Novelis finally buys Aleris, but what about the timing?

After considerable delays and regulatory challenges in between, Hindalco Industries, part of the $48-billion Aditya Birla Group, has finally managed to conclude the acquisition of Aleris Corp, the US-based rolled aluminium products maker. But analysts who track the sector think that consummation of the deal, which was first announced back in July 2018, comes at an inopportune time with the global economy staring at a recession in the wake of the Covid-19 pandemic.

On April 14, Hindalco, an $18.6-billion metals company with interests across aluminium and copper, stated that it was closing the deal to acquire Aleris at an enterprise value of $2.8 billion, through its US subsidiary Novelis Inc.. The acquisition is expected to make Hindalco one of the world’s largest aluminium companies with a global footprint across North America, Europe, and Asia.

The problem is that the reasons for which Aleris appeared an attractive bet back in 2008 stand somewhat diluted at present. This is majorly on two counts.

One: to placate the US Department of Justice (DoJ), which initiated arbitration proceedings against Novelis in September 2019, the company will have to divest its aluminium rolling mill in Lewisport, Kentucky, and a finishing line for automotive products. The DoJ had a reservation against the deal as it wanted to “preserve competition” in the automotive sector, which is considered an important industry in the US. Novelis was already a strong player in the market for supply of automotive aluminium products (the business accounts for 26% of its product mix); and so is Aleris (where auto accounts for 22% of its product mix).

Apart from the Kentucky mill, Novelis also needs to divest a plant in Duffel, Belgium. This was a precondition for the European Union regulator clearing the deal, while preventing the concentration of disproportionate aluminium making capacity in the hands of one player. Aleris will be selling the plant to Liberty House for $337 million.

Second: The Aleris acquisition gives Novelis an entry into the high-end aerospace segment, where it works with marquee aircraft makers like Boeing, Airbus, and Bombardier. It is no secret that the aviation industry is perhaps the worst hit in the world, along with hospitality perhaps, due to the ongoing Coronavirus pandemic. The Covid-19 outbreak has forced countries to seal their borders and suspend air travel–both domestic and international. As such, the business of the aforementioned aerospace companies is bound to be put on the backburner as airliners suffer around the world.

“The benefit of the acquisition appears significantly diluted without auto assets and bleak outlook for aerospace in the medium term,” says a report by Kotak Institutional Equities. “With earnings hit due to Covid-19, Aleris would increase Hindalco’s net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) from 3.5x to 4.4x in FY21 (estimated). The leverage is manageable but uncomforting in recent times.”

All of this is in addition to the weakness in its own business that Novelis will have to face due to the global Coronavirus crisis. “Covid-19-led lockdowns in the US and Europe have impacted the auto finishing lines of both Novelis and Aleris along with auto OEMs. However, beverage cans volumes and favourable spreads are intact due to stocking demand of beverages during the lockdown. We factor in a 10% volume decline for Novelis, which would mainly come from the high-margin auto segment,” the Kotak report says.

But Aditya Birla Group chairman Kumar Mangalam Birla appears to think that the Aleris buy is of strategic value to his metals empire in the long-term.

“The closure of this deal amidst challenging market conditions reflects our conviction in the Aleris business and its value to our metals portfolio. Periods of turmoil have historically seen the emergence of champions, powered by quality leadership and sound business fundamentals. This is a long-term strategic bet, much like Novelis was in 2007,” Birla said in a statement. “The Aleris deal, crucially enables the further diversification of our metals downstream portfolio, into other premium market segments, most notably aerospace. Through the creation of an industry champion, we are reinforcing our commitment to our customers, employees and shareholders. At the same time, with this further expansion in our aluminium portfolio, we have taken a decisive step towards a more sustainable future.”

The enterprise value (EV) of the deal, as disclosed in the April 14 statement, is a tad higher than the original EV of $2.58 billion that was cited when the deal was announced in 2018. That is because Aleris’ debt has increased in the interim due to higher working capital requirements to ramp up operations. The final EV of $2.8 billion comprises an equity portion of $775 million and around $2 billion of debt that Novelis will either assume or extinguish. There is a $50 million earn-out payment as well. “Despite the increase in legacy Aleris debt, the implied EV multiple of 7.2x, in line with our acquisition case, on account of better EBITDA performance,” Hindalco said in the statement. On a trailing 12-month basis, ending December 31, adjusted EBITDA from Aleris’ legacy standalone operations stood at $388 million, higher than what was estimated when the deal was announced, according to Hindalco.

However, the final consideration for the deal will stand reduced to the extent of realisation from divestment of the plants at Duffel and Kentucky.

On Wednesday, at 1:36pm, Hindalco's share price was up 4.75% on the BSE at ₹119.20 per share, when the bourse’s benchmark index, the S&P BSE Sensex was up 1.42% at 21,126.05 points.