STREET VIEW: Tech Mahindra - Satyam deal

We present to you the views of different analysts across brokerage houses.

Citigroup – Wait for clarity

Lots of unknowns — Satyam’s financial details are not known at this point in time. Without knowing the same, it is difficult to assess the impact of the deal on TechM. The restatement of accounts is going to take a few more months.
What does it mean for TechM? — (1) TechM will become a scale player (total revenues of ~$2.3b) with diversified revenue base. (2) If the acquisition is fully debt funded, it could take TechM’s net debt to ~Rs. 22b. (3) Satyam is facing about a dozen class action lawsuits in the US plus the ongoing legal battle with Upaid – difficult to value the liabilities though.
Wait for clarity — We await details on Satyam’s financials. Lots of unknowns, client confidence issues, execution challenges and liabilities (Upaid and class action suits) increase the risk profile of Tech Mahindra, as a stock.

Deutsche Bank – Long-term positive

Acquisition of stake in Satyam: Diversifying Tech Mahindra’s risks: We believe Tech Mahindra's acquisition of a controlling stake in Satyam Computers will enable it to diversify its risks. Although Tech Mahindra has leveraged its B/S and become perhaps the most geared IT services company in the world, we believe Satyam's diversified service and client base will allow it to diversify risks away from the beleaguered telecom vertical and the volatile revenues from BT, its top client. We believe the share price already reflects concerns on the leveraged B/S and revenue volatility from BT; we reiterate Buy.

Poised to break into the big league of Indian IT service providers
We believe Tech Mahindra’s impending acquisition of a controlling stake in Satyam is a step in the right direction. The biggest positive for Tech Mahindra is diversification of its revenues in terms of clients, geography and service lines. A heavily leveraged balance sheet (net D/E ratio of 1:1) means Tech Mahindra may need to arrange for an equity partner in the near future. We expect the Satyam deal would be EPS accretive from its first year; however, this assumption could be affected by the outcome of the various lawsuits facing Satyam.

BofA - Merill Lynch: Positive, wait for clarity

We believe the Satyam acquisition would help diversify its exposure beyond telecom services providers and reduce concentration of top client (BT) from current 60% to ~25% post acquisition. TML currently address only the telecom services domain and is one of the largest vendors for BT globally. TML would also emerge as the fourth largest listed offshore service provider from India. Expect stock to re rate on revenue diversification and scale.

Given no data on Satyam revenues and possible liability from class action suits, we have done simplistic scenario analysis based on Satyam employees and possible civil suit liabilities, which indicates flattish to -7% decline in EPS impact for TML post consolidation. Key risks stem from quantum of liability from US civil suits and integration risks

Scenario analysis given below

STREET VIEW: Sterlite - Asarco deal

We present to you the views of different analysts across brokerage houses.


CLSA Asia

“Sterlite has driven a hard bargain acquiring Asarco for 50% lower price. At 5.2x EV/EBITDA assuming long term copper prices, the new acquisition price does not look expensive on a long term view - especially given potential for reserve enhancement and cost reduction. Near term, copper prices could see a sharp drop, which could severely impact consolidated profits. The acquisition will also substantially reduce Sterlite’s net cash position. We believe stock will ontinue to be driven by nearer term profitability issues and maintain U-PF”

Credit Suisse

“The new price of US$1.7 bn has a NPV of US$1.4 bn, US$400 mn higher than our previous estimate: to take Rs30/share out of fair value. As per Sterlite’s management, Asarco can produce 200 kt of refined copper: the 237 kt CY08 sales volume includes tolled production. The cost (ex. tolling) is US$1.5/lb. At the current cost, production and prices, valuation is 10.5x EV/EBITDA, versus the sector average of 8.2x CY09. Sterlite expects production to rise 25% to 250 kt and costs to fall 20% to US$1.2/lb, bringing down EV/EBITDA to 4.2x (Fig. 2) at current Cu prices. Sterlite’s expectation of a three-year payback seems to be based on a Cu price of US$4,100/t (now US$3,662/t). Asarco’s Jan. 2009 P&L shows a US$1.5/lb cost of production, a sharp fall MoM. EBITDA of US$1.8 mn turned positive after four months. The US$1.1 bn in upfront payment will make Sterlite a net debt company, though gearing will remain nominal. Subsequent payments should be possible from Asarco operations. We would have been more positive if the transaction had not taken place or if the acquisition price was lower than US$1 bn. We remain positive on Sterlite due to its Zn and power businesses.”

BOA – ML

“Asarco is value dilutive in our view; Reiterate Neutral. Sterlite announced that it has signed a new agreement with Asarco to purchase its operating assets for up front cash payment of $1.1bn and staggered payment of $600m over next nine years. On NPV basis, this implies total cost of $1.35bn. We value Asarco at $750m and hence believe this acquisition is value dilutive. On a near-term 1 year horizon, we estimate, it is earnings dilutive by 7%. However, we think a good part of the bad news has already been reflected in the current share price. Asarco can be funded internally given that Sterlite (stand alone) has cash of ~$2bn.”

“Asarco needs copper price of US$4,600/ton to be value neutral
Our value of $750m for Asarco is based on the assumptions of: Cu price in FY10/11 of $3500/3761/t, cost of production at $3087/t & WACC of 13.7%. We get EBITDA/t in FY10/11 of $588/862 and from FY12 onwards we take $1000/t. To be value neutral, we need Asarco to earn EBITDA of $1650/t. Given that Asarco is a high cost asset (in 3rd quartile globally), contrary to management expectations we believe cost reduction will be challenging. Hence, for the acquisition to be value neutral, we need copper price to be (and sustain over the
25-year mine life) at $4600/t vs spot of $3700/t.”

Goldman Sachs

“This is an earnings accretive transaction, with valuation multiple of about 3.0x CY08E EV/EBITDA (GS estimate based on limited disclosures by the company) vs Sterlite at our target price implied multiple of 2.7x FY09E EV/EBITDA. We await further details on the operating financials of Asarco. We also believe significant uncertainties exist before conclusion of this
transaction.”

Implications
“We reaffirm our Buy rating on the stock, for the following reasons: 1. Valuation – In our view after deducting immediate cash payment for this acquisition: a) Sterlite is still trading at 0.8x FY2010E P/B with FY2010E ROE of 11.8%, vs global comps trading at 0.9x P/B with 6% ROE. b) Net cash on balance sheet accounts for roughly 35% of market cap. 2. Competitive industry position – We believe that: a) Sterlite is among the lowest cost producers of zinc in the world, and b) possesses strategic advantages in its forthcoming aluminium projects, in our view.
Our target price is unchanged. Risks: M&A risks, metal prices, project funding & execution, delays in securing balance stakes in key subsidiaries, and delays in securing coal blocks.”

Kotak Institutional Equities

“Sterlite has announced the acquisition of ASARCO for a consideration of US$1.7 bn—of this, US$1.1 bn would be paid upfront and the balance US$600 mn would be paid over a period of nine years which would be in the form of a senior secured, non interest bearing promissory note. The deal has been backed by two letters of credit totaling US$100 mn issued by ABN AMRO, Chicago and an additional US$25 mn letter of credit would be issued if the bankruptcy court approves the disclosure statement for ASARCO’s reorganization plan. Upon closing, ASARCO will release Sterlite from any claims arising out of the first purchase and sale agreement signed in May 2008.

In NPV terms, the acquisition value is US$1.3 bn. Sterlite would be acquiring the operating assets of ASARCO which include smelting capacity of 270,000 tons, refining capacity of 500,000 tons and copper mines with an estimated reserve of 5 m tons of copper (to last 25 years). Sterlite has indicated that it would not be acquiring any liabilities and would be completely ring-fenced from existing environmental liabilities. We believe the acquisition will likely be positive for Sterlite given (1) the mining reserves of ASARCO, (2) Sterlite’s past operational track record, no other company would be better equipped to reduce costs at ASARCO and (3) attractive acquisition price given current copper prices. Our DCF calculation indicates that, at a long-term copper price of US$3,800/ton, the ASARCO deal would be value neutral to Sterlite. Current copper prices are at US$3,850 ton.”

Macquarie Research

“The deal – better than expected: The new offer includes an upfront payment of US$1.1bn and deferred payments of US$600m over the next 9 years (non interest paying and non recourse, US$20m each year and US$460m bullet payment in the 9th year). This represents an effective cost of US$1.4bn against the street’s expectation of US$1.5-2.0bn. This is a substantial improvement over the previous bid of US$2.6bn and is better structured with a lower initial cash outflow. EPS accretive and positive NPV: Based on our copper price forecasts, the deal has a NPV of US$350m and would add Rs23 to our target price. It is marginally EPS decretive in FY10, but would add around Rs5, or 10%, to our FY11 EPS estimate. Asarco assets – sufficient scope to improve: Asarco operated at a cash cost of US$1.45/lbs of copper in the December quarter and in January at US$1.37/lbs against the current copper price of US$1.6c/lbs. Also, it has 5m tonnes of copper reserves which, on the current production of 200kt,
represent 25 years of mine life. Smelter capacity is even higher at 270ktpa.
Management expects to increase production by 25% and reduce costs further
to US$1.25/lbs, to bring Asarco to the second quartile of the cost curve. Well funded for the acquisition: On its standalone balance sheet, Sterlite has US$2bn of cash and doesn’t need to raise debt for this acquisition. It has already provided for equity contributions of US$500m each for its energy business and the Vedanta alumina ventures and is still left with US$1bn for reducing minorities in Hindustan Zinc and Balco (estimated cost US$1.5bn).”

Nomura

“Although the bid price was expected to come down as management was renegotiating the deal, the structure of the deal is favourable for Sterlite as just US$1.1bn will be paid upfront and the balance of US$600mn will be paid over a further nine-year period. While earlier we were building in US$-1.3bn on account of the Asarco acquisition, at current copper prices with new bid price there will be value destruction of US$670mn only. We have valued Asarco at the current copper price of US$3,681/tonne and total reserves of 5mn tonnes. Total net profit from Asarco will be in the range of US$45-50mn, which will be close to INR3.3/share of Sterlite, according to our estimates. However, total cash and cash equivalents for Sterlite will also be reduced by US$1.1bn, which will result in a similar fall in other income.”

STREET VIEW: DLF is looking to take a stake in DAL

We present to you the views of different analysts across brokerage houses.

CSFB
The story so far …
DLF Assets Ltd (DAL), a promoter company, entered into an agreement to buy 13 mn sq ft of commercial assets from DLF at a 9% cap rate. Against this, DLF recognised revenues of Rs101.7 bn between FY07 and FY09E at an average rental of Rs58/sf/m and PBT of Rs68.2 bn (~Rs40/share). Of the 13 mn sq ft, 9 mn sq ft is to be completed and ~6 mn sq ft leased by March 2009. The purchase was financed by about Rs1 bn in promoter equity, Rs43.5 bn in private equity (PE) from D.E. Shaw (US$400 mn) and Symphony (US$675 mn). The total outstanding from DAL to DLF is expected to be about Rs57.2 bn (US$1.1 bn) as of March 2009.
Valuation loss due to adverse cap rate movement
Cap rates and valuations have moved adversely since DAL contracted to buy at a 9% cap rate from DLF. Yields for listed Indian commercial assets currently range from 13% to 20%. We believe the fair valuation for DAL today could be somewhere between 11% and 13% cap rate resulting in a Rs19-32 bn erosion in DAL’s asset value.
Loss on private equity transaction
Media reports suggest D.E. Shaw wants to exit from DAL and that it has been promised a USD-protected return. We estimate the potential loss on an assumed 12.5% return to be about US$172 mn on the D.E. Shaw investment. While we do not know Symphony’s terms, we estimate a further potential loss of about US$209 mn if it were on similar terms as D.E. Shaw’s.

Reliance Equities
Merger likely to result in a dilution of 10–15% in DLF. The DLF-DAL merger is likely to result in dilution of 10–15% in DLF (assuming DAL’s are valued at the sale price). DLF had sales of Rs 106.2 billion in FY08–9M FY09 (out of a total transaction value of Rs 150 billion) to DAL. DAL paid Rs 51.6 billion (entirely through private equity funding), while the rest Rs 54.6 billion is yet to be paid (receivables). The merger would bring DAL assets on DLF’s books, while DLF shares would be issued after netting the receivables.

Morgan Stanley
What may happen – OPTION 1: DLF could take a partial equity stake in DAL in lieu of receivables. OPTION 2: DLF could buy the entire equity of DAL and merge the company. In option 2, the valuation at which DLF would acquire DAL and who would pay for the difference will be the key. It appears that DLF could buy back the assets at a meaningfully higher cap rate (12% or so), implying 30% or so lower value.
What would this mean for DLF – In option 1, not much would change for DLF except that receivables would get promoted to investments. In option 2, P/L impact – DLF would get rental flow of Rs 6 bln pa (available to securitise), B/S impact – assumes $1.05 bln debt (DE Shaw/Symphony) and assets sold to DAL. Valuation difference would either result in book writedown (DLF bears the cost) or new receivable/cash (promoters bear the cost).
Our thoughts - We think that DLF should transition its business model to ‘third party’ sales and mark down its historical DAL sales to market value. Intrinsic value of 9.5 msf of now completed DAL assets is roughly Rs60 bln at 11% yield vs Rs110 bln booked by DLF. Stay U/W