CMC: Byte into it

Recommendation: Accept

Krishnan Thiagarajan

TATA Sons is coming out with an open offer to acquire 16.69 per cent of the equity capital of CMC at an offer price of Rs 281.26 per share.

This open offer follows the share purchase agreement entered into by Tata Sons, the principal holding company of the Tatas to acquire a 51 per cent equity share of CMC at Rs 196.73 per share.

The government shareholding, pursuant to this acquisition stands reduced to 32.31 per cent. CMC supplies hardware and software products, installation and commissioning of systems, software development and system engineering. It has a strong domestic market presence, R&D capability and systems integration expertise in key sectors of the economy.

Existing shareholders of CMC should accept the open offer for three key reasons. First, as the offer price represents a healthy 43 per cent premium to the negotiated price paid by Tata Sons to the Government, tendering to the offer makes eminent sense. Taking the SEBI Takeover Code formula, the average of the 26 week price at Rs 281.26 was fixed as the offer price as it was higher than the negotiated price of Rs 196.73 per share. The shareholders stand to benefit as the offer price happens to be higher than the negotiated price paid by Tata Sons to the Government.

Second, from an operational perspective, the restructuring of CMC's operations under the Tata Sons management may take some time (of say, six months to a year) to take concrete shape and start yielding results to the bottomline.

In the offer document, Tata Sons has indicated that "Tata Sons plans to explore possibilities for restructuring and/or rationalisation of businesses/assets of CMC which may include but not be limited to disposing off or otherwise encumbering its assets in the ordinary course of business..."

*Prima facie, an examination of business segments targeted by CMC and group companies under the Tata banner reveal a couple of overlapping businesses. These businesses are - "software development" in which Tata Consultancy Services is a major player and "systems integration" in which Tata Infotech is a key player.

With such an overlapping business profile, there is a possibility of extensive realignment and restructuring of business within CMC and the Tata group.

In any case, it will take a while for Tata Sons to streamline and remove the key weaknesses of CMC such as weak marketing network, poor human resource policies and refocus it on its key strengths such as third-party maintenance and strong R&D efforts.

Finally, at the current offer price of Rs 281.26, the price earnings multiple of CMC works out to 15 times the annualised per share earnings of Rs 19.15 for 2000-01. With operating profit margins at 9 per cent in 2000-01 and around 13 per cent in the first half of 2001-02, and relatively low net profit margins *vis-a-vis the frontline and medium-sized software companies, the CMC stock appears fully valued at Rs 281.26.

Shareholders may use the opportunity to exit the stock through the open offer route and re-enter at declines depending on the course of the restructuring put through by Tata Sons. As the current market price of CMC has run past the offer price, shareholders may contemplate selling the stock first in the open market. If that fails, the shareholders can tender to the open offer.

The offer opened on November 27, 2001 and closes on December 26, 2001. The lead manager is DSP Merill Lynch.