>Crompton Greaves Limited (JP MORGAN)

Using the cash cow for group needs?

• Bad news outweighs good: Crompton Greaves made two announcements yesterday: (1) A buyback of Rs.2.24B up to a price of Rs.170/share - EPS accretive to the tune of ~3.6%, (2) Acquisition of 41% stake in a promoter group company Avantha Power at Rs.2.27B, valuing the latter at Rs.5.5B. Avantha Power has 95MW of captive operating capacity, 60MW in expansion stage and 1200MW of projects in pipeline.

• Prima-facie, acquisition appears expensive. We value 1) 95MW of existing captive capacity at Rs25MM/MW (2.5x book) and 2) 60MW in expansion stage at Rs10MM/MW (1x book). Based on this, it is difficult to attribute more than ~Rs.2.5-3B fair value to Avantha Power. We do not value 1200MW in the pipeline, as we await clarity of progress in settling land acquisition issues, securing clearances and achieving financial closure. Based on financials of another group company (BILT) which owns 26% stake in Avantha, we deduce Avantha Power's annual profit to be ~Rs51MM.

• CG may have to raise debt to fund acquisition: As of Dec-08 CG had ~Rs3.5B gross cash on its books, but may need to borrow ~1.5B to fund the acquisition + buyback. The Thapar group harboured grand ambitions for Avantha, but CG management had consistently denied any intention to play a role in funding this. The sudden move to partner Avantha is negative in our view, as: a) it exposes a low capex, low net DER (0.33x) business to funding and project execution risks accompanied with prospects of back ended cashflows, and b) The acquisition in generation is broadly unrelated to Crompton’s T&D product profile, in our view.

• We retain Neutral and Mar-10 DCF-based PT of Rs150 (WACC: 15.8%, g: 5%, Terminal year: FY18): YTD CRG has consistently shown strong execution and margin stability; however market fears regarding acquisition related uncertainties could be a near-term overhang on the stock (already down 10% today). We expect to seek clarity from management on debt levels in Avantha and timelines for capex and commissioning of 1200MW capacity. Key risk to our PT stems from weak order flows in overseas power segment and potential funding/ project execution risks.

To see full report: CROMPTON GREAVES