of the long-standing request of Japan’s Sumitomo Wiring Systems to have focused participation in the harnessing business as it wanted to focus on the domestic market, Sehgal, chairman of Motherson Sumi Group, said in a conference call with analyst in July.

Motherson Sumi, on the other hand, has been focusing on expansion and is the most aggressive auto component maker in India, having acquired 22 companies as of March 2019.

The Group Now

• Founded in 1986, Motherson Sumi Systems Ltd. is a joint venture between the $11.7 billion Samvardhana Motherson Group and Sumitomo.

• Prior to the restructuring, the Sehgal family owned 3% of Motherson Sumi Systems, promoter firm Samvardhana Motherson International Ltd., or SAMIL, held 33.4%, joint venture partner Sumitomo owned 25.3% and the public held 38.3%.

• SAMIL is owned 90% by the Sehgal family, 6.5% by Sojitz Corporation of Japan and 3.5% by employees.

• SAMIL, which has various subsidiaries and joint ventures, also owns 49% in Samvardhana Motherson Automotive Systems Group BV with Motherson Sumi holding the remaining 51%.

The Restructuring

In the first part of the restructuring, the domestic wiring harness business will be spun off in the 1:1 swap ratio and will be later listed on the stock exchanges. Meaning, the Sehgal family will own 3%, Motherson Sumi will hold 33.4%, Sumitomo will own 25.3% and the public will hold 38.3%.

SAMIL will then transfer its 49% stake in Samvardhana Motherson Automotive Systems to Motherson Sumi Systems, making it a 100% subsidiary of the company.

SAMIL, including its subsidiaries and joint ventures, will merge with Motherson Sumi. Shareholders will get 51 shares of Motherson Sumi for every 10 shares held in SAMIL.

At the end of it, promoter holding in Motherson Sumi Systems will increase to 50.4% from 36.4%. Public shareholding will fall from 38.3% to 31.9%, while Sumitomo will continue to hold 17.7% in the new entity.

Motherson Sumi will be renamed as Samvardhana Motherson International or SAMIL.

The shareholding of the wiring harness business and Motherson Sumi will be locked for the next two years, Sehgal said during the analyst call.

The proposed restructuring aligns interests of all stakeholders and creates a platform for future growth through inorganic and organic routes, Raghunandhan NL, analyst at Emkay Global, said in an Aug. 11 report. “Reduced stake of Sumitomo Wiring Systems in MSS will allow it to pursue acquisition opportunities more aggressively.”

Valuations

Antique Stock Broking raised concerns. “Prima facie, the valuation approach by bankers looks more designed rather than an independently achieved exercise given the trading multiple of respective competitor businesses in India and Europe,” said Priya Ranjan and Anand S, analysts at Antique, in a July report.

The merger is skewed in favour of promoter entity as it has been done at the peak business valuation of financial year 2019 and not financial year 2020 which ended recently, they wrote.

The company announced its restructuring on July 2, 2020. Ideally, the company should have taken the last financial year 2019-20 to arrive at the valuation report and the swap ratio. But it went with the financials of 2018-19.

Customary valuation methodologies are typically forward looking and not backward and hence the understanding that it is based on FY19 is clearly flawed, said Kunal Malani, head of strategy and mergers and acquisition at Motherson Group, said in an emailed statement to BloombergQuint. "We do not understand how the referred analyst assumed such an argument when he himself does the valuation on forward looking basis."

The company said valuation was done by Price Waterhosue & Co LLP and BSR with fairness opinion from Bank of America and Axis to Mother Sumi board. Kotak Bank provided the advise and fairness opinion to SAMIL board and shareholders, it said. "They have adopted multiple methodologies as is customary in such situations and followed SEBI/stock exchange accepted norms. The report will also be in public domain in the next few days as its under review by the exchanges. This is as per the law of the land."

Antique Broking, however, called the firm’s decision to use peak profitable year FY19 instead of FY20 to apply multiples “strange”. “The exorbitant valuation assigned to SAMIL's businesses and Samvardhana Motherson Automotive Systems is beyond their understanding of prudence and ~80-100% premium to their global peers like Valeo, Faurecia, Magna, Lear, Plastic Omnium, BorgWarner, etc.,” the brokerage said.

A higher valuation assigned would have resulted in higher dilution of equity at 43% for the business excluding wiring harness unit, which will eventually lead to the Sehgal family owning 50.4% in Motherson Sumi after restructuring compared with the current holding of 36.4%, Antique Broking said.

“The management's valuation rationale isn’t convincing and unfavourable to minority (share) holders,” the note said.

The fairness or the more than fair swap is reflected in how economic ownership of the Sehgal family has changed pre and post swap, said Laksh Vaaman Sehgal, vice chairman at Motherson Group and director Motherson Sumi Systems Ltd. Adding that the restructuring will be EPS accretive in the first year of the merger or 2021-22, he said, "This also highlights that the swap ratio is more than fair and tilted towards the public shareholders."

Balance Sheet Pressure

The demerger of the domestic harness business will be margin dilutive, Crisil said in its July note. It will further increase the net debt-to-equity ratio to under 2 times in the interim from 1.4 times as of March this year, the rating agency said.

A gradual business recovery from fiscal 2022 and better contributions from Samvardhana Motherson Automotive Systems’ key greenfield projects, and only moderate capital spending by flagship Motherson Sumi Systems should help restore leverage levels over the medium term, Crisil added.

That, however, would put at risk company’s Vision 2025 plan to achieve a revenue target of $33-35 billion with return on capital of 40%, according to Crisil.

After the restructuring, all subsidiaries and joint ventures of SAMIL would become the joint ventures and subsidiaries of Motherson Sumi.

According to Crisil:

• This consolidation will increase Motherson Sumi System’s debt by Rs 2,200 crore or nearly 20%, and add nearly Rs 1,100 crore of cash and equivalents.

• Motherson Sumi had gross debt of Rs 13,218 crore, and cash and equivalents of Rs 4,135 crore as of June, according to its investor presentation.

There is business revenues of Rs 2,800 crore and Rs 250 crore plus of Ebitda that the merged entity is getting together with capabilities across six to seven new product lines incubated over the last few decades, said Sehgal, adding that the potential global market size of these new product lines is over $200 billion. "Hence, if it is viewed like any other acquisition that MSSL may have done, it is very attractive for MSSL shareholders."

Antique Broking acknowledged that the restructuring will open $200 billion addressable market as this was restricted due to Sumitomo Wiring Systems which wanted to focus only on the domestic wiring harness business.

Edelweiss said in a note while SAMIL, excluding the profit from associates, booked a net loss in financial year 2019-20 due to impairment and interest costs, the management is looking at a turnaround of its greenfield facilities, which should help revive profitability.

And the restructuring is a positive step to simplify the group structure, Jay Kale, vice president and equity analyst, auto and auto ancillaries, at Elara Capital, said in the report. “Post it (restructuring), the investors will be able to decide on the kind of exposure they would want.

(Updates an earlier version with the statement from the Motherson Sumi group)