The Longest Ride.

     Four – decade old Apollo Tyres is in a sticky situation. Struggling to regain the market’s favour after a $2.5 billion bid for Cooper Tire was punctured over a year ago and following a dismal third quarter performance in the recently concluded fiscal, the stock has taken a beating in the recent past. Urging its investors to hang on, the management continues to reassure them that not all is lost and that Apollo, much like its Greek namesake, would once again shine bright.

     In the larger scheme of things, the broader markets continue their upward trajectory, inching firmly past each new resistance zone. Intermittent bouts of volatility do ensue but the markets continue to trend higher, driven by pharma and consumer stocks that are in the limelight. Laggards like Apollo Tyres are often left biting the dust. Yet, Apollo harbours a secret, one that soon promises to reverse the stock spiral and take the company back to the glory of its heyday.

     Apollo Tyres and the Indian markets. Two entities, separated by years and expectations, yet whose ticker trajectories are about to be converged and united by fate, in the most unexpected – and bullish – of ways.

     If the above description struck you as being suspiciously similar to the teaser of a recently released flick, well, you certainly aren’t in the wrong. And Apollo Tyres’ journey over the past few years has been nothing short of a thriller, to say the least. The Gurgaon – based company and India’s second largest tyre major, which was largely an India – focussed entity, made its early foray into the global market by acquiring Dunlop’s African operations, with its masthead in South Africa, in 2006. While Dunlop gave Apollo a toehold in several African and some European markets, the bulk of its topline still stemmed from India.

     Three years later, even as the world was reeling from the financial crisis, which had dealt a severe blow to the automobile industry and in turn, the global auto ancillary and tyre producers, Apollo made a bold move and scooped up the Dutch company, Vredestein, which was a subsidiary of the bankrupt Russian giant, Amtel - Vredestein. While the markets questioned Apollo’s move of entering a depressed and stagnant European radial market, Apollo’s move on Vredestein was executed with an intention of giving it an entry into several lucrative European markets, which offered fatter margins than those that Apollo could earn back home in India. Vredestein also enabled Apollo to add marquee clients such as Porsche. Apollo had sealed the Vredestein deal at an attractive valuation and it intended to use its newly – acquired European arm to bolster both its topline and bottomline.

     While Apollo was making forays into markets around the world, it certainly wasn’t ignoring its home turf, where the action was beginning to heat up. India, after all, was and still happens to be the second fastest – growing automobile market in the world and that growth would also spur the auto ancillary and tyres sector. While Apollo was firmly in the lead in the commercial vehicles segment, it trailed its Chennai – based rival, MRF and Goodyear in the passenger vehicles segment and Ceat in the two – wheelers space. A year or two post 2008, while the passenger vehicles segment had begun to grow again at a single – digit rate and the two – wheeler space was already clocking a double – digit growth rate, the commercial vehicles segment was still in the doldrums and even clocked negative growth for five years on the trot.

     Today, the situation is little different. A quicker lift – off in the two – and – four – wheeler segments has seen MRF and Ceat grow faster than Apollo. While MRF leads in India, with a 29% market share, Apollo stands at around 22%. The Indian economy’s growth of around 7% is seen as a harbinger for a pickup in the CV segment, which happens to be Apollo’s bread – and – butter business in India. Apollo has been trying to compete with Ceat and MRF in the two – and – four wheeler segments but it continues to trail its peers. At the same time, it has been investing in ramping up capacity at Vredestein and in its African operations. Apparently, Apollo’s penchant for a global play hadn’t seemed to have dwindled, despite the doom and gloom that shrouds the West. And it was precisely this penchant that led to the Apollo – Cooper Tires saga in 2013.

    

     While Apollo already had a presence in Africa, Europe and India, its negligible share in the American market stood out like a sore thumb. The USA, not entirely unlike Europe, offered higher profit margins than most of Apollo’s other foreign markets, despite clocking a low rate of volume growth. And Apollo harboured ambitions of transitioning from being a me – too player in the global pecking order to emerging as a global behemoth. Being the seventeenth – largest player in the global industry just wasn’t good enough for Apollo.

     In May 2013, Apollo announced that it was acquiring Cooper Tires for $2.5 billion, an acquisition which was expected to catapult it to being the world’s seventh largest, in its sector. Cooper was also Apollo’s avenue of entering the American and Chinese markets and the company had lined up debt funding to see the deal through. Apollo had structured the Cooper deal on the lines of a leveraged buyout (LBO), with a large chunk of the debt intended to be serviced by Cooper’s cash flows and only $400 million or so falling on the Indian parent. The deal was expected to create value for shareholders on both sides of the transaction. Or so Apollo thought.

     The markets, however, were not impressed by Apollo’s bold and brash move. Many felt that Apollo was overpaying for Cooper. Over the course of two days, Apollo’s stock tanked from a level of around Rs. 90 to Rs. 56, over concerns that Apollo was loading its balance sheet with excess debt and that its cash flows weren’t robust enough to service the ballooning interest payments. Apollo’s top brass, however, was going full steam ahead in its endeavour to seal the deal, despite the strong market opposition. Soon enough, it began to run into trouble from some unexpected quarters.

     Cooper’s trade unions were united in their stance of voting dead against Apollo stepping into the driver seat at Cooper. Apollo sought more time to make concessions to the labour unions and then sought a reduction in the deal value as a consequence. If that wasn’t enough, Cooper’s Chinese JV partner, the Chengshan Group, strongly opposed the merger. With Apollo attempting to negotiate a truce, Cooper refused to accept a lower valuation and accused Apollo of dilly – dallying. Cooper even went as far as suing Apollo. Eventually, the two sides failed to bury the hatchet and Cooper terminated the stake – sale agreement.

    

     With Apollo having walked away empty – handed from its tango with Cooper Tires, the markets expected the company to focus on organic growth, for the foreseeable future at least. But Apollo, in its typical swashbuckling style, didn’t seem like it had any intentions of toeing the line. Apollo still hungered for size and scale, coupled with a desire to break into the top echelon of the global tyre – makers. After a year of lying low, Apollo made an unexpected appearance on the M&A scene. With MRF on the verge of signing a deal to acquire Kesoram Industries’ solitary tyre production facility in Uttarkhand, Apollo made a last – minute entry out of the blue and triggered a bidding war with MRF. Both MRF and Apollo were eyeing the large plant, which would give the acquirer a distinct edge over its peers in the North Indian market. With each party attempting to outbid the other, the deal valuation soon reached an astronomical level of Rs. 2000 – odd crores. With a valuation of that sort, the only entity that would benefit is Kesoram but Apollo’s optimism – or aggression – may be an all – out attempt to engage MRF in a slugfest.

     In recent times, Apollo’s scrip has had a terrible run at the bourses, vastly underperforming the broader markets and its peers. While MRF, Ceat, JK Tyre and Goodyear have raced ahead, Apollo has lost its treads and contracted over the past twelve months. A large part of Apollo’s recent 30% crash came on the back of its decision to shutter its Durban plant and exit direct production in South Africa. Apollo had decided to adopt a trading operation in the country instead. In 2013, Apollo had sold one of its South African plants to Japan’s Sumitomo and its recent move completed the shift from a production operation to a trading model in the rainbow nation. Apollo undertook a one – time write – off, which dented its consolidated results and if that wasn’t sticky enough for the markets to digest, Apollo’s topline shrunk from Rs. 3400 crores in the corresponding quarter of the previous fiscal to Rs. 3000 – odd crores. The Q3 debacle resulted in Apollo’s scrip tanking from a level of over Rs. 250 to a low of around Rs. 160. While Q3 may have been a one – off nightmarish quarter, the company would have to beat market estimates in the upcoming quarters to regain the markets’ favour. Apollo has also announced that it has started work on a new plant in Hungary, which should crank up by 2017. Moreover, the company is most certainly on the lookout for any possible acquisitions that come its way, given its hunger to take the inorganic route to accelerate growth. Additionally, in a bid to increase visibility in Europe, Apollo has signed on as the ‘official tyre partner’ of Manchester United.

     Apollo’s overdrive, however, may not be devoid of logic. While the company may be raising the stakes for now, it certainly happens to be in a sweet spot. Its two largest inputs are crude oil and rubber, commodities which have been the talking points of the markets as of late. While crude oil has fallen from its $115/bbl level to a range of around $60/bbl, rubber prices are at their five – year lows, on the back of a glut in the East Asian markets. While Apollo’s production costs have fallen, tyre price cuts have not been executed across the board and the company’s margins have been on the rise as of late. Moreover, both the passenger vehicles and commercial vehicles segments are slowly gathering pace and are likely to accelerate in the years to come.

     Over the past few years, Apollo has been looking to derisk its business and increase its market share in the passenger car segment, which does offer a larger customer base and higher profit margins. Apollo has also become a major player in the tyre replacement market, which is growing at a quick clip. This segment, however, is far more lucrative than Apollo’s supplies of new tyres to automakers, which largely rides on bulk discounts. On the global front, Apollo and other tyre – makers, for that matter, are witnessing increasing competition from Chinese tyre – makers who are using the crash in input prices to their advantage and flooding the Western markets, leading to price wars across the board. The wave of consolidation in the industry, such as ChemChina’s recent buyout of Pirelli, is another factor to contend with. Barring the Chinese quagmire, the industry’s outlook seems to be optimistic for now. Apollo’s profit margins and returns on capital have been displaying a steady uptick in recent years and with both crude oil and rubber prices near their all – time lows, a situation which could prevail in the medium – term, the company’s smooth cruising is likely to continue.

     As far as the Apollo stock angle goes, the scrip is trading at an attractive valuation of around 9 times earnings, a steep discount when compared to peers such as MRF and Goodyear. And Apollo happens to be one of the few stalwart companies out there that have an impressive return on capital in the range of 20% and a market capitalization less than its topline. The oddity is that while Apollo’s valuations were comparable to those of MRF and JK Tyre around six months ago, the drop has largely come about, following Apollo’s disastrous Q3 results. One bad quarter, however, does not a future make. Moreover, the recovery wave in the global automobile industry is bound to lift Apollo in the years to come. But that’s not all. Fate is all set to deal a card in Apollo’s favour. For, Apollo harbours a little secret, one that promises to ensure that its stock has a smooth, long ride back to its pedestal.

     UFO Moviez, India’s largest digital cinema platform provider, recently launched a Rs. 600 crore IPO, in a Rs. 615 – 625 price band. Despite a slow subscription at the get – go, the IPO was subscribed twice – over on its closing day. UFO, which clocked a topline of Rs. 421 crores and a bottomline of Rs. 46 crores for FY14, is growing at a blistering pace and controls nearly 55% of the digital cinema business in India. With the multiplex sector on expansion mode, new screens are adopting and existing screens are migrating to the digital platform, whence UFO’s growth. UFO’s revenues arise out of the digital platform provided to film distributors for transmitting movies, rentals from exhibitors for their equipment and on – screen advertising. And those revenues are unlikely to go anywhere but skywards for now.

     Where does Apollo Tyres feature in all this, you might ask? Well, Apollo International holds close to a 10% stake in UFO Moviez and there would be a significant amount of value unlocking that would take place upon UFO’s listing. What that effectively means is that once the market takes cognizance of Apollo’s stake in UFO, Apollo’s scrip itself would experience a significant pop – up and considering the markets’ ebullient mood, if UFO debuts at a premium to its listing price, the spurt in UFO’s scrip would be mirrored by Apollo Tyres’ stock as well. And that’s neither a prediction nor a prophecy. It’s more of a spoiler really.

     For now, while all the forces that influence Apollo Tyres in one way or another are aligning in the company’s favour, the company may soon do its tagline’s bidding and go the distance. And while Oona Chaplin and Scott Eastwood’s debut vehicle, with a budget of around $30 million and a disappointing global box – office taking of a little over $40 million, may not have exactly lived up to its name and gone the distance, Apollo’s scrip is showing signs of soon embarking on a rubber – scorcher of an upward move. 

     At the end of the day, as far as Apollo Tyres is concerned, it may just turn out to be its longest ride.