M&M’s farm equipment division sells tractors and related equipment to farmers. The acquisition brings it closer to providing a wide network of products and services to the farmer. Through its agri-business division, it markets pesticides and growth promoters and seeds, and also procures farm produce through its distribution network. In effect, it capitalises on the farmer’s recognition of the brand (from its tractor division) and also cements its relationship with the farmer. That gives it a competitive edge as it becomes a very familiar, and if it plays it right, a trusted partner to the farmer.
EPC Industrie is a relatively small company, with sales of Rs 72 crore in 2009-10, and sales grew by 32% in the first nine months of 2010-11, compared to last year. Its profitability is relatively low, however, and its operating profit margin is around 10%, it earned a net profit of Rs 1.2 crore or a net profit margin of just 2%. It has two divisons, one is micro-irrigation which had revenues of Rs 61 crore and segment profit of Rs 6.7 crore, and the second is its infrastructure and industrial piping division, with revenues of Rs 5.5 crore and negligible profits.
M&M will be picking up a 38% stake in the company through a preferential allotment worth Rs 43 crore, by issuing 65.6 lakh equity shares at a price of Rs 66.1 a share. This values EPC’s equity at Rs 174 crore. Including loans of Rs 38 crore and excluding cash of Rs 5 crore, EPC’s enterprise value works out to Rs 207 crore. The deal is valued at a EV/Sales of about 2.4 times and a EV/Ebidta of about 23 times. Ebidta stands for earnings before interest, depreciation, tax and amortisation.
That is clearly a high price to pay for this company, but M&M appears to paying for its potential rather than its historical performance. At the preferential allotment price, the company is valued at a price to earnings of 44 times its annualised earnings per share for 2010-11.
M&M will improve EPC’s performance through a series of steps. First, it is likely to pay off high cost debt on EPC’s books, of about Rs 38 crore, which itself will add back Rs 3.6 crore to its profit before tax of Rs 2 crore. But M&M will also have to invest significantly, as these products are not bought off the shelf, but are to be demonstrated and installed by the company. Post-installation, sales of spares and servicing will provide a steady stream of revenues.
Jain Irrigation is the main player in this market, and its annual report, estimates the market size at about Rs 2,500 crore and its own share of the market at 55%. Sizel also brings with it better operating efficiencies and savings on procurement too.
EPC thus has a long way to go to become a much larger player in this market. In its 2009-10 annual report, the company says: “With multiple challenges of managing growth and liquidity constraints, the Management is aggressively focusing on increasing both the top line and bottom line by adding new products and expanding into the newer markets. Further expansion of business demands increased capital infusion for working capital needs as well as Capex requirements of the Company. It would be a major challenge to fund the growth of the company.” That challenge appears to have been tackled by selling out to M&M. EPC operates at barely 30% of its installed capacity.
EPC is promoted by Krishen Lal Khanna who is also the chairman and managing director. The promoter’s stake in the company, prior to the allotment, is 26%, while 52% is held by financial investors, Schroder Credit Renaissance Fund and Credit Development Renaissance Fund LP.
The company’s stock price was up by 20% to Rs 77, at the time of posting, reacting to the news, though it appears unlikely that M&M will be paying more than the preferential allotment price in its 20% open offer.