EUR 120.00 For Business Accounts Only

MOSL: SADBHAV ENGG. (Buy)-SIPL merger in favor of SADE’s shareholders

SADBHAV ENGG.: SIPL merger in favor of SADE’s shareholders; To issue one equity share for every three equity shares of SIPL

(SADE IN, Mkt Cap USD0.3b, CMP INR140, TP INR225, 60% Upside, Buy)

• SADE-SIPL merger ratio in favor of former's shareholders: The Board of Directors of Sadbhav Engineering (SADE) has approved the merger of the company and its listed subsidiary Sadbhav Infrastructure Project Limited (SIPL). In consideration of the merger, SADE will issue one equity share for every three equity shares of SIPL. We note that the merger ratio of 3:1 (versus our expected ratio of 2.7:1 based on intrinsic valuation) is somewhat in favor of SADE's shareholders. As a result of the merger, the promoter stake in SADE will come down from 46.55% to 38.74%. The merger is likely to be completed in 6-9 months.
• Merger was inevitable post sale of nine operational BOT assets in SIPL: To recap, SADE had divested its stake in nine road assets at an EV of INR66.1b, resulting in a debt reduction of INR40.6b at the project level and realization of INR25.5b in lieu of equity invested. Of this, INR19b is expected to be cash consideration and the remaining INR6.5b in the form of the units of the InvIT, IndInfravit Trust, to the tune of a 10% stake. Post the asset sale, SIPL will have three operational assets and a portfolio of 11 HAM projects, thereby reducing the dependency on traffic growth. Anyway, the investor interest in the listed asset arm has been on a decline, as InvITs are better products compared to listed companies in the road assets business, given the removal of the dividend distribution tax on SPVs and the minimum construction risk.
• Merged standalone to capture deleveraging benefits but also future equity funding risk to SPVs: Prima facie, the merger appears value accretive to standalone SADE as the entire benefit of debt reduction in SIPL standalone gets captured in the new merged entity. Thus, the estimated merged SADE standalone FY21 PAT increases by 85% to INR4.4b from INR2.4b earlier. Over FY19-21, adj. PAT CAGR is estimated at 54.5% and adj. EPS CAGR at 40.3% as there is a dilution of 21% on share capital. However, we note that the future equity commitment in SPVs (both for loss making SPVs like Rohtak Panipat and Rohtak Hissar as well as equity commitment in HAM portfolio) now comes on SADE’s balance sheet. Thus, if SADE bids for new projects on a HAM basis, it will have to use the balance sheet strength of merged SADE rather than SIPL earlier.