By buying Jaguar and Land Rover for $2.3 billion, is Tata Motors taking on more than it can manage? Will the $3 billion debt be a big burden in future? By Vivek Sharma
'Tata buys into 40 years of trouble' is how a blog on the website of Fortune magazine described Tata Motors' acquisition of Jaguar and Land Rover (JLR). Ever since Ford put JLR on the block and Tata Motors emerged as the preferred bidder last year, commentators and analysts have categorised the deal as audacious, ill-advised, risky, and overambitious. Very few have been willing to give much of a chance to Tata Motors in reviving the iconic auto brands, something which Ford failed but not for lack of trying.
Then came the furious reactions from many domestic commentators on the perceived insults by westerners who feared the devaluation of these brands under Indian ownership.(See:Takeovers and racial prejudice)
Speculation about re-branding, from Tata Jaguar to Tata Land Rover to just Tata Rover, was rife. Someone in London even demanded the British government take control of the Jaguar brand, as it symbolised the best of British traditions!
The rough road ahead
Challenges, real and perceived, surrounding the just announced $2.3-billion deal are many. The Fortune blogger was not completely off the mark when he talked about '40 years of trouble'.
Jaguar, for all its aristocratic and elegant, but understated brand appeal, has indeed been the most troubled of luxury car makers for many decades now. Land Rover has been far healthier by virtue of its products that were segment leaders and benchmarks in the SUV market. But, the worldwide shift from fuel-guzzling SUV's to more efficient cars has clouded the brand's outlook.
Luxury cars may be highly profitable, but the segment is very competitive with several well-entrenched players and prestigious brands. Most luxury car brands are backed by very large auto companies. The Porsche-Volkswagen combine controlling brands like Porsche and Audi, Daimler with its Mercedes range, BMW, Toyota with its Lexus and Fiat with its wide range that includes Ferrari and Alfa Romeo. Tata Motors will really be the pygmy in this group with the least financial and technology resources and experience in managing luxury brands.
The increasing tendency of governments in developed markets to impose stricter emission norms will pose a major challenge to Tata Motors in future. While Ford has agreed to supply engines and provide technology support, sooner than later, Tata Motors will have to develop its own capabilities to build advanced engines, transmission and safety systems to compete on an equal footing with other luxury car manufacturers. Without such capabilities, it will be difficult to distinguish its brands from its competitors' and develop a consumer following.
Tata Motors' biggest strength is its ability to develop and launch products at very low investments, when compared to its global peers. In the past, this has been mostly achieved by ingenious methods like importing a used Nissan assembly line for the the Indica.
The company has been very successful in developing multiple variants on the same platform to exploit market niches while keeping development costs down. Recently, Tata Motors even bought phased-out products from other manufacturers and launched it in the domestic market – like the Tata Winger which was the old Renualt Traffic.
But, these strategies often compromise on product quality and will never work in the luxury car market. Ford realised this after it launched the Jaguar X-Type on the Ford Mondeo platform. That was an absolute disaster for the Jaguar brand, which has not yet completely recovered from that fiasco. Luxury cars should have distinct styling and features, with absolutely no doubts about quality. Only then will the price be less of a concern for potential buyers. That is a new philosophy that Tata Motors will need to adapt to fast.
Can Tata Motors bear the financial load?
Analysing the net assets of JLR, which Tata Motors will get in return for $2.3 billion in cash, for any hidden value is unlikely to be fruitful. JLR has been on the block for well over a year now and many potential bidders must have gone through its balance sheet thoroughly.
Tata Motors would also have made its detailed due diligence and the price which it has agreed to pay must be based on the true worth of JLR's net assets. Besides, the $2.3 billion will be a 'sunk cost' for Tata Motors in accounting parlance and should not receive too much importance.
The JLR assets Tata Motors will acquire are relevant only for their productive purposes or if part of those assets can be divested to raise cash. By all indications so far from Tata Motors, the company will not divest any of JLR assets.
Hence, the only pertinent question is whether Tata Motors can service the additional debt it is taking on to finance the JLR deal. Apart from the $2.3 billion to be paid to Ford, JLR will need investments for product development, facility improvements and marketing. That explains the reported $3 billion Tata Motors has sought from a consortium of banks including SBI (See: SBI, Citigroup, JPMorgan to provide $3 billion for Tata Motors' Jaguar-Land Rover acquisition).
For Tata Motors, the JLR deal is at a time when the company is all set to revamp its entire range of passenger vehicles and is launching significant new products like the Nano. Developing, redesigning and marketing automobiles require a lot of investment, apart from management effort and attention. So, can Tata Motors service additional $3 billion in debt without affecting its domestic product launches?
Based on the numbers for last financial year, Tata Motors is not a highly leveraged company. Its total debt was $1 billion which gave a debt-equity ratio of under 0.6. Interest costs were less than a per cent of total revenues.
When it adds the $3 billion in additional debt, the ratio will obviously change. It is very likely that Tata Motors will have to raise additional capital – either by way of a rights issue or a follow-on public offer – to retire a part of this debt and keep its gearing ratio at a comfortable level.
This will be similar to what Tata Steel did for the Corus acquisition, which was initially financed with debt, a part of which is being retired by raising additional capital.
Cash flows of JLR should be enough to service a major part of the additional interest costs for Tata Motors. Land Rover is profitable and is unlikely to see any major deterioration in cash flows as it has a strong product line-up.
Jaguar is making losses, but is believed to be close to cash break-even after the successful launch of the new XF model. It should not be too difficult for Jaguar to preserve its current financial position until its product line-up is completely revamped. Therefore, Tata Motors doesn't have to bear the entire interest burden on the additional debt.
The risk is if the global economy were to weaken further and demand for luxury cars and SUV's slips, the JLR cash flows will deteriorate and Tata Motors will have to cough up cash generated from its other businesses to service the debt.
On top of it, the company will have to invest heavily in product development – for JLR and the low-cost Tata range. Such a scenario could really stretch the company and it will have to negotiate a difficult phase, like it did after the Indica launch.
Transition to the global stage
If the Nano catapulted Tata Motors to global attention, it will be Jaguar and Land Rover that will really establish the company's global presence. It will be many years before the Nano or any other Tata car becomes a major presence in international markets. But, Jaguar and Land Rover are already global brands and the industry will be keenly watching their fortunes as a Tata brand.
In a sense, Tata Motors is the perfect owner for Jaguar and Land Rover. These brands must retain their distinct identities and persona for survival. Buyers are attracted to a Jaguar because it is distinct from a BMW, Mercedes, Lexus or an Audi. The new XF is a case in point – it is a classic Jaguar but every bit contemporary.
Any of the big car companies would have been tempted to fiddle with their brand identities, if they happened to own them. It is far easier and cheaper to turn out new products by sharing the underpinnings and designs across brands.
Tata Motors will not do it, because it just doesn't have similar products to do so; instead, this inability may well turn out to be a virtue as Jaguar and Land Rover will be allowed to do their own things – at a safe distance from the rest of Tata Motors' businesses.