| Oct. 5 - 18, 1998 |
Grasim Industries
Ashapura Minechem's Open Offer
Grasim Industries
Is consolidation enough?
For benefits from the merger of the cement business to percolate down to the bottom line, a further restructuring is required
Every promoter is bothered about his company's market capitalisation. And why not? A decline in market capitalisation amounts to a decrease in wealth. Young Kumar Mangalam Birla, chairman of the A V Birla empire, too, was worried when he saw the market capitalisations of his flagship companies - Hindalco Industries, Grasim Industries and Indian Rayon - dwindling on the bourses, with no end in sight to the southward journey of their share prices in the last few years. More recently, the three companies' combined market capitalisation declined to near Rs 5,800 cr from Rs 8,500 cr at end-Mar.'98. No doubt, the slide in commodity prices due to the downturn of the commodity cycles did its bit to depress the market capitalisations of the Birla companies, but, scrips of peer companies with a similar quality of management were trading at better PE multiples.
The problem was quite serious. Consequent to his meetings with the country's top fund managers, Birla found the answer to his worries - focus. With global valuation norms being applied to domestic corporates, thanks to the influence of foreign investment institutions in the country, fund managers advised Birla to focus on core competencies as globally diversified companies are less fancied than those with a clear focus. They stressed on the bringing together under one roof the cement businesses of Grasim and Indian Rayon. This would achieve synergy for the cement business, one of the group's core competencies.
Last fortnight, bowing to pressures from the stock markets, Birla finally announced his decision to consolidate the cement businesses. The plan : Indian Rayon will transfer its cement business as a going concern to Grasim, by way of a scheme of demerger. And Grasim, in turn, will issue 3 shares/GDRs for every 10 shares/GDRs of Indian Rayon.
Will the market now enhance the valuation of A V Birla group scrips on the bourses? Though the market's immediate reaction to the decision to merge the cement businesses has been enthusiastic, with Grasim hitting the upper circuit breaker on the BSE the very day next after the announcement, the upsurge proved short-lived as both scrips declined subsequently. The high volatility in these scrips has also indicated that much more needs to be done for the benefits of the consolidation to percolate down to the bottom line.
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Supply overhang
Major capacity expansions in cement
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Company Location Capacity Date of
(mln t) commission
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L&T Pipavav, Guj. 1.75 Apr.'96
Jaiprakash Ind. Rewa, MP 1.5 Aug.'96
DLF Cement Rajasthan 1.5 Jun.'96
Binani Zinc Sirohi, Raj. 1.6 Mar.'97
Total for 9703 12.15
Prism Cements Satna, MP 2.1 Jun.'97
L&T Pipavav 1.75 Mar.'98
Total for 9803 5.75
L&T Tadpatri, AP 1.75 Apr.'98
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The question arising is: In what ways will benefits accrue post-merger? As parts of the A V Birla group, both Grasim and Indian Rayon's cement businesses, under common control, are effectively under one roof when it comes to tapping local markets. Says Anil Singhvi, treasurer, Gujarat Ambuja Cement, 'I don't consider it as a consolidation. The two companies belong to the same group.' Often, there are wide variations in cement prices between various regions due to regional demand-supply imbalances. Manufacturing units located in proximity to consumption centres have a definite advantage as costs of transportation of cement, which are quite substantial, are saved. In fact, regional forces are what which come to the fore when the cement industry is in its downturn, as is the situation today.
With cement being a volumes business, economies of scale are vital, and hence, for the merger to pay dividends to Grasim, overlaps in marketing as well as administration have to be done away with. And the sooner it is done, the better it is, as it will strengthen economies in purchase, research, process development and management. Birla's announcement that Grasim's cement division would be under the charge of a single person, M C Bagrodia, and C P Jajoo as manufacturing head and O P Puranmalka as head of marketing of the division would report to him, augurs well and is a step in the right direction.
A sharper focus on cement could be achieved by separating the cement business from the textile business of Grasim, feel some analysts. Though the creation of a separate cement company for the A V Birla group was also one among the options which were considered before arriving at the decision to demerge the cement business of Indian Rayon in favour of Grasim, the same, according to Birla, would have entailed high transaction costs and would not have provided access to the much-needed cash for future growth in cement, and, hence, this option was struck out.
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Takeovers as against expansions in cement
Greenfield project*
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EV EV/Ton
(Rs cr) (Rs)
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Without jetty 450-475 3,600-3,800
With jetty 550-575 4,400-4,600
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* Estimated for a 1.25-MTPA capacity
EV/ton: Enterprise value per tonne
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Acquisitions
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Target Acquirer Capacity (MTPA) EV/Ton (Rs)
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Raasi India Cements 1.80 3,217
Yerraguntla India Cements 0.40 4,950
Visaka India Cements 0.90 3,111
Dharani Grasim 0.90 3,222
Wt. avg. 3,367
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Besides having a leadership in the domestic market, Grasim's VSF division is also its cash cow. Moreover, it has recently completed a major expansion of capacity in VSF with the commissioning of a 60,000-tpa greenfield project at Kharajh in Gujarat. VSF and cement will together account for 80% of sales and over 90% of profits, after the current consolidation of the cement business in Grasim.
As for cement, Grasim has been in trouble for some time now because it has concentrated on markets in Madhya Pradesh and Rajasthan, which are cement surplus regions. Indian Rayon's thrust, on the other hand, is in the high- growth market of Karnataka where realisations are much higher. This will provide a breather to Grasim after consolidation. Grasim will also benefit from Indian Rayon's Birla White brand which is the market leader in white cement. With a total of seven brands under its fold, Grasim can ride piggyback on multiple-brands in a sluggish cement market. Says Ved Prakash Chaturvedi, senior vice president, investment, SBI Mutual Fund, 'Tapping local markets with multiple brands will be easier because the units are spread all over the country.' Grasim will have a presence in six states, compared to only two now, considering the locations of the cement manufacturing units of the two companies.
However, with no overlap in the manufacturing units of the two companies in any state, the consolidation, as such, will not impart any pricing power to the group in any region. This is unlike companies like India Cements and Gujarat Ambuja Cement which derive pricing powers in the south and Gujarat respectively, due to their strong presence in these regions. India Cements' recent acquisition of Raasi Cement has further strengthened the former's position in the southern markets. Birla, however, is quite confident of synergy gains accruing to Grasim after consolidation. 'The consolidation of the two businesses eliminates the conflict of interest between the cement undertakings of the two companies for shareholders. Importantly, it will also bring in significant synergy gains, estimated at approximately Rs 15- 20 cr a year in the short term and potentially up to Rs 30-40 cr over the long term, resulting in a significant enhancement in earnings,' he avers.
The merger of the cement businesses of the A V Birla Group, nonetheless, is in keeping with the trend of consolidation of capacities in the cement industry. Sluggishness in the industry has triggered acquisitions and mergers in the recent past for expansions of capacities, rather than the setting up of more expensive greenfield projects (see table : Takeovers as against expansions in cement). With excess built-up capacity and oversupply, and with the resultant pressure on cement prices continuing to affect the industry, acquisitions also mean that no fresh capacity is created, and the oversupply situation, to that extent, is not accentuated.
With demand boost unlikely in the near future (cement companies expect a stable 8-9% demand growth in 9903) and oversupply continuing, many more acquisitions and mergers are expected in the coming months. Says a senior official of ACC, 'Consolidation in the cement industry is a welcome development, in the sense that few players will be commanding the market in future.' Leading cement companies like Larsen & Toubro and Gujarat Ambuja Cement have already indicated that acquisitions will be their preferred route for future growth.
With consolidation in the industry, a handful would emerge as top players, on the basis of their total capacity. And for the top players, consolidation will eventually translate to pricing power, with each one having its own hold over a region.
Birla's decision to merge the cement businesses is also seen by many as a move aimed at enhancing valuation of scrips of group companies on the bourses, so as to tap the market effectively to raise funds for Hindalco Industries, which has mega expansion plans on the anvil. But for this, an improved investor perception of the group is a must.
To improve the valuation of the A V Birla group scrips, financial interlinkages in the form of cross-holdings should be done away with. Various companies belonging to the A V Birla group have holdings in group companies as trade investments. A separate trust or a holding company could be set up for this purpose.
Meanwhile, with the single largest revenue earner, ie, the cement division (9803 sales : Rs 820.72 cr), being hived off from Indian Rayon, without any cash accruing to the company, analysts are skeptical about the company's future growth potential. Their concern is also due to the fact that its other businesses like VFY, carbon black and insulators, are relatively smaller businesses and some of them (VFY, carbon black) are witnessing a donwturn. Birla however continues to maintain that all the businesses of the company would continue to grow and provide earnings enhancement.
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9803 Actuals 9803 Reworked*
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Gross sales 4022.59 4843
PBDIT 698.45 866
Equity 72.31 92
Debt-equity 0.6:1 0.7:1
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* Estimated figures after consolidation of
cement business
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9803 Actuals 9803 Reworked*
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Sales 1817.02 1000
PBDIT 428 261
Equity 67.48 67.48
Debt-equity 0.5:1 0.4:1
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*Estimated figures after demerger of cement
business takes effect
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But the acquisition of Indian Rayon's cement division could prove to be quite enticing for Grasim. With Indian Rayon's cement business under its fold, Grasim's 9803 sales shoots up by 20% to Rs 4,843 cr from Rs 4,022 cr. The profitability rises even higher as its PBDIT goes up by a whopping 24% to about Rs 866 cr from Rs 698 cr, with further potential for increasing profitability. And all this without paying any cash, but by issuing about two crore additional shares to shareholders of Indian Rayon.
Since the issuance of additional equity shares by Grasim to Indian Rayon's shareholders would dilute the A V Birla group's stake in Grasim to 20% from the current 22%, the group has decided to maintain its holding at the existing levels through open market purchases. This is expected to nullify the adverse impact on Grasim's share price which could arise in the short term because of the expansion in its equity. In the long term, the Grasim scrip appears attractive from the investment point of view, considering the strong growth prospects. Any decline in share price would provide a good investment oppourtunity.
On the other hand, the Indian Rayon scrip could witness selling pressure once the record date for issuance of Grasim shares to Indian Rayon's shareholders expires. For, in the absence of the cement division, Indian Rayon's 9803 sales declines substantially to Rs 1,000 cr from Rs 1,817.02 cr, while PBDIT plunges by 39% to about Rs 261 cr from Rs 428 cr. Without any reduction in Indian Rayon's equity, the company's historical earnings (9803 EPS : Rs 31) decline substantially. However, Birla's announcement that Indian Rayon would buy back 15-20% of its equity after the current restructuring is likely to check a major slide in the scrip.
But as Indian Rayon's shareholders will get Grasim's shares as consideration, any increase in the Grasim stock will also benefit Indian Rayon shareholders. Nonetheless, while Grasim shareholders would do well to hold the scrip, Indian Rayon shareholders may consider booking profits.
Ashapura Minechem's Open Offer
For the heck of it
The offer for sale to reduce promoters' stake at Rs 170 per share against the market price of Rs 80 is ridiculous
Here is an offer for nobody. Still, it's being made because it has to be. The promoters of Ashapura Minechem (AML) are offering a part of their stake to the public so as to comply with the requirement of diluting their holding to less than 60%, in accordance with the Rule 19(2)(b) of the Securities Contract (Regulation) Rules, 1956. Nothing wrong in the intention. The hitch, however, is in the pricing of the offer. The promoters are offering their shares at a steep price of Rs 170 per share as against the market price of Rs 80 per share.
A recognised export house, AML manufactures bentonite powder, bentonite processed lumps, processed barytes and salt which find applications in the petroleum sector. They are critical inputs in oil pelletisation, oil well drilling and foundry. AML's factories are situated at Bhuj-Kutch in Madhapar village and Ler village in Gujarat. It holds /controls quarry leases for bentonite mining covering an area of 478.57 hectares in Gujarat.
The company has a formidable presence in the export market as well. The exports have risen from Rs 7.78 cr to Rs 40.05 cr in the last five years. AML accounts for over 80% of the country's total shipment of bentonite to the global markets.
The company went public in Jul.'93 with an issue at a premium of Rs 40 per share aggregating Rs 3 cr. It declared a 1:1 bonus issue in Dec. '95. As on Aug. '98, the outstanding equity capital is Rs 5.99 cr, of which 78.55% is controlled by the promoters and their relatives. At present, retail investors hold around 16%, government companies 1.82% and mutual funds 3.09%.
The promoters are making the public offer with the main objective of reducing their stake in the company from 78.55% to 60%. This, claims the company, will enable it to comply with the listing requirement that at least 25% of the equity shares be listed on exchanges. Regulations do not permit promoters of a listed company to hold more than 75% of the equity because low floating stock is subject to manipulation.
For the promoters, the proposed offer for sale of 12 lac shares could bring in a bonanza - a cool Rs 20.40 cr! This, without any corresponding benefit to the company or its existing shareholders. But, the question is, who will subscribe to shares that are being offered at a whopping premium to the current market price? Interestingly, the offer price is also much higher than the scrip's 52-week high of Rs 89, and its all-time high of Rs 135 (adjusted for 1:1 bonus) in 1995. In its heydays in 1995-96, the stock was a favoured pick, but it's a different story now.
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AML's financial performance
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(Rs cr) 9803 9703 9603
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Total Income 77.57 66.79 51.51
Interest 2.34 2.41 1.18
Depreciation 0.53 0.42 0.36
PBT 8.35 7.00 6.02
PAT 8.15 7.00 6.02
Share Capital 5.99 5.99 5.99
Book Value (Rs) 52.28 42.04 49.92
EPS (Rs) 13.03 11.33 10.00
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Ludicrous Reasons
AML's promoters are asking for a higher price because..
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* It is India's largest producer of bentonite
* It is managed by promoters with rich experience in the bentonite field
* It has won certificates of merit from the Union commerce ministry for
outstanding export performances in 9203 and 9403
* It has a marketing agreement with Mitsubishi Corporation
* Its shares are already listed on Mumbai, Ahmedabad, Chennai, Delhi and
National Stock Exchanges
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Aware of the fact that nobody would subscribe to the issue at such a premium, the company lists some 'funny' reasons to justify the same (see box: Ludicrous reasons). The company's financials are too 'usual' to justify the 'unusual' offer price. For the year ended 9803, AML recorded a net profit of Rs 8.15 cr on a turnover of Rs 77.57 cr. On an equity of Rs 5.99 cr, the earnings per share (EPS) works out to Rs 13.04. As on 9803, the company's book value stood at Rs 52.58. Market players feel that these financials are very moderate for such a high offer price.
The company feels that the value of its share could be as high as Rs 207.53 on the basis of its earnings / performance for the last five years, implying a P/E ratio of 16. Against this, currently, the AML stock trades at Rs 81, at a P/E multiple of 6.13. The funniest part is that AML's fundamentals do not change post-offer because the proceeds will go to the promoters' kitty.
The promoters had been postponing the dilution in stake, with due permission from the finance ministry because of poor market conditions. However, the ministry's decision to avert a further delay in reduction of promoters' stake has forced the promoters to sell their holdings even in this poor market. However, their strategy seems to be of procrastinating the issue till the market revives so they get a good price when they offload their holding.