Acquisition at a good price, but tough road ahead

Despite fears to the contrary, Jyothy Labs has managed to sew up its buyout of a controlling stake in the Indian arm of German FMCG major Henkel India, at quite a reasonable price. The company has inked a deal to buy a 50.97 per cent equity stake in Henkel India at a mere Rs.20 per share.

The consideration of Rs.118.7 crore values Henkel India in toto at about Rs.233 crore, which is a good 43 per cent discount to its valuation in the stock market.

Not a stiff price

What explains this “discounted” price for the equity stake is the other contours of the deal. In addition to the payment for the equity stake, Jyothy Labs has also agreed to take on debt worth Rs.454 crore and preference shares worth Rs.44 crore, currently weighing on Henkel India's balance sheet. Adding these values into the purchase price, Jyothy Labs has shelled out an “Enterprise Value” of about Rs.730 crore for the buyout of Henkel India.

That is about 1.6 times the latter's annual sales in 2010 (Rs.450 crore). But even that's not a very stiff price in the FMCG space, where anxious acquirers have been known to pay even 4-5 times the annual sales for a particularly juicy target.

Apart from Henkel India's manufacturing facilities and assets, Jyothy Labs acquires with this deal the global rights to make and market Henkel India's homegrown brands - Margo soap, Neem toothpaste and Chek detergent. It has also been “assigned the global rights” to make and market brands belonging to Henkel AG- Henko and Mr.White. Only brands such as Pril and Fa, which are part of Henkel AG's global portfolio, have been made available to Jyothy through a perpetual licensing agreement, which will entail payment of a 2 per cent fee on sales. This is usual for such arrangements.

Tax breaks

For Jyothy Labs, the benefits from this buyout are threefold. One, the company can speed up the broadbasing of its brand portfolio and quickly expand its distribution reach into new markets and formats. Henkel India's predominantly urban presence (70 per cent of sales from cities) neatly complements Jyothy Lab's small town strengths (70 per cent of sales from rural centres). Henkel's higher shares in modern trade too may give Jyothy additional foothold. Two, with the merger of Henkel India into Jyothy Labs, the latter will receive a tax shelter from Henkel's Rs.400 crore accumulated losses, thus extending its tax breaks beyond 2013. As the company repays Henkel India's debt, it is likely to turn profitable at the net level. Three, if Jyothy Labs does manage to leverage Henkels' brands- such as Margo, Neem, Pril and Fa- better than its erstwhile owner has, it may manage to build a reasonably big basket of brands that is the key to survival in the FMCG space.

It is the last task, however, which may prove quite challenging for Jyothy Labs. It has traditionally fared well by offering a strong value proposition with strong brands in niche markets such as fabric whiteners, dishwash bars and mosquito coils.

The company has also managed to keep its adspends quite low by not entering into heavily contested markets. However, the addition of Henkel's brands may require quite a significant investment in brand building in the initial years, at least if Jyothy Labs is to make a go of this acquisition.

The next two-three years may be critical. This is probably why Henkel AG has decided to take stock of its option to acquire a 26 per cent stake in the company, a full five years from now.

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