Tata Motors Says Hello to Luxury

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Tata Motors (TTM), which I profiled on these pages roughly five months ago, is the front-runner to take over Ford's (F) premier brands, Jaguar and Land Rover. 
 

There are some questions about how quickly a deal between the two could take place, with some thinking it's imminent, while others believe more time may be involved. Without a solid time frame, it's probably best to get an idea now of what the potential risks and rewards of a takeover (assuming Tata emerges as the winning bidder) will be for TTM shareholders. Let's examine both sides of the coin, beginning with the risks first.


The most obvious is headline risk. All of the potential hand-wringing in the press and moaning on the sell-side about how TTM paid too much for the two flagship companies and how it is going to mess up their balance sheet in the short-run.

The inevitable downgrades by ratings agencies like Moody's, S&P, etc., will likely take place. Most times after a big acquisition, especially if it's done with debt, these ratings agencies lower the credit rating on the acquirer due to increased costs.

If the dollar continues to weaken against the pound, margins could be affected, as both brands are manufactured in the U.K., and about 25%-30% of the two brands' unit sales are in the United States.

Is TTM going to have to issue equity to complete the acquisition, which would be dilutive to current holders, or will it use cash from other sources like parent Tata Holding, or debt or a combination of both?

The employee unions (currently backing Tata Motors) have asked for strict assurances from the winning buyer that there will be no job cuts, and pensions will be maintained and warranties honored. This could add to the buyer's burden should it make more sense to transfer some jobs elsewhere.

With clear signs of a slowdown stateside, how will unit sales of the two luxury brand be affected and will that be part of the negotiation? Will the buyer receive a discount from Ford as a result of the impeding US slow-down?

Top-notch brands like Land Rover and Jaguar require continuous investment in R&D to keep up with the latest advances, which could add margin pressure to TTM.
Now let's take a look at the potential rewards of this deal.


TTM will be taking over two premier brands that Ford seems to have turned around in terms of profitability. Ford said in the September quarter Jaguar and Land Rover were profitable, albeit modestly, but that was enough to offset losses at the Volvo unit.

By buying two world-renowned brands, TTM will make a huge splash into the international automobile arena, which will help leverage their local brands quickly and easily into areas like Africa, Southeast Asia and the former Soviet bloc. Better brand recognition could mean more unit sales in these areas of the company's other brands.

In India, acquirers can absorb the losses of the acquired company and use those losses to offset their income, which could be a huge benefit given the large loss carry forwards at Jaguar and Land Rover.

Despite negative perceptions of the quality of the Jaguar and Land Rover automobiles, both brands rank at or above par on most of their offerings as per JD Power rankings. Another way to look at it is that TTM could be buying an up-and-coming asset on the cheap.

TTM will eventually bring its world-class manufacturing and management efficiencies in place at the two brands and improve margins substantially over time.
Factor in the coming benign interest-rate environment in India, the soon-to-come spinoff of its finance and other divisions, the strong upcoming replacement cycle (almost 30% of India's existing commercial fleet is over 15 years old), the $2,500 "peoples car" making its debut tomorrow and the possibility of winning two of the world's premier automobile brand makes TTM a compelling story here. Headline risk notwithstanding.

Until the next time, happy investing.

 

 

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