Sudarshan Chemical (SCIL) announced a large acquisition of Germany-based Heubach Group at a highly discounted valuation on October 11. The speciality chemicals player manufactures colour pigments and is the largest domestic player.
While the leap the company has made is commendable and at the opportune moment, investors may hold the stock till further details emerge. The roadmap in turning around the acquisition, part of which turned insolvent, and incremental growth from the acquisition need to be articulated by the company before investing in the stock. The stock trading at 28 times one-year forward earnings also captures the deal enthusiasm and the company prospects in the long term.
The deal specifics
Heubach Group reported revenues of €878 million for CY23 (three times SCIL revenues) operating from Europe. The 200-year-old operator was under pressure in the last one year due to increased energy costs post Ukraine-Russia conflict, weak demand in Europe and America, and increased price competition from China and India. Also, 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 for a total consideration of €1 billion. The financial cost of acquisition at a time when speciality chemicals industry faced immense pressure impacted the target company leading to the sale.
The cash consideration for the acquisition is €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. The acquisition will not include any debt on the balance sheet of the target company.
The group involves a listed entity in India, Heubach Colorants India with a market cap of ₹1,250 crore. The company may have to go for an open offer (46 per cent public shareholding) based on regulations.
Scope for synergies
SCIL can gain on several fronts when the acquisition goes through. The Indian-based operator can gain a European asset footprint, crucial for sales in the US and Europe. It 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 a significant scope. Scope for savings in procurement and leverage from volumes of operations are also expected to provide immediate synergies from the deal closing. SCIL can also improve backward integration with the access to technology through the deal. With German and Europe focus of Heubach, where SCIL does not have 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.
Base operations
SCIL has reported strong revenue growth compared to the speciality chemicals sector with revenue growth of 10 per cent in FY24 and EBITDA margins improved to 12.5 per cent from 9.2 per cent in FY23. The company reported 4 per cent revenue growth in Q1FY25 and 12.7 per cent EBITDA margins. The margin expansion has been limited by the strong asset addition undertaken by the company. The company has added ₹750-crore capacity in FY24, which it anticipated would take four years to fully utilise and hence improve margins. But as the deal goes through, the company does not anticipate any major capex. Also, with the restructuring expected to be carried out, the new capacity can be fully utilised earlier.
The company is also increasing its speciality chemicals mix in product mix and decreasing commodity mix. This is also expected to aid margin recovery even without the acquisition synergies.
Valuation, financials
The deal will be financed by a mix of equity and debt, and SCIL currently has a net debt of ₹375 crore or 1.3 times net debt to EBITDA. It has to be seen how the cash outflow for acquisition and cash infusion for working capital and regulatory obligations will impact the debt metrics. Investors will also have to consider the pending open offer for the Indian listed arm. Beyond regulatory requirement of 26 per cent open offer, SCIL also may look beyond the offer to consolidate and streamline operations.
SCIL gained 16 per cent on the announcement and has since given up the gains and more. This could be attributed to the wider meltdown in the broader indices currently. Nifty-500 declined 8 per cent in the last month, but SCIL declined 11 per cent, despite rising on news of the acquisition in the period.
Existing investors can continue to hold the stock. Key monitorable will be the incremental information on the deal and integration roadmap before adding to positions.