Grasim: Cementing to L&T's strengths

Recommendation:

Grasim & Indian Rayon: Hold

Larsen & Toubro: Pare exposures especially on uptrend

S. Vaidya Nathan

IT IS the kind of deal that some companies make once or twice in a lifetime.

But in choosing its target, Grasim could not have done a better job for a deal of this genre. Three years down the road, the stake in Larsen & Toubro is bound to lead to a focussed restructuring that would be positive for Grasim shareholders.

Grasim has picked up a stake of just over 10 per cent in L&T from Reliance Industries at Rs 306.6 per share, a premium of 48 per cent to the market price. The price tag: Rs 766.5 crore.

Unless it messes up in an unexpected manner or the domestic institutions, which hold up to 50 per cent, refuse to play ball, there is no reason why this deal should not leapfrog Grasim's scale of operations and give it leadership in the cement industry.

The institutions are likely to be comfortable with Grasim. In this context, what does this deal mean for Grasim's shareholders:

Effective control: The stake may be just over 10 per cent only. But with L&T having no clearly identified promoter group, this may be enough to put Grasim in the driver's seat. Expect the company to buy more L&T shares to lift the stake to just less than 15 per cent. But this can happen over a three-year period.

`Strategic alliance' only: Grasim's acquisition of L&T is clearly a long-term play. For a three-year period, it may well be a case of`strategic partnership' or `strategic alliance' for purposes of public consumption. Only such a posturing will prevent an open offer requirement under the Takeover Code. For now, Grasim may take board positions and also initiate ground-level co-ordinated management, especially in the cement business.

`No open offer' crucial: This posturing would not invite the open offer trigger of `change in control'. This has been SEBI's ruling in the Gujarat Ambuja-ACC case. Grasim is bound to use it, as an open offer requirement could up the price tag to around Rs 2,400 crore. This would derail the economics of the deal. A waiting period of three years would give Grasim the chance to position itself as the `promoter' without an open offer.

No hostile bids too: Grasim can play the waiting game comfortable in the thought that a hostile bid for L&T is unlikely. The possible bidders may be only those with an eye on L&T's cement business. They can only be MNCs such as Lafarge, Cemex or Holderbank which are looking for an Indian presence. If they indeed want such a presence magnified by a big acquisition, their eyes may rivet on the likes of ACC or India Cements (to a lesser extent). With L &T, they may not want to get involved as the non-cement businesses which account for 66 per cent of the revenues. They may also be forced to buy out the FIs' stake which could raise the price tag significantly, as it may mean buying almost 100 per cent of L&T's equity. In the unlikely event of such a hostile bid, Grasim can even walk away with a big gain on its investment.

Bonding with L&T's cement: Grasim may have paid the price with an eye on just the cement business of L&T. Overall, the two would have capacity of around 28 million tonnes, close to 26 per cent of the industry capacity. On capacity, efficiency, geographic distribution and brand equity, L&T's cement business offers considerably more `value for money' than what ACC offered Gujarat Ambuja Cements (though this deal too is good for the latter). The combined cement presence would consolidate industry capacity and place in the hands of Grasim and Gujarat Ambuja considerable power to control trends. MNCs would have a lot of running to do to play catch up. This process could be time-consuming and expensive.

No demerger please: The deal may have for all practical purposes put the demerger of L&T's cement business on the backburner. Such an action now will give Grasim only 10 per cent of the cement entity which would go against the grain of the deal. And if 37.5 per cent is not offered to a strategic partner as planned, the demerger may make no sense. Grasim *with industry leadership - is unlikely to go for a partner who would later force its hand to shed control. No MNC may also be interested with Grasim already in the fray and calling the shots.

Merger, but no restructuring: The other side of the equation is the Grasim-Indian Rayon story. A restructuring to create focussed entities in cement and textiles (textiles is spread wide across both companies though they are under one umbrella at the shop/marketing level) has long been expected. This may well get postponed.

Instead, a merger first and a restructuring later with L&T could well be a possibility for two reasons: One, it could lead to a higher promoter holding. This may be important before L &T is ushered into the restructuring game as the group's holding in L&T cement may be substantially lower at slightly less than 15 per cent. Two, it could now further strengthen Grasim's balance-sheet and cash flows. Indian Rayon does not have any baggage now. There would also be the chance to free up more cash by exiting some of its businesses such as carbon black, insulators and Grasim's sponge iron that do not fit with the group's focus on cement and knowledge oriented-businesses.

Cement consolidation: Once the waiting period to avoid an open offer ends, a de-merger of the cement businesses of L&T and Grasim and a merger of the two may be inevitable. During the intervening period, the focus may well be on cutting L&T's debt burden, which was Rs 4,263 crore as of March 2001. What may happen is a pruning of L&T's numerous ventures to free up cash. L&T has 30 subsidiaries/associate companies, some of which may not fit into the long-term scheme of things. When the cement bonding can take place, the textile business restructuring may also happen. This would leave the group focussed on five areas -- cement, textiles/ready made garments, infrastructure, IT and finance.

*L&T's non-cement business: What makes the deal even more favourable for Grasim is the value in L&T's non-cement businesses. In engineering and construction and infrastructure, L&T is the premier player in India and that status may not get altered. Its other businesses such as IT and special product joint ventures also bring considerable value to the table. These make this deal one of the more attractively-priced acquisitions in the cement sector. Given the composite price paid, the pay-back for Grasim would make it worth staying with exposures in the non-cement business as well.

* Financing is no trouble: This deal will not stretch Grasim's financial position much. With some stress on profitability over the next two years likely, it may well be able to bankroll the deal without expanding equity. If it wants to cut debt, it is well-placed to raise fresh equity funds too much of an expansion in the equity base.

Clearly, the positives are many in the deal. The main negative is that shareholders cannot be now explicitly told of plans going forward as it could invite regulatory costs. But this uncertainty is only with regard to timing of moves and not what they may be (whose contours are largely clear). Shareholders in Grasim and Indian Rayon could stay invested while those in L&T should contemplate booking profits, especially using any uptrend.