Will Vivek Sehgal's gambit pay off?

A stretched balance sheet and an uncertain global auto market could upset Motherson Sumi’s grand plans

It’s very rare for Indian CEOs to lose their composure during analyst concalls. Usually, they and their acolytes ooze cream and honey about the latest quarter and regurgitate endless versions of it throughout the concall. Analysts, too, play along, not wanting to get into management’s bad books. So, when Vivek Chaand Sehgal, founder of Motherson Sumi Systems (MSS), in response to a follow-up query regarding the downside for the OEMs he supplies to, blurted, “You have to ask the OEMs the question, boss. I am no authority on this. Sorry about that”, one is not sure what the after chatter in the analyst community might have been.

 To Sehgal’s credit, he does majorly own and run a company with a present-day market cap of about Rs.10,000 crore and has delivered the targets set so far. Since early 2000, Motherson has been setting five-year topline and return on capital employed (RoCE) targets. RoCE is a metric used to gauge a company’s capital efficiency. MSS clocked sales of Rs.781 crore and RoCE of 40% by FY05. Continuing with its winning streak, the company surpassed its subsequent five-year revenue target by half a billion to touch $1.5 billion by FY10 and managed to maintain RoCE of 37%. Today, the company’s grand strategy is to clock about $5 billion in sales by FY15 and achieve a RoCE of 40%. 

Thanks to a slew of joint ventures and close to a dozen buyouts since 2002, Sehgal has been on track. But the big addition to MSS’ topline happened during the credit crunch of 2008. The world was in the grip of an economic slowdown and there was little festive cheer as businesses were closing down or were cutting back on production. The auto industry was especially badly hurt with sales of new cars falling by half in the US, the world’s biggest auto market, in Q4CY08; Europe wasn’t any better off. Back in India, Motherson couldn’t escape the impact, either. Orders from carmakers were drying up while inventory was piling up. The management had no choice but to halt production for about a week and give its employees a paid holiday.

“This building was empty,” says Pankaj Mital, COO and a 23-year-old veteran with the group, pointing at the Noida headquarters of MSS, “but we weren’t thinking about the fact that there was no work in India.” Instead, the COO and his boss were contemplating something for which the timing seemed just wrong— an overseas acquisition. “The markets wouldn’t remain suppressed forever — people wouldn’t be going back to riding horses,” justifies Mital. The only safety net MSS needed was enough cash to sustain operations for 10-15 months, the management believed, and that it had.

In March 2009, MSS and the group’s holding company Samvardhana Motherson Finance (SMF) bought out Visiocorp, the world’s largest automotive rearview mirror manufacturer, paying Rs.176 crore for a cash-and-stock deal. At the time, Visiocorp had sales of €700 million and a debt of €300 million. Even before the dust had settled around the acquisition, Motherson went ahead and snapped up another bankrupt European component maker in November 2011 — Peguform, a manufacturer of plastic components such as bumpers and cockpit assemblies for premium cars — for €141.5 million.

Today, with consolidated revenues of close to Rs.15,000 crore in FY12, MSS, which was founded 37 years ago to make power cables, is now the country’s largest auto component vendor. It is 50% bigger than its nearest rival Bosch India and nearly three-fourths of its revenue comes from abroad. Though there is growing concern over the sustainability of growth in global car sales, especially in Europe and China (big markets for Motherson),  the management is not averse to more buyouts if they meet requirements. Is Motherson biting off more than it can chew or is there a method in the madness?

Moving on up 

Today, Motherson is present across 25 countries with over 124 manufacturing facilities and holds about 25% share of the global exterior rearview mirror market and more than 65% share of the passenger car wiring harnesses market in India. Ask the 56-year-old Sehgal on what drives the company’s quest for growth and pat comes the reply: “It’s a four-pronged strategy: leveraging group synergies and strengths; evaluating potential for improvement; relevance for future growth (especially in the BRIC region), and lastly, but more importantly, acquiring companies at the behest of customers.”

The last factor seems to have become part of Sehgal’s core strategy. The Visiocorp deal happened because OEMs (original equipment manufacturers, that is, the car makers) didn’t want the company to go under, since its closure would have allowed Magna and Ficosa gain duopolistic dominance in the rearview mirror systems market in Europe. Several OEMs, which included the likes of General Motors, Hyundai, Ford, Volkswagen, Renault and BMW, actively supported Motherson’s bid. Moreover, an ongoing JV back home with Visiocorp meant Motherson was familiar with the business. The Peguform deal, too, happened in a similar fashion. “After owning the company for two years, the holding company, Cross Industries, was looking to cash out. Car makers in Europe were not very comfortable with the proposed sale as it would affect their supply chain and they asked us to look at acquiring it,” recalls Mital.

But the deals weren’t just about accommodating valuable customers. Both Visiocorp and Peguform are tier 1 suppliers and getting access to their customers and technology was a huge draw. With the Visiocorp acquisition, MSS not only gained entry into the European component market, but also became a global leader in one segment, rearview mirrors. Similarly, Peguform being a major supplier to premium carmakers such as Volkswagen, Daimler and BMW helped MSS gain orders as well as new technology related to plastic parts. The German company makes high-end plastic components for cockpits, dashboards, interior trims and vehicle exteriors. MSS was already present in this segment, but catering largely to Indian clients. The buy, therefore, gave it access to world-class designs along with technology and an expanded customer base. “We are now in all the BRIC countries, excluding Russia. By expanding in emerging and growing markets, we have developed a more balanced global spread,” points out Sehgal.

Staying local

A key difference in MSS’ acquisition strategy is that companies aren’t acquired with the aim of transferring production to India. Amtek Auto, for instance, did that in January 2006 when it bought the forgings business of the American Tyco Group and shifted operations to Pune. It also transferred the UK-based Sigma Cast Iron’s line for manufacturing turbocharger housings to India. “We have never shifted manufacturing to India,” asserts Mital. “Factors that work in one location may not work in another.” Also, MSS’ decision to retain Peguform and Visiocorp’s plants at locations such as Brazil, Hungary and the US besides others is driven by the need to be close to its customers. Many OEMs practise just-in-time inventory management, for which proximity to suppliers is needed. Mital offers another reason. “Locals know the laws of the land. So when we go for further expansion in these geographies, it is easier for us to set up new facilities.”

For now, Motherson is sitting pretty. Visiocorp in its current avatar as Samvardhana Motherson Reflectec (SMR) has clocked revenue of Rs.1,582 crore in Q2FY13, which is a 25% growth over the same period the previous year. “We infused €28.5 million capital in Visiocorp. This improved the balance sheet and is helping in improving margins and performance,” says MSS chief financial officer GN Gauba.

For Samvardhana Motherson Peguform (SMP), the company has identified four plants — two in Germany and one each in Spain and Brazil — as hotspots. These are loss-making plants and the company is rationalising product mix besides bringing down costs. However, some analysts are not convinced. “While there is scope to improve the profit margins of Peguform by way of rationalisation of operations, it may take longer than expected if global passenger vehicle sales flag,” states Subrata Ray of Icra. 

That seems likely given that the demand scenario too looks uncertain. While sales of Indian operations have increased 22% in Q2FY13 to Rs.947 crore, the chinks are becoming visible in overseas operations. SMP’s topline fell from Rs.3,285 crore in Q1FY13 to Rs.2,954 crore in the second quarter; similarly, sales at SMR, too, fell from Rs.1,606 crore in Q1FY13 to Rs.1,582 crore in the second quarter. However, Sehgal attributes the drop in sales to an 18-20 day shutdown in Europe in August and adds that SMR and SMP have secured orders worth €1.3 billion last quarter, while SMP has participated in bids worth €4.5 billion. 

Anybody’s guess

That said, the threat of cancellations cannot be ruled out in the event the slowdown in car demand exacerbates. European auto sales have already declined 4.6% in October. This follows an 11% plunge in September. Sales at Volkswagen AG, Europe’s biggest carmaker, rose a mere 1.5% to 255,120 vehicles last month. Daimler AG, owner of luxury car brand Mercedes Benz, posted a 3.2% sales gain to 53,178 units. But the Munich-based BMW, the world’s biggest maker of luxury cars, saw a 1.4% dip to 63,902 cars. “Our car makers have not given us a red flag yet. We are moving as per what they say. Europe is a bit on the weaker side because of weak overall numbers in France and Italy but, generally, the German car market is doing quite okay,” points out Sehgal, adding that 70-80% of the sales of SMP come from Germany and Spain itself. But that is another worry as unemployment in Spain is at an all-time high.

Incidentally, rivals Amtek and Bharat Forge are already seeing stress in the system. John Flintham, senior managing director of Amtek Auto, was quoted as saying, “Internationally, Europe continues to struggle and has not been helped by a significant decline in the traditionally strong German market.” 

Similarly, Baba Kalyani, chairman & managing director, Bharat Forge, stated in the second quarter earnings release, “All global OEMs are adjusting their production level to correct inventory levels leading to destocking of inventory across the pipeline.” While the risk for Peguform is higher in terms of client (the Volkswagen group accounts for around 50% of its revenues) and region concentration, SMR has an evenly distributed revenues profile: 45% of the sales come from Europe and the balance from other regions.

Leveraged push

MSS’ topline push has come at the cost of its balance sheet. While consolidated revenues have jumped seven times since FY08, the Peguform purchase increased MSS’ debt from Rs.1,263 crore in FY11 to Rs.4,883 crore as of September 2012. This over-three times jump in debt has sharply raised the debt-equity ratio to 2.2 times. RoCE has plummeted from a high of 40% in FY05 to 12% as of FY12. Net profit in FY12, too, dropped to Rs.260 crore against Rs.391 crore the previous year, mainly because of increased interest payments — which surged from Rs.58 crore in FY11 to Rs.165 crore. For FY13 till date, MSS has paid interest of Rs.129 crore.

 “The capital structure, profitability and debt protection metrics’ of MSS (consolidated) have deteriorated both due to the debt funded nature of the acquisition as well as weak profitability of the acquiree,” mentions Ray of Icra. In order to improve its liquidity condition, MSS’ parent SMF did attempt an IPO earlier this year only to withdraw it after a dismal investor response. Sehgal, too, has pledged about 40% of his SMF holding with various lenders.

Even though analysts are cognisant of the risks, many of them have a ‘buy’ recommendation on the MSS stock. Jaibir Sethi of CLSA expects Motherson to more than double its earnings over FY12-14, driven by growth in the core business and profit recovery at Peguform. Sethi has a price target of Rs.235. Hitesh Goel of Kotak Institutional Equities has a target price of Rs.220 due to ‘high visibility of earnings’ and a ‘superior RoE and RoCE profile’.

Motherson’s stock at its current price of Rs.175 is up 94% for the year against a 22% gain in the benchmark Sensex. Though the price action has been mesmerising, MSS’ targeted RoCE of 40% seems a Herculean task given the debt on its balance sheet. The current bullish consensus leaves very little margin for error and the huge expectation build-up could come crashing down if the numbers fail to satiate the investors on the Street. We will let Sehgal’s confidence have the last word, though. Among the many forceful statements he made in the concall was this, “We are there in a long-term thing. We are not a quarter-on-quarter company. We have given a clear guidance that in FY15 we will go towards RoCE of 40%.”