After the pop, the drop

Pipavav Defence tanking below Reliance Infra's open offer price does not augur well

It was a deal that got everybody scratching. Their heads, that is. A leveraged buyer (Reliance Infra) acquiring a leveraged shipbuilder (Pipavav Defence) to get to that proverbial pot of gold. And given that everything with Reliance in it tends to get minutely dissected, the story for this move goes thus: India’s yearly defence budget is ₹240,000 crore and more than two-thirds is met through imports and middlemen. With inefficient government shipyards operating at full capacity, imagine the taxpayer money that would come to the Indian private sector if they get a chunk of the action. In fact, Shankar K, analyst at Edelweiss, says, “Reliance Infra anticipates a potential order book of ₹120,000 crore over the next five years in Pipavav Defence.”  

The rationale might have a little more credence than the multiple being paid for social media companies today but the defence opportunity has been an omnipresent one. It is not that a $40 billion defence market just fell out of the sky… taxpayers have been funding it for decades now. The only reason Indian companies — government or private — have not been able to service it is because they just don’t have the technical expertise to put together sophisticated weaponry. Even with respect to government and private shipyards, execution has been delayed and sloppy. If it was any different, then none of the major private shipyard companies like Bharati, ABG or Pipavav would have lined up for a CDR package. 

Evidently, if Reliance is involved, there has to be a government connection and there is one here. Pipavav is the now on-now off partner of Mazagon Dock, the government shipbuilder with a chokehold on building warships for the navy. While one has yet to see much action from their JV — Mazagon Dock Pipavav Defence, recently the private partner was shortlisted for a ₹60,000 crore submarine order.

Floating theory

This underwater kite flying only seems justified if, going forward, 100% FDI in defence is permitted. If not, except for Mahindra, Tatas, L&T and a few niche operators in south India, there is hardly any expertise to speak about in the private sector. But given that the sentiment is overwhelmingly ‘Make in India’, Indian companies are lining up for a piece of the action. The rumour was that Hero Motors, Mahindra and L&T were in the race too, before Reliance pipped them. Unfortunately, this local enthusiasm is not shared by those having the technology because FDI is capped at 49%. 

The disappointment for those punting was the valuation at which Reliance Infra is buying: ₹63 a share. As it became evident to the punters that instant gratification has been torpedoed, their fingers just hit sell. After peaking at ₹85, Pipavav now trades at ₹60, below the open offer price of ₹66. The earlier optimism was driven by the assumption that the interest outgo would be slashed drastically if the ₹5,500 crore debt was reduced. Bharat Chhoda, analyst, ICICI Direct says, “Lower Ebitda generation and higher interest cost negatively impacted profitability. More than 70% of Ebitda was eaten up by interest expense.” Chhoda recommends buying the stock with a price target of ₹80 instead of tendering the stock in the open offer.

While many an analyst went ga-ga about equity infusion easing Pipavav’s liquidity squeeze, not many have bothered to ask how Reliance Infra is funding the deal. Reliance Defence Systems, the open offer vehicle, will end up spending ₹1,263 crore to acquire 26% in Pipavav. While the grapevine has it that Reliance Infra will sell its cement business to fund the deal, the company is yet to confirm it. With lenders refusing to play ball on the debt recast (₹12,000 crore), the ship-builder’s defence appear weak. 


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