Shareholders in Cooper Tire & Rubber Company (CTB) have been celebrating following Wednesday's trading session. The manufacturer and marketer of replacement tires has agreed to sell itself to Indian-based Apollo Tyres.
In Thursday's trading session more and more investors were beginning to doubt Apollo's financing plans for the takeover. Consequently shares fell to levels more than a dollar below the bid, leaving a potential return of 3.5% for opportunistic investors.
The discount is understandable as there are quite some worries about the leverage which Apollo Tyres is employing in the deal in its attempt to buy a much bigger competitor. Shareholders with weak nerves should take their profits and sell their shares.
Cooper Tire & Rubber Company has reached a definitive merger agreement with Apollo Tyres under which the company has sold itself in an all-cash transaction, valuing the business at $2.5 billion according to the press release. Shareholders stand to receive $35 per share in cash, a 40% premium compared to the weighted average price over the past 30 days.
The tie-up will create the world's 7th largest tire company. Apollo is well known for brands including Apollo and Vredestein. Cooper is supplying tires through brands like Cooper, Mastercraft, Starfire and Avon, among others.
The deal is remarkable as Cooper is by far the larger party in this deal. The company generated annual revenues of $4.2 billion over the past year, and the combined company will generate sales of $6.6 billion, indicating that Apollo generated merely $2.4 billion in sales.
The companies stress that they have little geographic overlap. By combining their operations they are well positioned for growth in order to increase their global footprint. Following the merger, the companies expect to realize $80-$120 million in annual EBITDA synergies, to be achieved in three years following closure of the deal. Management expects to benefit from economies of scale, sourcing benefits as well as product optimization and manufacturing improvements.
Following regulatory and shareholder approval the deal is expected to close in the second half of this year.
Cooper ended its first quarter with $257.6 million in cash and equivalents. The company operates with $385.6 million in short and long term debt, for a net debt position of around $130 million.
The company generated annual revenues of $4.20 billion for 2012, up 7.5% on the year. Despite the increase in revenues, earnings fell by 13% to $220.4 million.
Based on the latest share count, the equity of the firm is valued around $2.2 billion, valuing the entire enterprise at $2.3 billion including the modest net debt position. This values the entire company at merely 0.55 times annual revenues and around 10 times annual earnings.
At current prices almost every investor in Cooper Tire is a winner. Only back in 1993 shares traded a bit higher in the high-thirties. Shares have seen quite a bit of volatility over the past decade trading in a wide $5-$25 trading range.
After peaking at $25 in 2007 shares fell all the way back to $5 during the crisis in 2009. Shares recovered toward $25 in 2011 and have traded around those levels during spring, before Apollo came with a knock-out premium of $10 per share.
Between 2009 and 2012, Cooper expanded its annual revenues by a cumulative 50% to $4.2 billion. Earnings tripled to $220 million in the meantime.
For Apollo the deal is transformational and it took its shareholders by surprise. Apollo claims to be the 15th largest tire producer in the world, making it much smaller than Cooper Tire which was the current number 11.
The combination creates the 7th largest global tire manufacturer with $6.6 billion in annual revenues. This means Apollo is far ahead of its target of becoming a top 10 tire producer, generating $6 billion in revenues by 2016. It also gives the company much needed geographic diversification by giving it a strong foothold in the US and China. This allows the company to reduce the dependency on struggling car markets in India and Europe.
The winner is this deal appears are the shareholders in Cooper Tire which receive a very decent premium of 40% for their shares. Other stakeholders may fare not so well. Apollo has promised to leave its three US manufacturing plants untouched and management in place. Yet if the company experiences any serious headwinds in the global economy in the coming years the high leverage ratio might result in severe cost cutting efforts or even plant closings.
Besides stakeholders in Cooper, which might be worried about the high leverage, shareholders in Apollo have their doubts as well, as shares have fallen 30% on the India stock exchange following the announcement of the news. Assuming 58 Indian Rupees buy one US dollar, the company is valued at just $570 million. This implies that Apollo acquired a company with a market capitalization four times its own size.
Apollo plans to finance the entire deal in debt, placing $450 million of new debt with Cooper Tire. The leverage will increase to very high ratios which brings great discomfort among Apollo's shareholders. Fortunately the company is planning to issue bonds with a long maturity of eight years, thereby alleviating some short to medium term credit risk. In theory, solid cash flows at Cooper Tire and expected synergies should provide enough cash flows to rather quickly reduce leverage ratio in the near future. Still the company remains extremely vulnerable to merger execution risks and global economic headwinds.
I can understand that some investors are wondering whether to tender their shares on the back of still modest valuation levels despite the 40% premium. Shares trade at just 10 times last year's earnings and Cooper has seen strong first quarter earnings as well, despite a fall in revenues. The modest valuation multiples might have prompted Apollo to come with a knock-out bid of $35 per share, representing a 40% premium to convince shareholders to tender.
Shareholders in Cooper Tire are advised to tender their shares, or sell them in the open market.