Fanatics

NMIMS, Mumbai
Dice of Zeus
Table of Contents:
Overview of the Indian Tyre Industry
Radialisation in the Indian Tyre Industry
Competition from Overseas and The End Users
Input costs of the Indian Tyre Industry
Porters Five Forces Analysis
Cooper deal
Pros of the Cooper Deal
Why not Cooper tyres
Threats for Apollo
Selection of the Target Company
Rationale behind the acquisition
Valuation of the deal on Standalone Basis








Overview of the Indian Tyre
Industry
Turnover of Indian Tyre Industry is Rs 43,000 crores as per ATMA for the FY 2011-12.
Tyre Export from India stands at 4209 crores.
There are over 40 tyre companies with the 10 large tyre companies accounting for 95% of total
tyre production.
Between March 2009 and March 2012, the industry is estimated to have added 62.4 million
tyres capacity, reflecting a CAGR of 16%, in order to bridge the demand gap
With the decline in the rubber prices form Rs 240 per kg in April 2011 to 160-170 during 2012-
13, domestic manufacturers were able to increase their profit margins with the bulk of their
revenue coming from replacement tyres segment.
Overall the Indian Tyre Industry domestic demand is estimated to have posted flat to marginal
volume de-growth (0% to -1%) during 2012-13.
The OEM segment in the domestic tyre industry reported around ~2% volume growth in
aggregate during 2012-13, as volume declines in Truck and Bus (T&B) segment (-23%) and
the tractor segment (-3%) was offset by growth in LCV (~11%), relatively modest growth in high
volume segment like passenger vehicles (PV, ~4%) and flat Motorcycle volumes.
The trends in the replacement segment were quite different, with healthy volume growth in T&B
segment and weak volumes in two-wheeler (2W) segment.



Radialisation in the Indian Tyre
Industry
Over the last few fiscals, the domestic tyre industry has been gearing up for the
imminent structural change in the T&B segment with cross ply tyres giving way to
the technically superior radial tyres.
Current Radialisation Level as a % of total tyre production is 98% for passenger car
tyres, 20% for LCVs and 18% for truck and bus segment.
Despite radialisations several advantages (additional mileage; fuel saving; improved
driving) other than in the passenger cars segment, radialisation is low in the other
segments.
This could be attributed due to several factors, viz. Indian roads generally not being
suitable for ideal plying of radial tyres; (older) vehicles produced in India not having
suitable geometry for fitment of radial tyres, unwillingness of consumer to pay higher
price for radial tyres etc. So, radialisation is only limited to the passenger cars
segment.
The future of radialisation will be governed by the following factors: Cost Benefit
Ratio, Road Development, Overload Control, User Education, Retreading
Infrastructure.

Competition from Overseas and The End
Users
Competition from Overseas Manufacturers:
After witnessing CAGR of 19% in import growth, tyre imports, especially from China, have declined
considerably in the FY 2011-12.
This is on the back of reduction in export subsidies and increasing cost inflation in China leading to erosion
of price competitiveness of Chinese tyres and significant rupee depreciation narrowing the price differential
between imported and domestic tyres.
The ramp up of domestic TBR capacities backed by massive domestic investments and slowdown in the
domestic T&B OEM market (major segment for imported TBRs) have also supported the moderation in TBR
imports.
End Users In The Tyre Industry:
Original Equipment Manufacturers This includes automobile manufacturers like Hero Honda, Maruti
Suzuki, Ashok Leyland, Tata Motors etc. The demand from the OEM market fluctuates directly in line with
end-use demand for the automobile/construction equipment segment; it is thus prone to a high degree of
cyclicality. The total tyre sales to OEMs are on an average 40-45% of the total sales.
Replacement Market These are the end customers who replace old tyres of their vehicles. Replacement
demand for tyres depends on on-road vehicle population, road conditions, vehicle scrappage rules,
overloading norms, retreading intensity and miles driven. It is less cyclical than OEM demand and is
generally a higher-margin business for tyre manufacturers. On an average, replacement market accounts
for 45-50% of the total sales.


Input costs of the Indian Tyre
Industry
Tyre Industry is highly raw-material intensive. Raw materials cost
accounts for approx. 72% of Tyre Industry Turnover.
Natural Rubber is the key raw material of the tyre industry with a cost of
45% of all raw materials.
Customs duty on tyres has been reduced over the last few years with no
corresponding reduction in basic rate of customs duty on Natural Rubber
The other raw materials consumed by the tyre industry are crude
derivatives such as synthetic rubber, nylon tyre cord fabric, etc. Therefore,
rising crude oil prices increase raw material costs and affect the
profitability of the company.
Raw Material Availability:
No domestic Production of Butyl Rubber and Styrene Butadiene Rubber
(tyre grades), & EPDM.
Production of Nylon Tyre Cord Fabric, Polybutadiene Rubber, Rubber
Chemicals, Steel Tyre Cord, Polyester Tyre Cord insufficient to meet
domestic demand.
Tyre industry imports raw materials on account of the following factors:
duty-free imports permitted against export of tyres; domestic demand
not sufficient to meet complete requirement; technical and
commercial considerations;
business strategy to have multiple sources of supply.

Natural Rubber 44%
Nylon Tyre Cord
Fabric
19%
Carbon Black 12%
Rubber Chemicals 5%
Butyl Rubber 4%
PBR 5%
SBR 5%
Others 6%
Porters Five Forces Analysis
Competition
Rivalry:
Medium
Availability
of
substitutes:
Medium
Buyers
Power: High
Entry
Barriers:
Medium
Suppliers
Power: High
Power of the Buyer: Indian Tyre industry has more than 40
players and so the buyers has many alternatives to choose
from and also there are no switching costs. Due to this, Tyre
manufacturers cannot pass on the increase raw material
costs to the buyers.
Power of the supplier: Major Raw material of the tyre
industry is natural rubber. The demand for natural rubber is
outpacing the production of natural rubber as a result
increasing the power of the suppliers.
Competitive Rivalry: The top 10 players hold more than 95%
market share, however the individual market share of the
companies are quite close to each other as a result they
cannot fully pass on any price rise to OEMs due to fear of
losing their market share.
Availability of Substitutes: If domestic prices are dearer
compared to the overseas market, the OEMs start buying
tyres from overseas markets like China. However, in case of
replacement tyres, consumers does not have this liberty.
Entry Barriers: As the industry is highly capital intensive and
even the margins are low, the chances of entry of new
players in this industry appears low. However, Automobile
manufacturers can enter this market through backward
integration as it is advantageous for them.
Pros of the Cooper Deal
Access to fast growing markets of North America and China: While its acquisition of
Netherlands-based Vredestein Banden in May 2009 gave Apollo a foothold in the European
markets, Cooper Tires will help the company spread its wings in the US.
Inline with Apollos goal of becoming a truly global company: Cooper derives about three-
fourths of its revenues from the North American markets. After this buy, Europe and US will together
bring in 55 per cent of Apollos consolidated revenues.
Both having a strong presence in the replacement category: Similar to Vredestein, Cooper
caters predominantly to the tyre replacement markets. Replacement segment is reasonably shielded
from the cyclical nature of new vehicle sales and replacement sales bring in higher margins.
Diversified product offerings: Cooper complements Vredestein in terms of product line. While the
latter focuses on winter and speciality tyres, these tyres contribute only to 10 per cent of the
revenues for the former. Cooper instead focuses on light vehicle tyres.
Coopers manufacturing base in China: It is advantageous to Apollo. Its reputation as a low-cost
manufacturing base and proximity to India and rubber producing nations of South-east Asia will
stand Apollo in good stead.
OEMs associations that do not overlap
A good track record of driving sales growth

Why not Cooper Tyres?
Problems with Cooper tyres Chinese partner: Cooper Tire has a JV with the Chengshan Group called Cooper
Chengshan Tire Co, in which Cooper is the majority shareholder with a stake of 65 percent. Its chairman Che
wants to acquire cooper tyres for himself, alternatively he is asking Apollo tyres to buy his share at nearly thrice
the price than what Apollo is ready to pay. Che did not allow Cooper tyres management to enter his factory in
China or handle them the financial details of the company even though he is a minority shareholder, which
speaks of the influence chairman Che has in China and the potential problems that could arise on going ahead
with the acquisition without his support.
Problems with USW: The union has around ten demands, which included coverage of two other plants (not
unionised) and one-time bonuses for all union members among several other conditions. By Apollos estimate,
the additional cost of meeting those demands was about $130-140 million. This also affects long term
sustainability as whatever is agreed to would go into union contracts which forever would have an implication on
the company.
High Leverage: Even if Apollo tyres was able to resolve the above issues, the leverage involved in the deal of
acquiring a company which is bigger than Apollo tyres will pose a significant risk on its balance sheet. Apollo is
paying 43% more than the market value for Cooper Tyres. The shares of the Apollo tyres fell significantly after
the announcement of the deal signalling the negative sentiments of the shareholders.
Due to these reasons, even though there are many pros to this deal, it is better for Apollo tyres to not go
ahead with this deal, rather prefer the acquisition of an Indian tyres manufacturer which can strengthen its Indian
operations and also help in its vision of becoming a global player

Threats for Apollo
Economic downturn or slowdown in the key markets - Europe
and India - leading to decreased volumes and capacity
utilisation.
Increased competition from global players like Michelin and
Bridgestone in India, particularly in the truck-bus radial tyre
category.
A quicker than expected decline in volumes within the truck-
bus cross ply segment, resulting in redundant capacities
needing investment to convert into other product segments.
Continued threat of raw material price volatility translating
into pressure on margins during a quick rise in raw material
prices.
Selection of the Target Company
These acquisitions of JK and CEAT as well as acquisition of MRF will come under the
scrutiny of CCI, as Acquisition of JK Tyres leads to acquiring more than 40% share in
the Truck & Bus segment with the second competitor MRF having only 21% market
share. And so the bargaining power of Apollo increases in this segment which CCI will
not allow. Same is the case with MRF and CEAT. These deals do not appear to be
possible.
Apollo tyres has not much presence in the 2&3 wheeler segment, so acquiring TVS
Srichakra or Falcon would provide it with good market share to compete with the
market leader MRF, but acquiring TVS Srichakra is not possible as TVS Srichakra is a
result of backward integration of TVS and so TVS will prefer not to sell. Falcon on the
other hand is in losses, and so need to be carefully evaluated before going ahead with
the acquisition of Falcon.
Remaining option is Balakrishna Industries Ltd, it caters to a niche segment and get its
90% revenue from US and Europe. Acquisition of Balakrishna will lead to Apollo
becoming the largest tyre manufacturer in India beating MRF. Balakrishna Industries is
also a non competitor of Apollo, leading to synergies.


Selection of the Target Company
One of the major reasons for Apollo tyres interest in acquiring Cooper Tyres is to enter new
geographical markets.
Apollo has its presence in Europe and Africa, so, only Indian tyre manufacturers who have their
presence in the other geographical markets or in a different segment in the existing markets
will create synergy.
CEAT has acquired the global rights of brand CEAT from Italian tyre maker Pirelli for Rs 55
crore. The acquisition will help CEAT enter new markets such as Latin America, Europe and
the US in the radial tyre segment. The tyre manufacturer use to export to Latin America and
Europe under brand name Altura before the acquisition. CEAT exports to USA, Africa, America,
Australia and other parts of Asia and can help Apollo in entering the global market using the
CEAT global brand name.
J.K.Tyres acquired Mexican tyre major Tornel which has 3 plants in Mexico. Due to this,
acquisition by Apollo could lead to access to Mexico, markets of Latin America and a possible
foray into the US markets due to the close proximity of Mexico to US.
Rationale behind the acquisition of
Balakrishna Industries Ltd
Market penetration in US and Europe: 90% revenue of Balakrishna Industries Limited
comes from US and Europe. It will give the firm an entry in the US market.
The firm is relatively stable and generates good cash flow.
The category it caters to requires large number of products and the quantity required
for these products is small. Any new competition entering this market will require a lot
of capital investment.
They produce 100-120 skus every year which is highest produced by any company in
the world.
Their turn around time for a new product is 8 to 10 weeks, worlds fastest.
US economy is now starting the signs of improvement. This will boost the trade
prospect.
The high leverage this firm enjoys gives it very low WACC which is a great deal for
the shareholders of Apollo.


Rationale behind the acquisition of
Balakrishna Industries Ltd
Balkrishna Industries has lower operating costs due to its manufacturing plants situated in India.
The company's labour costs are nearly one-fifth of the costs incurred by global players. Labour
accounts for nearly 4% of the total costs for the company. Besides, the off highway tyre segment
is a high variety, low volume business, which requires a good distribution network for growth.
Their raw material logistic cost is low due to close proximity to worlds largest rubber growing
regions.
Some tyre majors including Continental and Goodyear exited the OTR and farm-tyre market in
the US in 2005-06 as labour costs began eating into profitability. This is an opportunity for
Balakrishna Industries.
BKT has a very low cost distribution model. Manufacturing is done only for confirmed orders.
Company sells to distributors at 30% discount to global leaders who in turn keep 5-10% margin
and pass on the rest cost benefit to end users. This creates distributors loyality.
Their new plant at Bhuj will provide them with 60% capacity to manufacture radial tyres which
enjoys 8-10% higher margins than cross ply. This plant is situated at a location which will also
give it great mobilization capability and advantage with respect to power supply.


Synergies:
Apollo tyre's sale has been stagnating in the off highway segment of tyres. This
acquisition will give it boost in this segment.
This will help de-risk dependence on the Indian market which is going through a
turbulent time.
This will also provide it with perfect synergy. Apollo Tyres and BKT are not
competitors in any segment. This will help Apollo Tyres cater to a larger audience.
Apollo Tyres will be able to leverage the supply chain and presence of BKT in the US
market to promote their own products which was their reason of trying to acquire
Cooper Tyres.
Combining with Apollo would give BKT opportunity of utilizing its Indias network
which is a market where BKT is now trying to enter.
Its will also give companies better synergy in the European and African market where
BKT is not present.
Revenue Share of Apollo geographically
Before and After Acquisition:
65%
23%
12%
India
Europe
South Africa
44%
25%
14%
13%
4%
India
Europe
South Africa
US
Asia
Segment wise revenue share of Apollo
Before and After the acquisition :
33%
48%
9%
9%
1%
Passenger Vehicles
Truck Bus
Off highway
Light Truck
others
24%
35%
34%
7%
1%
Passenger Vehicles
Truck Bus
Off highway
Light Truck
others
Valuation of the deal on Standalone
Basis
We assume that the BKT will run as a standalone company without any synergy with
Apollo Tyres.
Average revenue growth = 27%
Corporate tax rate = 30%
Risk free rate: 8.82% (10 year government bond yield rate)
Expected Market Return for India: 18.6% (according to NASDAQ)
Beta: 1.33 (reuters)
Cost of Equity using CAPM model : 22%
Post tax Cost of Debt: 1.7%
Debt to Equity Ratio - 1.45
WACC=11.765%



BKT has a market share of approx 6% in the international OTR segment.
International OTR segment is growing at a CAGR of 6%, whereas BKT sales are growing at a CAGR of 27%.
With such high growth, BKT will capture 20% of market share within 7 years.
Assuming that their cheap labor advantage will slowly perish with time and after capturing a market share of 20%
it will be difficult for BKT to penetrate the market, we have assumed the company will grow at a CAGR of 6% after
4 years.

According to valuation done on the following slide the deal is worth close to
$3.2 billion.
Its market capital is only $0.7 billion.
There is a lot of debt and contingent liability in its books due to which its
shares are being undervalued.
Contingent liability is more than 170% of its net worth.
Recent capital expenditures allow it a large
increase in its capacity and cash flows.
Its new green field tyre plan in Bhuj will provide a
major increase in production capacity and also the
technology.
Promoter and promoter group hold 58% of its total
shares. By the way of a block deal a substantial
controlling stake in the company can be acquired.

Financing of the deal:
BKT has the capability of acquiring debt at a very low rate from European and US market. They
can easily hedge the risk with their own revenue which primarily comes from these regions.
The market capitalization of BKT is Rs3801 crores.
By raising Rs2790 crores at their Mauritious unit(same as in the case of Cooper) they will be
able to acquire more than 50% of their shares at 50% premium.
Looking at the enterprise value of the organization this is a viable option.
For acquiring 75% stake in the company at 50% premium they will require Rs 4276 cr.
This additional Rs 1500 crore can be raised by leveraging their stake in BKT from European or
the US market.
Currently BKT have a borrowing cost close to 2.5 to 3 percent.

References:
Balakrishna Industries Annual Reports.
Apollo Tyers annual Reports.
Investment Information and Credit Rating Agency of India
Limited.
Competition Commission of India Limited.
ATMA
Reuters
CRISIL
Moneycontrol.com


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