Video summary:
On Oct 11th, Sudarshan Chemicals announced in a press release that they are acquiring Heubach Group, a 200-year-old company and one of the largest pigment manufacturers in the world. The deal is interesting in many ways:
- Heubach is more than 3x the size of Sudarshan in terms of revenue.
- The deal happened at an attractive valuation of around 0.2x CY23 sales.
- And more importantly, there is no debt transfer from Heubach to Sudarshan. It is purely an assets and operations transfer.
*Source: Oct 11th, 2024 press release
The market reacted positively, with the stock hitting the upper circuit at 20% on Friday. However, there are a couple of questions that need to be answered in this deal: How are they going to fund it? What are the turnaround plans? Historically, most European acquisitions have had to navigate stringent labour laws. How is Sudarshan going to handle that? Let’s try to answer these and a few more in this post.
A bit about both parties
Family-owned and operated, Sudarshan Chemicals was started in 1952 with an initial focus on products like pigments, agrochemicals, and masterbatch businesses. In the last two decades, they shifted to focus solely on pigments and went on to become India’s largest pigment player, with an estimated market share of 35%, globally the third largest. They also expanded their portfolio from organic and inorganic pigments to high-performance and cosmetic product ranges.
Over the last 10 years, they have achieved a revenue CAGR of 10%, EBITDA CAGR of 11%, and PAT CAGR of 12%, all while maintaining a healthy balance sheet and return ratios.
For those with a keen interest in how it all started, here’s an interesting recap of how Sudarshan made it big:
Heubach Group is a 200-year-old company based in Germany. It is one of the major players in the pigment industry, with a global presence of 17 production facilities across the United States, Europe, and Asia.
Heubach Germany has two Indian subsidiaries:
- Heubach Colorants India: A listed entity that clocked FY24 revenue of 791 Cr and is 54.3% owned by Heubach GmbH.
- Heubach Colour Private Limited: An unlisted entity that clocked FY23 revenue of 500 Cr (as per Tofler). Heubach GmbH’s holding is not available.
Both of these companies will become part of Sudarshan post-deal, which will improve Sudarshan’s consolidated revenues by around 20%.
Why did the Heubach Group fail?
The going was good for the Heubach Group up until 2021, when they reached 1 Bn euros in revenue. In Jan 2022, Heubach and S.K. Capital bought Clariant’s Pigment business for about 850 Mn euros, most of which was funded through debt. However, things started to go south after the Russia-Ukraine war.
There was a drop in demand in Europe and China, and high energy costs pushed up the cost of raw materials for Heubach. Leveraged balance sheet & rising interest rates made the situation worse, leading to financial distress and eventually affecting the solvency of the Heubach Group.
The deal structure
The deal involves both cash & share swap.
- Cash deal for assets from insolvent companies in Germany
- Shares swap deal for solvent companies of the Heubach Group
- Total deal value 1180 Cr
- Funded using a mix of debt and equity
- Expect to complete the transaction by the first quarter of 2025, subject to regulatory approvals
A Catch-22: Fundraising, Equity dilution, and Low promoter holding
Sudarshan approx needs 2100 Cr for this transaction (1200 Cr for the deal + 900 Cr as working capital & other restructuring expenses).
Just to give you a perspective, the balance sheet size of Sudarshan Chemicals as of FY24 is 2346 Cr.
Ohh boy, that’s indeed a biggg deal for them. At least in terms of scale.
Coming back: They are going the QIP route to partially fund this acquisition. But this brings in another problem for the management – low promoter holding. You see, Sudarshan management currently owns only 30.5% of the company. Equity dilution at this point will further dilute their overall holding.
When asked this question in the recent con call, the management clarified that some promoters in the past opted to discontinue being labeled as promoters while remaining as shareholders. They are confident that the promoters will continue to support the company if needed. However, low promoter holding will remain a risk, not necessarily for this deal, but over the long-term.
Turnaround Plan
As per the management:
- Everything will be under a single organization.
- Focus on restructuring underperforming sites and plants, and increasing efficiencies by reducing manufacturing and procurement costs.
- No significant potential contingency liabilities. Pension liabilities are there, but that is accounted for.
- Efforts will be made to regain previous clients.
- Reducing SG&A, especially in the first year of the deal.
- Other cost optimization areas include high IT costs, with back-end operations like finance, insurance, and IT being streamlined.
- Lean and efficient organization (job cuts?)
- Speciality products to continue to be manufactured globally. Commodity products will be moved to India.
Is it a good buy now?
Probably, yes.
Sudharshan’s FY24 revenue is at 2,500 Cr, and post-acquisition, we expect the Heubach Group to add an additional 6,000-7,000 Cr. Let’s conservatively estimate 5,000 Cr, as there could be some risks like old clients not coming back, restructuring issues, or other integration hiccups.
That means we are looking at an estimated 8,000 Cr in revenue for the full year FY26. Margins will be under pressure for the initial 1-2 years due to the merger challenges. However, the management has guided EBITDA margins to be around 12-15%.
If we estimate FY27 revenues at about 9,000 Cr, with a conservative 10% margin, we are looking at an estimated EBITDA of around 900 Cr, which is a 3x jump from the current levels over three years. At a 7,500 Cr current market cap, it seems like not everything is factored in, as the market is uncertain about the management’s execution capabilities.
Did they bite off more than they can chew?
Too early to say. But it’s not going to be an easy ride for the management.
In general, big deals—especially overseas acquisitions—come with their own initial struggles. We have seen this with several examples in the past, like Chorus Steel, JLR, GMM Pfaudler, etc.
It’s not always about the debt; it’s also about the management bandwidth, product transition, dealing with local authorities, existing setups, manpower, and bringing customers back. It’s definitely an uphill task for Sudharshan’s management. If they can pull it off, it will be commendable and could create significant value for shareholders over the next 3-5 years.
To summarize
The good:
- Post-deal, Sudarshan will hold the #2 market share in the pigments segment globally
- Value capture from the deal will start within a year, but the full benefits will be visible in 2 years
- No pension or other major contingency liabilities
- No further growth capex is planned in the near future
- If everything works out, there’s a potential for 3x revenue growth and 3x EBITDA growth in about 3 years
The not-so-good:
- Leveraged balance sheet
- Handling 17 overseas plants and other integration hurdles
- Sudarshan’s domestic business is still going through a cyclical downturn
- Low promoter holding (30% as of now)
Disclosure: Sudharshan Chemicals is a part of our Capitalmind PMS Portfolios. This article is intended solely for informational purposes and should not be considered as an investment recommendation.