Junk Bonds Set to Strain Apollo Tyres Following U.S. DealSiddharth Philip
Apollo Tyres Ltd., which lost a quarter of its market value yesterday after announcing the biggest takeover by an Indian company in the U.S., will sell junk bonds to fund the $2.5 billion purchase, prompting analysts to warn the debt will strain the tiremaker’s finances.
High-yield bonds in the U.S. carry a coupon of about 6.75 percent to 9.5 percent and Apollo Tyres’ planned offering would be in this range, Chief Financial Officer Sunam Sarkar, said in a telephone interview yesterday. The tiremaker opted to finance its purchase of Cooper Tire & Rubber Co. using bonds “because it gives us great flexibility,” Sarkar said.
The borrowing will more than double Apollo Tyres’ debt to equity, a measure of leverage, to 1.9, Sarkar said. The funding plan for the acquisition, which the company says will help it access the largest automobile markets in China and the U.S. and negotiate better deals on raw material purchases, prompted analysts at Emkay Global Financial Services Ltd. and Prabhudas Lilladher Pvt. to put their ratings on the stock under review.
“We believe Apollo might have bitten more than what it could chew,” Surjit Singh Arora, a Mumbai-based analyst at Prabhudas wrote in a report to clients. “We are concerned about the huge debt burden, which could strain the balance sheet of the combined entity.”
Apollo Tyres, based in Gurgaon, India, slumped a record 25 percent in Mumbai yesterday, wiping 11.8 billion rupees ($204 million) from its market value. The stock changed hands at 69.90 rupees, or up 2 percent, as of 9:39 a.m. local time. Cooper Tire shares surged 41 percent in New York on June 12 after Apollo Tyres said it will pay $35 a share, or 43 percent more than the previous day’s closing price, to the Findlay, Ohio-based company’s shareholders.
The deal gives the Indian tiremaker access to customers in China and North America, markets where it didn’t have a presence, Sarkar said. Cooper Tire made 69 percent of its $4.2 billion revenue in North America last year and said last month it’s focused on expanding the supply of light vehicle tires in China as a key part of the company’s international strategy.
“One of the great synergies of this deal is the sheer scale,” Sarkar said. “Our purchasing power becomes that much better than it was as two independent companies.”
Apollo Tyres opted to fund the deal through bonds instead of bank loans because bonds are “covenant light,” Sarkar said. The company’s European unit and Cooper Tires will together raise about $2.1 billion through the bond sale, while the Indian parent will separately borrow $450 million and use the money to buy into Cooper Tire’s equity, he said.
“We only service the interest,” Sarkar said. “The bullet repayment is at the end of the tenure of these bonds, which are 7-8 years.”
The cost of insuring the debt of Cooper Tire using 5-year, credit-default swaps rose June 12 to the highest since November 2012, CMA prices showed.
“If the bonds are secured against the company’s U.S. assets and offer a higher coupon, then the deal should sail through,” Hemant Dharnidharka, Bangalore-based head of credit research at SJS Markets Ltd., said in a telephone interview yesterday. “In past acquisitions, companies have opted for a bridge loan for financing transactions, which is subsequently refinanced through a bond sale.”
In March 2008, Tata Motors Ltd. agreed to purchase Jaguar and Land Rover from Ford Motor Co. for $2.4 billion, funded through a $3 billion bridge loan it took from banks for 15 months. The loan and the subsequent increase in debt led Standard & Poor’s to cut Tata’s credit rating at the time.
In the year ended March, Jaguar Land Rover contributed 72 percent of Tata Motors’ revenue and 88 percent of the company’s operating income, according to data compiled by Bloomberg.
India’s largest tiremaker, founded in 1972, reported a 49 percent increase in profit to 6.13 billion rupees in the year ended March 31. The company derived 65 percent of its revenue from the domestic market, while Europe accounted for 23 percent of sales, according to data compiled by Bloomberg.
“The fact that we now have access to markets like North America and China, Europe, India, Latin America, is broad-basing the risk profile,” said Sarkar. “So if one or two markets go through their own challenges, there are other markets which the company can still rely upon. It’s a mix of growing markets and developed markets with good margin profile.”
Annual car sales in India fell 6.7 percent to 1.89 million units in the 12 months ended March, the biggest decline since 2001 as slowing economic growth and high interest rates kept buyers from showrooms. The European auto market is contracting for a sixth consecutive year to a two-decade low amid a recession in the countries using the euro.
In contrast, growth in China’s total vehicle market, including trucks and buses, will probably accelerate this year and surpass 20 million for the first time on a rebound in economic growth and urbanization, according to estimates by the China Association of Automobile Manufacturers in January, while U.S. sales continue on a pace for the best year since 2007.
“We see the decision to acquire CTB as highly strategic and of great significance for Apollo Tyres,” Ambrish Mishra and Himanshu Sharma, analysts at JM Financial Ltd. in Mumbai, wrote in a report yesterday. It gives Apollo “immediate access to large U.S. and China tire markets, which otherwise would have been tough to penetrate.”
The acquisition of Cooper Tires would make Apollo Tyres the world’s seventh biggest tiremaker with as many as 30,000 employees worldwide, the company said. India would account for 22 percent of Apollo Tyres’ sales post the purchase, from 65 percent presently, Vice Chairman Neeraj Kanwar told reporters at a briefing on June 12.
“There is perfect complementarity between the two companies, in terms of markets that we address, in terms of brand positioning, in terms of product portfolio,” Sarkar said. “Just because it’s a time of gloom and doom in different markets around the world doesn’t mean we should cease planning and investing in the future.”