Can disinvestment be strategic too?

D Sampath Kumar

WHAT is a strategic investment? Going by corporate announcements, just about any investment a company claims is 'strategic' would appear to be so. But if one assumes that acquisition of a substantial stake is a pre-requisite for the investment to be labelled 'strategic', one could not be more wrong. Sometimes, an investment as small as five per cent of the paid-up capital of a company has been declared 'strategic'.

Of course, such a declaration has been particularly useful to an investor in assuaging incumbent management's fears about the acquirer's intentions. Thus, even if the investor has picked up stake with long-term plans of taking over management control, it is customary to declare at the outset that it is purely strategic, implying that they have no designs on the target company.

But what of acts of disinvestment? Could they also signal strategic intent? The example of Reliance Industries exiting last week from Larsen and Toubro, a company in which it made the initial investment back in the late 1980s and one, that it carried in its books for as long as 13 years or so, offers an interesting case study of strategic possibilities from an act of divestiture.

Reliance Industries' decision to divest, in favour of Grasim, its stake in L&T could potentially confer on the former the status of a preferred suitor for the Aditya Birla group's stake in Mangalore Refineries. It is no secret that the Birlas have been wanting to exit the refinery project on the South-West coast.

For one, the company isn't doing too well _ its losses are quite substantial, even by the standards of standalone refineries. Again, after de-bottlenecking the refinery, its enhanced production capacity of 10-12 million tonnes would still make it only a marginal player in an industry where large size and downstream marketing infrastructure are the key success factors. The Birlas' decision to exit the venture, made official nearly nine months ago, has nevertheless not been consummated.

The reason why the Birlas could not offload their stake has to do with the nature of arrangement it had with its co-promoter, Hindustan Petroleum Corporation (HPCL). In terms of the agreement with it, the Aditya Birla group had to offer the stake first to Hindustan Petroleum Corporation (HPCL). But HPCL has been unable to either decide on the acquisition itself or the price.

Consequently, the deal has been hanging fire since March 2001. The Petroleum Minister has now promised an early resolution of the dispute. But it is anybody's guess how long the dispute would linger.

As a public sector company, it would be unwilling to offer a premium to the current market price. The minister wouldn't direct the company to do otherwise for fear that the opposition would latch on to it to allege malafides. At the same time, HPCL cannot for long deny the co-promoter (the Aditya Birla group) the right to divest its stake in the venture or secure a better price.

For the Reliance group, the Mangalore refinery deal could be potentially of considerable strategic significance. Control of the refinery opens up the Southern market for the group, in an era post-decontrol, in the petroleum industry. Mangalore Refinery is also a stake holder in the company that will control the Mangalore-Hassan-Bangalore product pipeline, thereby giving an extra edge to the marketing infrastructure of any player in this industry.

Should Reliance also succeed in winning the IBP disinvestment bid, the company's marketing muscle in the South would reinforce a manufacturing base in that region. Of course, all this is going to cost money. But the war chest that Reliance has always been to command has only got a booster dose of Rs 750 crore with its exit from L&T.

The situation, thus, has all the ingredients of a win-win proposition. The immediate outcome of Reliance's decision to exit L&T has been the vaulting of Grasim from a leading player in the cement industry to the position of number one and, that too, by an overwhelming margin. This is no mean advantage as it can position itself even more aggressively to bid for existing capacities controlled by a number of smaller players.

Smaller players have really very little choice in the matter. At some stage they would have to exit from the business as the market power of the larger and geographically diversified players in the industry would be too much for most of them to cope with. If the situation is thus tailor-made for Grasim to become a manufacturer of global size, then the defining moment in this saga would quite clearly be the acquisition of ownership control of L&T. And that would be courtesy the Reliance Industries.

Will this scenario hold good? It just might. Consider the evidence. Reliance claims it no longer needed to stay invested in L&T as the original purpose for which it was acquired the stake is no longer valid. The company has said that at the time it invested in L&T, it had a clutch of projects to implement. Since then, it has invested close to Rs 36,000 crore in various projects and has thus reportedly acquired project management capabilities of its own.

The two statements taken together suggests that its original intent was to leverage L&T's project management capabilities (with or without direct management control) for its own projects in a manner that would go beyond a supplier-customer relationship. But now that it has acquired such capabilities on its own, it says it no longer needs to stay invested in L&T. It cannot be that such a realisation _ that its strategic purpose has been achieved _ has dawned at exactly the same moment that Grasim wanted to buy out its stake.

Had this realisation dawned at any time before the deal had been concluded, it would have served the cause of superior corporate governance (had Reliance taken investors into confidence about the changed circumstances). More so, when you consider the fact that the deal had such immense profit potential (a capital gains of Rs 360 crore is an emphatic proof of that) for the company. It would be more appropriate to view this deal as an extension of a continuing strategic intent.

The tale might well have an interesting twist. When all the heat and dust settles down, Grasim might well decide that its interests are not best served by hanging on to the engineering business of L&T, which is what the company started with in the first place. Then who better placed than Reliance to make a bid for that business?

Grasim is also better placed to use the creeping acquisitions route to beef up its stake as its acquisitions would not be tainted by a controversial past, as a similar approach by Reliance might have been. So, when its share of the engineering business is divested in favour of Reliance, the latter's stake would be far higher than what it held prior to the latest divestment. What is more, it might remerge as in effective control of the company washed of all stigma from its earlier misadventure.