SSKI - Bajaj Auto's Q4FY07 results (DOWNGRADE TO UNDERPERFORMER): De-merger blues - What about value creation?

Bajaj Auto's (BAL) Q4FY07 performance has been above our expectations both at the top line (due to higher realizations) and at the bottom line (aided by higher other income). Q4FY07 net sales grew by 6.8% yoy to Rs23.14bn driven by 1%yoy increase in volumes and 5.8%yoy and 6.3%qoq surge in average realizations. EBIDTA margins were in line with our expectations at 14.1% and net profit declined by 3.9%yoy to Rs3.21bn.
Bajaj Auto in its de-merger plan has proposed to de-merge its businesses into two new entities - manufacturing and finance & insurance, while the existing company will continue to act as a holding company retaining bulk of the surplus cash/investments along with 30% equity stake in each of the new entities. We believe the creation of a holding company structure fails to meet the very objective of the de-merger process and would lead to value entanglement for the shareholders rather than value unlocking. The value diminution caused in the manufacturing business as a part of the de-merger process due to an enhanced equity base (43% dilution -at par) does not get fully recaptured in the holding company, as valuation of the holding company's interests in the de-merged entities will attract a significant discount (50% assumed). Further, the company's disclosure as regards to Allianz having an option to increase its stake in Bajaj Auto's Life Insurance business to 74% and in the General Insurance business to 50% from 26% each at present at a very nominal value (upto 2016) has come in as a very big negative surprise. After accounting for the likely impact due to the company's proposed de-merger plan and its new disclosures pertaining to its insurance businesses our SOTP price target for the company has been lowered to Rs1996/share from Rs2625/share, a sharp drop of 24%. The downgrade in the per share value has been much steeper as compared to a downgrade of ~5% in the target market cap due to the impact of an enhanced equity base. We are downgrading our recommendation for the stock to UNDERPERFORMER from NEUTRAL.

SSKI - Bajaj Auto's Q4FY07 results (DOWNGRADE TO UNDERPERFORMER): De-merger blues - What about value creation?