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Buy Apollo Tyre

Apollo Tyres  shares plunged 25 percent on Thursday to close at Rs 68.55 on NSE, the street finding company'sacquisition of US-based Cooper Tire & Rubber for Rs 14,500 crore hard to digest.

The deal will help the company accelerate to become the seventh largest tyre maker in the world. Apollo and Cooper had combined sales worth USD 6.6 billion in 2012.  Also this deal will help Apollo gain access to newer markets, at a time demand in India has been sluggish on the back of the slowdown in auto sales.

However, Apollo's net debt:EBITDA and net debt:equity will significantly jump up, given the deal is entirely funded by debt and that has got the market worried.
"This will result in an increase in the consolidated debt:equity for Apollo from 0.75x to 1.35x and the net debt:EBITDA from 1.7x to 3.8x. The sharp increase in debt we reckon will be an area of concern for investors who were expecting balance sheet deleveraging in the next two years," Credit Suisse analysts Jatin Chawla and Akshay Saxena, said in a report.
Based on calendar 2012 numbers, the acquisition is EPS accretive, the analysts said, but add that investors will question the sustainability of EBITDA at Cooper, given that 2012 profits to large extent were driven by favourable raw material cycle.

Goldman Sachs too feels Apollo Tyre's net debt to equity will rise even though Cooper Tire will service a significant portion of the additional debt.
"We believe, execution is key in order to generate stable margins, particularly amid a volatile demand and raw material environment, and reduce leverage over time," Goldman Sachs' Sandeep Pandya and Sumeet Jain said.

Apollo Tyres is funding the Cooper Tire acquisition via USD 2.5 billion debt, out of which USD 2.1 billion will be taken at the holding company level, which will include Cooper Tire and Apollo's European operations (Vredestein). USD 450 million debt will be taken in Apollo's Mauritius subsidiary and would be serviced by the Indian operations.

"After the transaction, debt/EBITDA for the consolidated operations would be close to 3.5x, which is aggressive, in our view, considering that a benign raw material environment has buoyed EBITDA margins of tyre makers globally," according to Jasdeep Walia of Kotak Institutional Equities.
Walia says since the size of the transaction is very large, compared with the current operations, it could swing either way for Apollo Tyres.

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