At the start of this calendar, few in the market would have heard of GMM Pfaudler. But with the stock price soaring from a little under Rs 2000 to nearly Rs 7000, this previously little known firm is now the talk of the town.

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So, what is GMM Pfaudler? The company was founded in 1962 as Gujarat Machinery Manufacturers. In 1987, Pfaudler Inc-- a world leader in process equipment and solutions for the chemicals and pharmaceuticals industry--picked up a 40 percent stake in the company. By 1999, the stake had risen to over 50 percent, and GMM Pfaudler became a subsidiary of Pfaudler Inc.

Thanks to its parent’s technological prowess, GMM Pfaudler today boasts of a commanding 60 percent share of the domestic glass lined equipment market.

Even before the proposed acquisition of its parent Pfaudler Group (we’ll get to this in a bit), GMM Pfaudler was well positioned to ramp-up its operations over the next few years. Besides the two new furnaces at its Gujarat unit, the recent acquisition of a facility in Hyderabad would help it strengthen its presence in the southern market.

In fact, the company under its internal programme UDAAN is targeting revenues of Rs 1,000 crore by 2023 and Rs 1,300 crore by 2025. And the street is hopeful of the company achieving its targets, helped by the tailwinds in the pharmaceutical and chemical sectors and a pick-up in heavy equipment sales to new segments in the hydrocarbons sector.

Amidst this positive backdrop and a rapidly rising share price, came the announcement of the company’s plan to acquire a controlling stake in its parent, Pfaudler Group. Point to note is that Pfaudler owns the technology that the company needs to grow its business. The proposed acquisition gives GMM Pfaudler control over the technology, as well as the $280 million business spread across the globe, which accounts for 30 percent of the global volumes in the oligopolistic industry. So, the acquisition makes sense.

The acquisition structure

What doesn’t make sense, on the face of it, is the route taken to acquire the business. Besides the complexity, it raises concerns of minority shareholders not benefitting to the extent they should be.

The acquisition is proposed to be done through GMM International, a new company to be set up in Luxemburg.

GMM Pfaudler will acquire 54 percent in the company (34.4 percent directly and 19.6 percent via its subsidiary Mavag AG).

The owner of Pfaudler Group, Pfaudler Inc (which is controlled by private equity player Deutsche Beteiligungs AG (DBAG)) will retain 20 percent stake and the Indian promoters, Patel Family, will acquire 26 percent.

To fund the acquisition, GMM Pfaudler and its subsidiary will use internal accruals of $10 million and take on debt of $17.4 million.

The question is: could not GMM Pfaudler have simply bought out its parent directly. We asked the management the same and whether at some point GMM Pfaudler will acquire full control. The unedited Q&A transcript is shared below.

If eventually, GMM will own 100 percent, why not now?

Current ownership structure has been created with a view to increasing alignment and incentives between Patel family, DBAG and GMM Pfaudler for value creation in the Pfaudler global business. Promoter investing along with company also shows commitment and belief in the business.

What is the purpose of promoters’ participation?

As mentioned above - increasing alignment and commitment in value creation of Pfaudler International business given that Tarak Patel is actively involved in management.

Why a 26 percent stake for promoters—any rationale?

Shareholding structure had to include DBAG, Patel family and GMM Pfaudler. Further, the intent was also to not increase GMM Pfaudler leverage levels beyond current envisaged levels or dilute existing GMM Pfaudler shareholders.

Any conditionalities / options with respect to stakes of shareholders—any put or call options / buyout conditions?

No such options.

What is the timeframe for GMM acquiring 100 percent?

Will depend on execution of identified opportunities to improve global Pfaudler profitability. Possibly 3 -5 years.

How are promoters raising the money to fund the acquisition?

From their internal resources. Promoters have always been conservative about personal debt and will not raise personal debt to fund the acquisition

Ownership limitations

The above responses need to be seen in context of the company’s ownership structure and the likely objectives for this deal.

Presently, Pfaudler Inc (or DBAG) owns a little over 50 percent, the Patels just under 25 percent and the public 25 percent. The public holding just meets the minimum public shareholding norm prescribed by SEBI. So, if equity capital is to be raised, it can’t exclude non-promoters as the public shareholding would then fall below the stipulated 25 percent. But if any money is raised without involving the promoters, the delicate balance in shareholding will get disrupted—with DBAG’s stake slipping below the majority level.

So, even though raising the required money given GMM Pfaudler’s Rs 8500 crore market capitalization would mean a very nominal dilution, it would require all existing stakeholders to bring in proportionate funds to retain the delicate balance in the existing shareholding structure.

And if all the money is raised via debt, it can mean an undue burden on GMM Pfaudler—something the management has referred to in its responses.

But this still doesn’t completely explain the structure. To do so, we need to understand the transaction.

Follow the Money

Understanding any transaction is best done by tracking the flow of cash. In the case of GMM Pfaulder’s acquisition of Pfaudler Group, $40.6 million goes to DBAG. So, if one of the objectives of the deal was to take some money off the table (DBAG had acquired Pfaudler for €83.5 million), subscribing to a fresh issue of shares would not serve the purpose, nor would a share swap (See: Rights Issue Math below). And if burdening GMM Pfaudler with too much debt was not considered prudent, the happy alternative could have been roping in the Patels directly into the holding company—in a way mirroring the Indian company capital structure. What this does is, ensure commitment of the Patels to making Pfaudler Inc more profitable by offering them an “incentive” in the form of direct equity. This is typical private equity.

High Stakes and Valuations

Now let’s look at what the proposed holding structure spells. The economic equity interest of DBAG, Patels and GMM Pfaudler minority shareholders in Pfaudler Group will stand at 47 percent, 39 percent and 13.5 percent, if we consider their stakes in GMM Pfaudler separately. This translates into a claim on Pfaudler Group’s EBIDTA of Rs 133 cr (@$=75INR) of Rs 63 crore, Rs 52 crore and Rs 18 crore, respectively.

At the proposed valuation of about Rs 380 crore for Pfaudler Group’s acquisition the EBIDTA to acquisition cost seems very attractive at ~35 percent. Compare that to the EBIDTA to market capitalization of GMM Pfaudler at 1.37 percent and you can’t help but notice how much more bang for the buck that is. What I’m pointing to, is that the economic interest that could have been acquired by buying shares of the Indian company to fund the acquisition would have compared very poorly to the present structure.

The other big question this raises is: has KPMG, the independent valuer for the transaction, got Pfaudler Group’s valuation right? If yes, has the street got GMM Pfaudler’s valuation wrong? Both can’t be right at the same time.

And what’s a bother for the future is the likely valuation equation for GMM Pfaudler to gain 100 percent control of Pfaudler Group in 3 to 5 years. Here, one must appreciate that while the promoters may not have any malafide intent behind the structuring of the deal, it does create unwarranted complexities that raise red flags.

Given this, and that even with a target of Rs 1300 crore being achieved for the domestic business along with an EBIDTA margin of 20 percent in 2025, along with an optimistic 20 percent CAGR in EBIDTA of Pfaudler Group, the EBIDTA to market cap yield of the combined business (after deducting interest on additional debt at 8 percent) will result in a yield of around 5 percent. Compare that to the EBIDTA to market capitalization yield of a frontline technology stock like Infosys at 7 percent for 2022, three years less, and you wonder whether the GMM Pfaudler stock has run well ahead of its fundamentals.

Those already owning the stock should consider, whether, like the parent, it is time to take some money off the table. Prospective investors can wait for a better price point

First Published:Aug 29, 2020 11:06 PM IST