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Eicher Motors – Would Ducati be a feather in the cap?

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Eicher Motors, block deal, shares, stock market

Having established itself as India’s number one premium two-wheeler brand with Royal Enfield (RE), Eicher Motors is now looking to strengthen its global presence as well as expand its portfolio. Media reports say Eicher is in the race to acquire globally recognized iconic brand Ducati. The goal is to enter the superbike (800cc -1200cc) segment by riding pillion on a strong global brand.

Ducati - Brief Profile

Ducati is an Italian iconic motorcycle brand which manufacturers superbikes in the 800cc to 1200cc segment. The company has built a strong brand over the years by emphasizing on reliability and at the same time, low maintenance costs. It is now a big name in high-end bikes and an iconic brand among bike enthusiasts.

Given the low success ratio of M&As globally, it is natural for investors to wonder if Eicher should be pushing for the deal.

Access to a well-established brand

Royal Enfield has become a very strong brand among the youth in India. Volume sales have grown at an eye-popping 51 percent compounded annually between 2011 and 2017.

Adding Ducati in the portfolio will give Eicher access to a powerful brand and its products, and an entry in several unexplored markets where Ducati has a strong presence.

RE is a dominant player in the mid-sized (150cc-700cc) segment, but has no presence in the Superbike (800cc -1200cc) segment where Ducati is a dominant player. Adding Ducati to its portfolio would give Eicher access to superbikes and it would then be able to cater to a full range of premium bikes to its customers.

Access to a powerful R&D center

Innovation through constant research and development (R&D) is the key differentiator in the auto industry. Ducati, over the years, has spent significant time and money in building its R&D capabilities, the results of which are visible in its products.

Eicher also continues to focus on R&D and keeps on launching new and innovative products from time to time. It has been spending in setting up new technical centers, one of which is in the UK.

The deal with Ducati will help Eicher to use Ducati’s R&D capabilities to bring in high quality products to cater to a dynamic market.

Access to a strong distribution network

Currently, the company has 26 exclusive stores and 600 multi brand stores in international markets. The deal with Ducati would help Eicher to use Ducati’s well-established global distribution network. Additionally, Ducati would also be able to gain access to Eicher’s distribution network in India, an emerging market for premium bikes.

Capacity Constraints

Eicher has been facing capacity constraint now. It has been steadily adding capacity for Royal Enfield that has increased from 60,000 units in CY11 to 675,000 units in FY17. Despite aggressive capacity addition, the company’s growth is still constrained by the same.

The deal with Ducati, however, would not provide additional capacity to Eicher. However, it would give Eicher access to an established product range without worrying about adding capacity.

Financials

Ducati sold 55,451 bikes in CY2016, up 1.2 percent (YoY) and generated revenue close to Euro 730 million, up 4.1 percent (YoY).  It recorded EBITDA margin of 14 percent in CY16, down 30 bps (YoY).

RE, on the other hand, sold 666,490 bikes in FY17 and generated EBITDA margin of 31.3 percent on the back of operating leverage and cost optimization strategy.

Though, Ducati’s margin is much lesser than that of Eicher, we believe that Ducati would be able to optimize its cost with the help of Eicher that would lead to margin improvement.

Eicher Ducati_07092017

Deal valuation

News reports say Eicher would have to shell out EUR 1.5 billion to EUR 1.7 billion to acquire Ducati, which values Ducati at an EBITDA (2017) multiple of 15 to 17 times. The closest listed player in the premium bike space, Harley-Davidson Motor company, currently trades at 12 times trailing EBITDA multiple, indicating that Eicher is not paying too much of a premium to Ducati.

Eicher Ducati_07092017_4

Our back-of-the-envelope suggests that Eicher can clinch the deal without much of an impact on its long-term financials.

The likely funding scenarios

Under scenario 1, 30 percent of the deal amount is assumed to be funded by debt and the remaining amount is through equity that would lead to equity dilution of 8.3 percent. The EPS for Eicher (the combined entity) would fall by 13 percent.

Under scenario 2, total amount is estimated to be funded equally by debt and equity, leading to equity dilution of 6 percent. In this scenario, the EPS decline could be around 16 percent.

Under scenario 3, total amount estimated to be funded by debt is 70 percent and the remaining 30 percent by equity, leading to equity dilution of 3.5 percent. The EPS then could witness a decline of 19 percent.

The fall in EPS varies across these three scenarios because of the interest cost based on the capital structure used for funding.

Eicher Ducati_07092017_3

Eicher Ducati_07092017_2

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