Apollo Free To Walk Away From Cooper Tire Deal On December 31

Cooper Tire & Rubber Co on Monday December 16, 2013 lost its court bid to force Apollo Tyres (ATL) to complete their proposed USD 2.3 billion merger. In June 2013 ATL had announced the acquisition of Cooper Tire (approximately 2.5x its size) for a consideration of USD 2.5 billion (about Rs 15470 crore) to be funded entirely through debt. Since the announcement, Cooper Tire has faced opposition from its workers in the US plant (the workers are demanding higher wages) and its Chinese joint venture is protesting against the deal.

Apollo Tyres faced problems in financing the deal due to increased liability and also required a price reduction from Cooper Tire. As ATL plans to raise the entire deal amount of USD 2.5 billion through debt, investors have worried a takeover of Cooper would lead to an increase in debt levels and stretching its balance sheet.

Cooper Tire is the 11th largest tyre company in the world by revenues and supplies premium and mid-tier tyres worldwide through renowned brands. With revenues of USD 4.2 billion, the company is almost twice the size of Apollo Tyres. With total revenues of USD 6.6 billion, the combined entity of ATL and Cooper Tires would become the seventh largest tyre company in the world.

With the acquisition of Cooper Tire, ATL would gain access to the US and Chinese markets where it currently does not have presence. The USA is the largest market for Cooper Tire accounting for about 70% of the company’s revenue. The Chinese market contributes about 23% while the rest is contributed by Eastern Europe. The deal would also provide synergistic benefits in the areas of raw material sourcing, technology, and research and development.

However, the valuations look expensive and the deal would put stress on the balance sheet of ATL. The company had offered a price of USD 35 per share to Cooper Tire's shareholders for the deal which was at a premium of 40% to the price prevailing before the announcement of the deal.

After raising debt for the above transaction, the debt-equity ratio of the combined entity would shoot up from the current 0.67x on consolidated basis to close to 2x. The incremental interest cost is expected to shoot up by 1525 crore (USD 250 million) on the back of an increase in the debt. However, our analysis of the combined entity shows that the deal will be EPS destructive. Cooper Tire had net earnings of USD 0.22 billion for 2012, which translates roughly into Rs 1300 crore, while the incremental interest outgo to complete this deal will be more than Rs 1500 crore. 

Though the acquisition of Cooper Tire is a strategic fit, but the deal has been done at a relatively high valuation and puts a lot of stress on the balance sheet of ATL. Any adverse movement in the raw material prices and further downturn in the global economy are big risks to the company’s ability to manage an acquisition that is 2.5x its size.

As an alternative to a settlement or paying what it originally agreed, Apollo could hand over a USD 112.5 million reverse breakup fee to walk away, according to Cooper’s complaint.

We believe that the ruling is in favour of Indian shareholders of ATL and it will be good for the company to walk away with the deal by paying the penalty. As of now, investors should not enter the counter as still lot of uncertainty in terms of management commitment towards the deal and price remains, which will be an overhang on the counter.