In our bl.portfolio edition dated March 26, we recommended investors to book profits in the stock of Siemens Ltd on account of its unsustainable valuations and unfavourable risk-reward for investors. The stock has been in the news recently after the company announced the sale of its low voltage (LV) motors and geared motors business to the parent Siemens AG’s step down subsidiary Siemens Large Drives India Private Limited (a subsidiary of Innomotics GmbH).
Since the announcement, the stock corrected by around 10 per cent last Monday alone. This is quite significant given the fact that Indian-listed subsidiaries of many MNCs are viewed as prized possessions by market participants, resulting in abnormally high valuations for many of them. To some extent, this perception appears to have taken a beating after the recent restructuring proposed by Siemens.
There have been many market advisors and analysts crying foul, that the deal undervalues the business and is unfair to minority shareholders. But are they right? Here, we assess all the factors and explain whether its a case of being unfair to minority shareholders, or one of abnormally high valuations assigned by markets getting tested by fundamentals.
First, what’s the deal!
Last week, the board of Siemens Ltd, an Indian listed subidiary of MNC Siemens AG approved the sale of its LV motors and geared motors businesses for a cash consideration of ₹2,200 crore. This translates into 2.1 times its FY22 revenue and 15.5 times its EBITDA. The valuation was arrived at by Grant Thornton Bharat LLP on the basis of discounted cash flow method (using WACC of 12.4 per cent) and EV/EBITDA multiple of peers. The cash shall be distributed to the all shareholders of Siemens Ltd by way of special dividend.
The sale has been in line with the Siemens AG’s intent to carve out the LV and geared business from across its group companies globally and operate a legally separate and independent company within the Siemens Group, namely Innomotics GmbH.
Also read: Siemens to acquire EV division of Mass-Tech Controls
Along with enabling a separate entity to run the business, the management believes the motors business is not a strategic fit to the overall growth plans of Siemens Ltd, which is moving up the value chain from electrification to automation to digitalisation.
Further, as per the management, LV motors growth has seen low single digit growth during 2018 to 2023, while the motors business going forward shall become commoditised and there may be chances of less value unlocking by keeping it within Siemens’s portfolio. However, as per a Kotak Institutional Equities report, the business appears to have good prospects with healthy domestic demand and exports prospects due to China+1. Further, peer companies like CG Power are even expanding capacities while ABB India has already done the same.
The sharp reaction in stock may have been on account of the concerns over the rationale and valuation of the deal, leading to allegations of corporate governance issue, as it raises the question of whether the interests of minority shareholders of Siemens Ltd were adequately considered.
Why the fuss?
Against the high EV/EBITDA (FY22 EBITDA) multiple of 52 times at which Siemens Ltd is valued by the market, consideration received for LV motors is at EV/EBITDA of 15.5 times. LV motors business has been generating higher EBITDA margins at around 13.4 per cent against that of about 11.1 per cent at the company level.
Peers such as CG Power and Industrial Solutions , ABB India and Bharajt Bijlee command a far higher valuation. The stock of CG Power and Industrial Solutions currently trades at an EV/EBITDA of 45.43 times while that of ABB India is 55.31 times.
This deal has brought to light the disparity between market-assigned valuations and independent third-party report valuation, which the board of Siemens Ltd has considered for the deal. Since LV motors business margins are better and growth prospects decent, markets have voted thumbs down on the deal, with some players crying foul. However, what is important to be noted is that consummation of the deal will require the approval of minority shareholders of Siemens Ltd. To that extent, their interests are protected.
Another perspective that requires attention is, are markets right about the valuations they have given to these companies? While time will clarify this, here are a few comparisons to ponder over.
Valuation comparison of globally listed parent companies with their Indian counterparts can give a perspective.
Though the listed Indian subsidiaries have been experiencing tailwinds such as strong order inflows and backlog, their valuations are very pricey when compared with global capital goods companies, which have also delivered good growth in the last few years.
With an EV/Revenue of around 9.3 times and 7.3 times, stocks of ABB India and Siemens Ltd are trading at 347 per cent and 372 per cent premium to their parent’s stocks. However, revenue growth has not been starkly different. Further, the parent companies also have better operating margins than Indian listed subsidiaries.
While order growth in India is better, whether it justifies such a premium in valuation is questionable. The right approach would be to assess the reasons for disparity between market-assigned and company-assigned valuation rather than concluding the deal is unfair to minority shareholders.