Stock Review: Motherson Sumi

The latest overseas acquisition by Motherson Sumi System will help the company expand its presence in Europe. However, in the short term, the deal is likely to pull down overall profitability. Some analysts are also worried over the possibility that the transaction, which will be funded through debt, would strain its balance sheet.

Motherson's stock closed 3.5% lower on Wednesday over these concerns. MSSL is going to acquire a 80% stake in Germanybased Badische Plastikwerke, Peguform, which manufactures high quality interior and exterior products for automotive original equipment manufacturers through a joint venture with its group firm Samvardhana Motherson Finance.

MSSL has not disclosed the deal amount. Peguform earned . 8,494 crore in FY10 with operating profit of . 402 crore. The bigger size of operations suggests that the deal size would entail MSSL to raise fresh debt.

MSSL's management has said that it would fund the deal with debt once the deal valuation is finalised. Even though, MSSL is banking upon the synergies after this acquisition, the company may face pressure on the balance sheet since deal valuation can be on higher side due to size of the operations in terms of revenue. The company had consolidated debt of . 1,263 crore as of March 2011 with debt-equity ratio of 0.8. Raising more funds would increase the leverage of the company compared to its peers. This may make it difficult to raise funds for expansion in the future. Another challenge is the lower profit margin of the German company. At nearly 5%, its margin is half of MSSL's margin. This would adversely impact overall margin of the combined entity after consolidation. However, the deal makes strategic sense to MSSL. It will help the company move up in the value chain to become a technology-driven products company. MSSL's polymer business will also be strengthened after the acquisition.

After the integration, nearly half of MSSL's revenue will come from Europe, which increases currency exposure risk. This may necessitate the use of effective currency hedging policies. The acquisition looks beneficial in the long term. It reaffirms the company's strategy to grow inorganically and develop well-diversified business portfolio across the globe. The acquisition is in line with company growth target of $5 billion sales by 2015 with close to 70% business from the overseas market.