Private equity company Apollo Global Management LLC proposes to invest Rs 2,250 crore in the Welspun group’s steel business –pipes and related projects. The transaction will be carried out through multiple transactions by the PE firm which has about $70 billion or Rs 31,500 crore assets under management as of March 2011.
In the first phase, Apollo will invest Rs 1,305 crore in Welspun Corp at Rs 225 a share (conversion price). This is the listed flagship of the group, which makes steel pipes chiefly supplied to the oil and gas industry. The company earned revenues of about Rs 8,000 crore in 2010-11, from the supply and installation of steel pipes and from selling steel plates and coils.
Apollo will invest Rs 788 crore through a preferential allotment of fully/compulsorily convertible debentures and Rs 517 crore in the form of global depository receipts. The debentures will pay out an interest of 5% and will be converted into equity shares at Rs 225 a share. This will represent 13.3% of Welspun Corp’s equity capital. The GDRs will also be issued at an underlying price of Rs 225 a share and will carry no voting rights. That appears to indicate that Apollo may stay below the 15% trigger for making a mandatory 20% open offer to public shareholders.
Welspun Corp’s use for this money is already decided. The transaction proposes a buyout of a group company Welspun Maxsteel (Maxsteel) by Apollo and Welspun Corp. Maxsteel was formed for the acquisition of the sponge iron (Vikram Ispat) business from Grasim Industries. It is expanding its sponge iron capacity from 1 million tonnes to 1.75 million tonnes, with an integrated pellet and steel plant (1.5 million tonnes), and captive power.
Maxsteel is owned by Welspun Steel, a company which makes steel reinforced bars (rebars) used in the construction industry. This is a closely-held company of the promoter group. The company had paid Rs 1,030 crore for the acquisition of Vikram Ispat from Grasim.
Welspun Steel will get Rs 945 crore for selling Maxsteel. Welspun Corp will pay Rs 805 crore for an 87.5% stake in Maxsteel and Apollo will pay Rs 140 crore for the remaining 12.5% stake. The consideration is lower than the price Welspun Corp paid. But the promoters continue to own a stake in Maxwell through Welspun Corp, leaving scope for an upside.
Also, Apollo is paying a premium of 22%, as it has valued Maxwell at Rs 1,120 crore compared to Welspun Corp’s Rs 920 crore. Apollo will also invest another Rs 130 crore towards capital expenditure in Maxsteel, but whether this will be as debt or additional equity has not been mentioned.
In sum, the transaction will see Welspun Corp buy out the promoter-owned sponge iron business through this transaction, using the funds provided by Apollo. Also, Apollo gets a significant (but not controlling) stake in Welspun Corp. It has the option to invest in individual businesses, without breaching the control limits. Maxwell will need additional investments for its expansion plans, for example.
The total firm investment by Apollo is Rs 1,575 crore and will go up to Rs 2,250 crore only if its discussions to buy into Welspun Corp’s infrastructure business succeed.
Apollo is in talks to invest a sum –of up to Rs 675 crore- in Welspun Corp’s infrastructure subsidiary Welspun Infratech (Infratech). Infratech owns a 61% stake in Welspun Projects (earlier known as MSK Projects) and also owns a 60% stake in Welspun Infra Projects Pvt Ltd. WIPPL has invested Rs 470 crore to acquire a 35% stake in Leighton Contractors (India), an infrastructure company. Welspun Corp’s infrastructure segment contributed to about Rs 170 crore to revenues and Rs 6 crore to profit before interest and tax. The full contribution of the infrastructure business will be seen in 2011-12.
The group had earlier proposed a restructuring of the infrastructure business to bring all units under Infratech. The promoters 40% stake in WIPPL will be acquired by Infratech, giving it 100% ownership. Apollo’s proposed investment in this business is still in the discussion stage but is likely to be project-linked, that is it may prefer investing in special purpose vehicles created for executing specific projects.
The transaction offers a few broad benefits. One, the promoters have managed to unload some of the investments on their books. Apollo’s entry, and especially if the infrastructure leg of the deal is also sealed, will reduce their future commitments to the business too. Even without this transaction, Welspun Corp would have benefited from the reorganisation of the infrastructure business. It will have Rs 500 crore left, after acquiring Maxwell, which it can use for its projects.
The bigger benefit is getting the sponge iron and steel plant, which will give their company access to raw materials. It will create an integrated chain, from sponge iron to steel to plates to pipes. That will ensure all the value addition is captured inside Welspun Corp. The company will also be able to grow its business, without having to raise further debt. Its debt to equity ratio is already 1.1:1 times; and interest ate into 14% of its profit before interest and tax during 2010-11.
Apollo has also paid a sizeable premium for a stake in Welspun Corp, at a 33% premium to Friday’s closing price. On Monday, after the announcement was made its share rose by 2.8% after rising by over 4% initially, as investor enthusiasm got dampened by the absence of an open offer. Last, private equity companies come with an exit in sight, which means they will work towards improving the market valuation of both Welspun Corp and Maxsteel. This will be done both on the operational front –better scale, efficiency and product mix– and on the financial front by lowering debt.
They may even nudge Maxsteel towards an IPO to unlock the value of their stake. When that happens, Welspun Corp’s shareholders could benefit indirectly too. But all this is predicated on how well the industry grows and the competitive risks. The benefits brought by private equity investors is no match for a downturn in the industry, as has been seen in the textiles industry.
Read the press release from Welspun here.
Updated on 20 August 2011 to correct typos.