PE deal gives Welspun Corp premium valuation, but little cheer on cash front

BL Research Bureau | Updated on June 30, 2011

Cash infusion to be limited by purchase of group company

The $500-million (roughly Rs 2,250 crore) private equity deal between Apollo Global Management and Welspun group may be the second largest PE deal this year, but with much of the money being redirected into the purchase of another group outfit, this may not make a sustainable addition to the cash coffers of Welspun Corp (WCL). It nevertheless may give a leg up to the company's stock valuation, given that the deal sets a benchmark much higher than the market price.

Deal Dynamics

As a part of the total investment plan, funds affiliated with private equity major Apollo will invest Rs 1,305 crore in WCL, of which Rs 788 crore will be invested by way of a preferential allotment of FCD/CCD (fully/compulsorily convertible debentures) and Rs 517 crore by way of non-voting global depository receipts. The FCDs/CCDs, which carry a coupon of 5 per cent, will mandatorily be fully converted within 18 months into equity shares at Rs 225 a share. This represents 13.3 per cent of the equity capital of WCL (well under the open offer trigger limit of 15 per cent). The GDR too would be converted or subscribed at Rs 225/share. The conversion price envisaged in the deal, therefore, comes at a neat 33 per cent premium to Welspun Corp's closing price of Rs 169.20 on June 28.

But even as the deal will see the PE major infuse a substantial sum into the pipe maker, the latter may not retain much of this cash for itself. For one, Welspun Corp will be immediately shelling out Rs 805 crore to purchase 87.5 per cent stake in the promoter–held company, Welspun Maxsteel (WMSL), leaving WCL with about Rs 500 crore only following the deal.

WMSL is among the largest merchant producers of gas-based direct reduced iron in the country. No doubt bringing WMSL under its ambit will help Welspun Corp better control its input costs, but it will also add to the company's debt burden. WMSL has a long-term debt of about Rs 600-700 crore. Welspun Corp ended March 2011 with cash of over Rs 1,700 crore.

In another leg of the transaction, Apollo will purchase the remaining 12.5 per cent of WMSL's equity for a total consideration of Rs 140 crore, thus giving the promoter a complete exit. The transactions therefore value WMSL, a company with sales of about Rs 1,500 crore, at about Rs 945 crore. The PE major will also invest another Rs 130 crore for WMSL's capital expenditure as the company is planning to set up a steel-slab plant. Apollo is also considering a $150-million (about Rs 675 crore) credit line for WCL's 100 per cent subsidiary, Welspun Infratech (on a project-specific basis).

Bottom line

Over the last couple of years, pipe manufacturers have been hit hard by a slowdown in demand and rise in input costs. While the backward integration by buying majority stake in WMSL would help Welspun Corp control its costs better, a lot will hinge on the order flows. WCL's outstanding order book was pegged at about Rs 5,400 crore by the end of March 2011 (0.8 times FY11 sales). Order wins and execution will play a key role in determining the fate of its infrastructure foray (through Welspun Infratech) too.

Published on June 30, 2011

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