Sudarshan Chemical Industries (SCIL) is the country’s largest and the world’s third-largest colour pigment manufacturer, with a market cap of around ₹7,500 crore. On Oct 11, SCIL announced a definitive agreement to acquire the second-largest pigment manufacturer, Germany-based Heubach Group, at a highly discounted valuation. The target company reported revenues of EUR 878 million for CY23 (three times SCIL’s revenues), and the cash consideration for the acquisition is EUR 127.5 million or ₹1,180 crore. The deal also involves a cash infusion of around ₹1,000 crore for working capital, restructuring, and meeting regulatory requirement. Post-Covid impact and under the weight of high debt, Heubach filed for insolvency in April 2024, which allowed SCIL to consolidate its position.
Along with the positives of the deal, apprehensions about profitability and earnings accretion are weighing on the stock. The stock returned 16 per cent on the day of the announcement and has since shed 7 per cent till Oct 15. We analyse the positives and the possible apprehensions of the deal.
Consolidating its presence
The acquisition adds 17 manufacturing facilities based in Europe, along with its customer base and technological prowess, at a discounted valuation.
The 200-year-old operator was under pressure in the face of increased energy costs post-Ukraine-Russia conflict, weak demand in Europe and America, and increased price competition from China and India. SCIL can restructure operations between Europe (designated for contract manufacturing and high-margin operations) and India (for commoditised business) to lower costs. The company can also optimise SGA (selling and general administration) spends, which it insists has significant scope. Scope for savings in procurement and leverage from volumes of operations is also expected to provide immediate synergies from the deal closing. SCIL itself reported revenue growth along with positive demand in Q1FY25 (10 per cent YoY in pigments) as it utilises its expanded facilities. It invested ₹750 crore in the last two years and expects to be fully optimised in the next two to three years.
Technical base and customer pool are also large positives from the deal. The speciality chemicals industry adds new relationships at a slower pace, as validation is an elaborate process of two to three years. With the German and European focus of Heubach, where SCIL does not have an overlapping presence in products or customers, the company should benefit from a ready customer base. Cross-selling and expanding the value share from existing clients of both companies are possible, with Europe and India offering distinct advantages.
Apprehensions to be addressed
The profitability of Heubach’s operations can shed light on the challenge of the turnaround involved, but it is not known yet until the deal closes in Q1CY25. SCIL itself is recovering from lower margins with the aid of lower raw material costs and improving operating leverage as volume recovery is underway.
The challenge in turning around Heubach might be multifold as the entity is a merged entity formed in January 2022. SK Capital, a PE firm specialising in speciality chemicals, partnered with the Heubach family in January 2022 to jointly acquire Clariant’s Global Colorants Business under Heubach. The financial cost of the acquisition, at a time when the speciality chemicals industry faced immense pressure, impacted the target company. Even though SCIL is acquiring a debt-free company now, the challenge of turnaround will be strong and yet unknown.
The cost of restructuring will also be gradually known. The ability of the company to optimise production facilities or the personnel capacity employed in Europe, along with the costs involved, will be an additional hurdle to margin accretion. The Heubach Group also involves a listed entity in India, Heubach Colorants India, with a market cap of ₹1,280 crore. The company may have to go for an open offer (46 per cent public shareholding) to take it private if it has to save on regulatory costs and streamline operations. The regulatory costs of restructuring, either in India or in Europe, may trim the benefits of the deal.
The deal will be financed by a mix of equity and debt, which is another overhang on the stock. The target can be acquired at 0.15 times sales compared to SCILs 3.2 times EV/Sales at which it is currently trading. However, SCIL currently has a net debt of ₹375 crore or 1.3 times net debt to EBITDA, and this can increase further with the added commitment to investing for a turnaround in Europe, which makes the leverage not insignificant. Despite the strong asset base being acquired at a discounted valuation, the ability to turn a profit will weigh on the stock in the short term.