Why romance turned sour for Apollo and Cooper

What would have been the biggest automotive acquisition by an Indian company in the US was called off because of dissent in the American company’s overseas units, rues Sharmistha Mukherjee

“Cooper was the best marriage for both companies,” or so believed vice-chairman and managing director of Apollo Tyres, Neeraj Kanwar.

But when the $2.5 billion deal between India's Apollo Tyres and the Cooper Tire and Rubber Co of the US -- the single largest outbound acquisition announced in India’s automotive history -- collapsed on December 30 after a prolonged engagement that was marked more by acrimony than romance, there was relief all around.

Apollo and Cooper are yet to make the customary rounds of courts to settle termination charges and break-up fees, but the mood already is buoyant among institutional investors who had red-flagged the highly leveraged transaction agreed upon by the Indian company.

The impact has been immediately felt on the stock markets -- shares of Apollo Tyres touched a 52-week high of Rs 117 on BSE on Monday.

Apollo maintains it is disappointed that Cooper ‘prematurely’ terminated the merger agreement.

However, sector experts maintain it is a stroke of luck for Apollo because the deal would have only served to add pressure to the combined entity’s consolidated balance sheet.

“There was a high risk of Cooper not being able to service the huge debt as margins were under pressure.

“With an annual interest outgo of $180-200 million, it would have put pressure on servicing the debt,” explains Surjit Arora, research analyst (institutional equities) at brokerage firm Prabhudas Lilladher.

Brokerage firms have increased their ratings of Apollo's stock, notwithstanding legal proceedings which may entail Apollo having to pay a break-up fee for non-completion of the merger.

Brad Hughes, Cooper’s chief financial officer, in fact, recently told investors via a conference call that his company believed it was not liable to pay the $50 million termination fee, but would continue to pursue payment of the $112.5 million termination fee by Apollo as well as ‘other possible damages’.

The Indian tyre maker has blamed Cooper, saying issues arising from the American company’s labour troubles at home and in China had made it difficult to secure financing for the deal.

“While Cooper’s lack of control over its largest subsidiary and inability to meet its legal and contractual financial reporting obligations have considerably complicated the situation, Apollo has made exhaustive efforts to find a sensible way forward over the last several months.

“Cooper's actions leave Apollo no choice but to pursue legal remedies for Cooper’s detrimental conduct,” says a statement from Apollo Tyres.

Most analysts are optimistic about the outcome.

“We are of the view that Apollo Tyres will not have to pay any termination fee as the earlier two rulings by the court in Delaware in the US were in Apollo’s favour,” says Arora.

A temporary halt of ambition

Irrespective of what the courts decide, the termination of the merger with Cooper represents a temporary setback for Apollo in its plans to gain scale on the global map.

The acquisition of Cooper, the world’s 11th-largest tyre company by sales, would have given Apollo access to the US market for replacement tyres for cars and light and medium trucks.

The deal would also have allowed Apollo brands to penetrate the market in China, the largest in the world for commercial vehicles.

The company, on completition of the acquisition, would have gained a footprint across four continents with 14 manufacturing facilities across the globe.

Of this, approximately 50 per cent of the manufacturing units would have been in low-cost countries -- China, India, Mexico and Serbia -- and enabled Apollo to realise its philosophy of near-sourcing, that is, 80 per cent of a plant’s production would go to near markets and 20 per cent to farther ones.

“It is not viable to ship tyres all the way from India and South Africa to Brazil.

It becomes very expensive for us, so you need near-sourcing,” Kanwar had told Business Standard in August last year.

The Cooper facility in Serbia would have helped Apollo enter the CIS (Commonwealth of Independent States), where both the brands are not present currently.

The added benefit of the merger, 40-year-old Kanwar had argued, would be the protection from the vicissitudes of business in a single geography.

Apollo, which currently does not operate in the US, garners two-thirds of its revenue from India, where a weak economy has hurt the demand for tyres.

“India is a difficult story. . . You have to de-risk. That's why, now, if you see the whole pie of Apollo, 43 per cent is North America. India, which was 65 per cent earlier, is down to 22 per cent.

“China is 18 per cent,” Kanwar had said of the combined entity, which was to get 40 per cent of its revenues from emerging markets, the remaining from the high-profit pools in Europe and America.

Blow that broke the partnership

But what soured the much-sought deal with Cooper (Apollo had initially agreed to pay a premium of 43 per cent on Cooper’s share price in June) and thwarted Apollo’s ambitious growth plans was largely the disruptions in operations at Cooper’s Chinese joint-venture, Cooper Chengshan Tire, which contributes nearly a quarter to the consolidated revenues of the company.

Workers seized control at CCT soon after the acquisition was announced on June 12, 2013, and subsequently filed a lawsuit seeking the dissolution of the pact, saying the sale to Apollo would undermine the venture’s interests.

The unit was key to the proposed takeover as financial information regarding CCT was required to close the financing for the merger.

Differences between the two firms over demands raised by employees at Cooper’s facilities in Ohio and Arkansas additionally complicated the deal.

Cooper filed a complaint in the Delaware Chancery Court on October 4, alleging that Apollo was delaying settling issues with the United Steel Workers, which had demanded that new agreements be drawn between them and the Indian company before the deal was concluded.

Cooper had alleged that Apollo’s delaying tactic was aimed at lowering the price of the deal.

Apollo, Cooper said, was facing ‘buyer’s remorse’ and was concerned about the protests at CCT and had been looking for a pretext to back out of the deal.

Apollo had paid a 43-per cent premium on the 30-day weighted average price of Cooper shares as in June 2013, but its own shares had collapsed on BSE (to a 52-week low of Rs 54.60 on June 21) as investors feared Apollo might have overpaid for acquiring the US company.

Apollo has admitted to having sought renegotiation on the value of its $2.5-billion deal with a price cut of up to $9 per share due to the persisting labour issues at Cooper’s Chinese and American facilities.

But the company rebutted allegations about attempts to back out of the merger.

In this battle of complaints and rebuttals, Apollo, for its part, has alleged the financial performance forecast of Cooper deteriorated consistently within a few weeks of the announcement of the deal in June.

On July 21, Apollo said Cooper projected $4.3 billion in revenues and $380 million in operating profits for 2013.

In September, Cooper revised the estimates to $3.4 billion in revenues (a drop of 21 per cent) and $257 million (a drop of 32.4 per cent) in operating profits for 2013, leading to Apollo developing more cold feet over the proposed transaction.

Announcing the termination of the merger deal on December 31, Roy Armes, chairman and chief executive officer, Cooper Tire, had said, “The right thing for Cooper now is to focus on continuing to build our business.”

If they can get past the legal battles, both companies may find going solo beats being in a pricey and problematic merger.

Expansion may get off the back-burner

Scale has been on Apollo Tyres’s radar screen for a while.

Many years ago, it was one of the suitors when tyre maker Modi Rubber was on the block.

But the sale never happened. Later, the company acquired Dunlop in South Africa and Vredestein in the Netherlands.

In 2005-06, Kanwar toured Sri Lanka to study the possibility of setting up a factory there.

But the size of the local market was too small to justify a full-fledged production unit. Kanwar has also been in discussion with the authorities in Thailand to set up a plant there.

Meanwhile, the Cooper deal happened. Kanwar had said that the plans to acquire Cooper did not spell the end of the Thailand project.

“I am still keeping (the) Thailand (option open). I will see what needs to be done.

“We have identified the land and negotiated with the government.

“We still have to finalise it.”

With the Cooper merger now terminated, Apollo may turn its focus back on the expansion of its plants in Thailand, say industry observers.

Image: Neeraj Kanwar; Photograph, courtesy: Business Standard