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Will the acquisitions pay off?

It remains to be seen whether the significant cost that GCPL will incur to fund its recent acquisitions will prove worthwhile

In the last three months Godrej Consumer Products Limited (GCPL) has announced five acquisitions: the remaining shares of Godrej Sara Lee; Indonesia-based Megasari Makmur group and its subsidiary; Nigeria-based Tura Group; Latin America based Issue group; and one more Latin America based company, Argencos. The two Latin American deals were done within a span of two weeks.

GCPL, which belongs to the Godrej group, is a mid-sized player in the Indian FMCG market. A long-standing player in the consumer goods business, it focuses primarily on categories such as toilet soaps (it is India's second-largest soap manufacturer) and hair colour (where it is the largest player). It targets mainly lower and middle-income consumers. It also has a presence in toiletries and liquid detergents. It has now entered the insecticide space with the recent acquisition of 49 per cent stake in Godrej Sara Lee. Explaining the group's strategy behind the recent acquisitions, Adi Godrej, chairman, said: “We have enunciated a three-by-three strategy for our international operations in the three continents of the developing world - Africa, Latin America and Asia - and in three categories - personal wash, hair care, and home care. We will target emerging markets with demographic and behavioural profiles similar to that of India.”

Companies within the domestic FMCG sector are increasingly focusing on rural markets. Godrej Consumer Products has, however opted for the opposite strategy - it has chosen to expand in international markets. To this Godrej responded: “If you look at our domestic growth rate I think it's one of the highest in the FMCG sector. So we are extremely focused on the domestic market. We produce a lot of cash. We can deploy that cash very successfully for improving the earnings per share of our shareholders.”

Godrej further explains that it looked at inorganic growth opportunities in India first, but couldn't find any. The other big opportunity area is the developing world, which the company is trying to capitalise on. Let us now turn to the company's recent acquisitions:

Godrej Sara Lee
Godrej Sara Lee (GSL) was a joint venture between the Godrej group and Sara Lee Corporation of US, with the latter having a 51 per cent stake. In May 2009, GCPL acquired a 49 per cent stake in GSL from group companies via share swap. GSL has a strong presence in categories like mosquito repellent, air freshener and shoe polish. It owns popular brands such as Good Knight, Jet, Hit, Ambi Pur, Bylcream and Kiwi.

On May 13, 2010, GCPL entered into an agreement with Sara Lee for the remaining 51 per cent stake for Rs 1,050 crore - valuing GSL at Rs 2,070 crore. Thus GSL has now become a wholly-owned subsidiary of GCPL.

Megasari Makmur group
GCPL also acquired the Megasari group of Indonesia. This acquisition consists of Megasari Makmur, a consumer products company, and its distribution arm, Intrasari Raya. The acquisition was to be funded through internal accruals and offshore debt. The cost of this acquisition was not disclosed.

Megasari Makmur is a leader in household insecticides in Indonesia, with brands such as Hit, Stella and Mitu. These brands contribute approximately 71.8 per cent to the company's total revenues. Most of these brands hold no. 1 or no. 2 position in the market. Analysts estimate that the company's 2009 revenue was US $120 million.

Tura Group
On March 13, 2010, GCPL acquired Nigeria-based Tura group. Analysts have valued this acquisition at approximately Rs 350 crore.

Established in 1986, the Tura group started by manufacturing and distributing soaps and thereafter expanded into other personal care categories. At present, Tura is among the top three soaps brands in the region and has a notable presence in other personal care categories such as moisturising lotions and skin-toning creams. With this acquisition, GCPL gets the right to manufacture and distribute Tura brands globally.

Godrej says that in Africa the company's emphasis will be to integrate the business and build a hub and spoke model with four hubs in West, East, Central and South Africa.

Issue group
On May 23, 2010, GCPL acquired 100 per cent stake in Argentina-based Issue Group at an approximate cost of Rs 2.3 billion. With this acquisition GCPL also gets Issue group's regional businesses in Argentina, Brazil and Uruguay, such as Laboratory Cuenca and Consell SA of Argentina, Issue Uruguay and Issue Brazil. The Issue Group is a major player in the Latin American mass hair colour market with 20 per cent market share in Argentina. In CY09, the group recorded nearly 22 per cent growth in Argentina's hair colour market. It is also the market leader in Peru, Uruguay and Paraguay.

Argencos
This acquisition too was done for an undisclosed amount. With this acquisition, GCPL will have control of nearly 25 per cent market share by volume and approximately 50 per cent of the hair styling category in Argentina.

Debt worries
According to a recent report from Emkay Research, “On rough-cut estimate, GCPL might have spent Rs 2,800 crore on acquisitions in the last three months. GCPL has guided for higher debt component for funding the acquisition. Accordingly, we have factored in debt of Rs 2,200 crore to fund the acquisition and net debt of Rs 1,800 crore (considering cash balance of Rs 400 crore). Further, we have factored in equity funding of Rs 600 crore at Rs 300 per share, translating into a dilution of 6.1 per cent.”

Responding to questions about how the acquisitions are being funded, Godrej said during the conference call: “We have both the board and the shareholders' permission to raise up to Rs 3,000 crore. We currently have Rs 3,000 crore on our balance sheet, or thereabouts. So if we have to raise even further funds then the balance will be raised through half debt and half equity.”

Impact on shareholders
On the positive side, these acquisitions could result in the company's overseas operations contributing more to the bottomline. But these acquisitions also pose certain risks. On the one hand, competition within the domestic personal care market is intensifying which could in future necessitate lower pricing and higher brand spends.

Acquisitions also entail execution risks. Are the companies that have been acquired really as promising as appeared at the time of due diligence (prior to the acquisition)? Acquisitions in foreign countries also raise the question of cultural fit. The debt burden will raise the company's interest cost. Further, the dilution of equity to fund these acquisitions could lower shareholders' earnings per share (by increasing the number of outstanding shares). These acquisitions will also expose the company to currency risk.

Between FY04 and FY 09, GCPL's sales have grown at a compounded annual growth rate (CAGR) of 15 per cent. Over the same period, PAT has increased at a CAGR of 20 per cent. The company is currently trading at a PE of 42.6 (June 29, 2010), which is much higher than its five-year median PE of 26.62. Given the high valuation, new investors would be better off staying away from the stock until it becomes available at a more attractive valuation, and until a clearer picture emerges on how the recent acquisitions have panned out.