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Funding the JLR acquisition remains a stiff challenge.

Raghuvir Srinivasan

Rights offer price of Rs 340 a share (ordinary) and Rs 305 an ‘A’ share; current market price of Rs 292 a share. Posed with this equation, it should be obvious to any shareholder of Tata Motors (TML) on what the response should be to the rights offer closing on October 20.

The market price, which is 15 per cent lower than the offer price, obviously makes the rights offer unattractive but shareholders may wait till the closing date of the offer before making a decision. While that is the easy part, the difficult question is whether the TML stock is attractive for acquisition in the market at the current price.

TML is now faced with a set of challenges, of the kind that it probably never faced before, across its businesses. Whether it is the demand recession in the commercial vehicles market or the slowdown in passenger cars; whether it is consummating the $2.3-billion Jaguar Land Rover (JLR) acquisition or productionising the much-awaited Nano, the challenges are varied and stiff.

The domestic commercial vehicle market is in the grip of a cyclical recession and TML’s sales in its bread-and-butter business in the first five months of this fiscal are flat. The tight, expensive money regime of recent months and more has dealt a body blow to commercial vehicle sales.

Even if the RBI is forced by global factors to drop rates, it is unlikely that demand will return soon in the commercial vehicle marketplace. This is because there are signs of a slowdown in the overall economy and it would take more than monetary stimulus to get the industrial sector back on track.

Optimistically speaking, there will be a lag of at least two or three quarters before cheaper money makes its mark on vehicle demand, assuming, of course, that rates are dropped soon and the overall economy doesn’t slow down further. In the passenger cars business, TML has been affected by the delayed launch of the new Indica which, unfortunately, coincided with a slowdown in overall car sales. Competition has also intensified in the segment that TML operates and the rising input and finance costs have certainly not helped the company.

The unfortunate problems surrounding the Nano project has, besides setting back the mass production plans of the car, also probably distracted TML’s attention from the main business of commercial vehicles. Achieving high-volume production of the Nano quickly is important for TML to recover the investments made in the project as the margins on the car are likely to be thin.

All these challenges would appear small when it comes to the big one of consummating the JLR deal and integrating the British company’s business into TML. The financial meltdown in the US and in Europe has come at a wrong time for JLR. The North American and European markets together account for almost half of JLR’s sales; the financial troubles in these markets cannot but have an impact on the sales of JLR’s luxury brands. Though Russia and China are fast-growing markets for JLR, together they account for less than 10 per cent of its current sales. They cannot by any means compensate for a loss of revenue from the major markets.

Market troubles are temporary and can be managed, but JLR faces a bigger challenge in emissions compliance issues. The soon-to-come European emission norms for vehicle manufacturers are stiff and large investments may have to be made by JLR to comply with them. TML could find itself funding some of this.

That brings us to the funding of the JLR acquisition. The bridge loan of $2.3 billion was to be repaid through the proceeds of the current rights offer (Rs 4,091 crore), issue of preference shares (up to Rs 3,000 crore) and issue of shares for up to $600 million (approx Rs 2,700 crore) in the overseas market.

TML has already dropped its plans to issue preference shares for up to Rs 3,000 crore. The company plans to liquidate some of its investments to compensate for this but it could come a cropper there because a majority of the Rs 4,910 crore investments (as of March 31, 2008) are in unlisted subsidiaries and joint ventures, including the joint venture with Fiat. Unlocking these is going to be a challenge, especially in the present market conditions.

Given the turmoil in the overseas markets, there could be some uncertainty surrounding the overseas share issue as well. In addition to all this, it is still unclear whether TML will be able to garner full subscription to the current rights offer, given the lower market price of its share.

All these together could mean that TML will have to borrow, even if at high rates, to repay the $2.3 billion bridge loan. Now, that brings in its own set of risks ranging from whether the funds will be available in the tight markets now prevailing abroad and, if so, at what cost.

The near-term, therefore, appears rather daunting for TML. But it may be wrong for long-term investors to be guided by the present short-term troubles that the company is facing. All said, TML is a fundamentally strong company and is the dominant player in India in its main commercial vehicles business. It is also a serious player in the passenger car market and if the Nano succeeds, TML will hit pay-dirt.

The company is also a strong player in the international markets, post-Daewoo and JLR acquisitions. Yes, JLR faces tough times ahead and TML is probably in for the long haul there, but the latter’s strong management bandwidth and JLR’s brand equity lend confidence.

The TML stock now trades at a PEM of 13 based on the annualised consolidated first quarter earnings and the fully diluted post-rights-offer equity. The challenges discussed above appear discounted in the price; but downside linked to the broad market is a near-term possibility. Shareholders willing to rough it out with TML for a three-five year holding period, are likely to benefit. The current market price is attractive if seen in the long-term context.

More Stories on : HCV/LCV/Tractors | Rights Issue | Recommendation | Tata Motors Ltd

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