The Hindu Business Line : Open offer for ACC: Accept; Buy at lower levels

HOLCIM of Switzerland — the world's second largest cement producer — is set to make a splash as it enters the Indian market. By making ACC the focal point of its strategy, it will become one of three major players. This position is in sharp contrast to those of other global majors, such as Lafarge of France and Italcementi of Italy, which have only a modest presence despite being on the Indian scene for several years now.

We had examined the implications for Gujarat Ambuja Cements of its strategic alliance with Holcim (Business Line dated January 23); now we examine what the Swiss major's entry means for ACC's shareholders as the time has come take a call on the open offer.

ACC shareholders may accept the open offer made by the Holcim group and Ambuja Cement India, a part of the Gujarat Ambuja Cements group. At Rs 370, the offer provides an exit point that could be used to capitalise on the premium the stock has commanded for several years as a potential takeover candidate.

We have a positive view on the prospects for the cement sector as well as ACC; the imminent emergence of Holcim as a majority shareholder with a decisive say in management is a favourable development from a long-term perspective. But shareholders should participate in the open offer, taking advantage of the assured price and contemplate re-entry subsequently.

The open offer appears to have ensured a stable trend in ACC's price, even as quite a few cement stocks shed about 10 per cent over the past month. In the post-offer period, the ACC stock could move to lower levels in line with the trends in stocks such as Grasim, Gujarat Ambuja and, to a lesser extent, UltraTech Cement this year. A decline in the post-offer period could be used to take exposures in the stock. Even if the anticipated decline does not materialise, there should be opportunities to re-enter the stock at levels close to the open offer price.

The open offer closes on April 12. The open offer document is available on the SEBI Web site (www.sebi.gov.in). The lead manager is DSP Merrill Lynch. The stock now trades at Rs 365. At least about 45 per cent of the shares tendered are likely to be accepted in the open offer. Any part of your holding not accepted should be retained.

Valuation could slip: In terms of enterprise value per tonne of capacity, the offer values ACC at a discount of about 25 per cent to Gujarat Ambuja and a premium of about 20 per cent to that of UltraTech Cement (owned by Grasim) as also several other cement companies.

Despite its inferior operational parameters, the ACC stock has consistently traded at higher price-earnings multiple compared to those of peers such as Gujarat Ambuja and Grasim. The premium element has been largely due to expectations of a hostile takeover bid. The Ambuja group owned just 14.4 per cent of ACC for close to five years; a hostile bid was a distinct possibility till the strategic alliance with Holcim was forged.

The issue of ownership of ACC has now been settled, even if acceptance level in the open offer is low; this is unlikely, though. The threat of hostile bids has also receded. The ACC stock is likely to be valued at a lower PEM that justifies its fundamentals relative to players such as Gujarat Ambuja and Grasim. The Holcim effect may provide a small premium to the PEM that is warranted by fundamentals.

A significant gap: ACC 's capacity of 18 million tonnes is set to increase by 2.5 million tonnes when modernisation and expansion at its plants are completed. Its efficiency levels are far lower than those of Gujarat Ambuja, Madras Cement and Shree Cement.

These companies have consistently notched up operating margins comfortably upwards of 20 per cent, even in difficult times for the industry, and almost 30 per cent when the going is good. ACC's margins have been in the 10-15 per cent range, though there has been a steady improvement after the Ambuja group picked up a stake. ACC has also become more aggressive in the market.

Spill-over effect from Holcim: The Swiss major's technological expertise is likely to add a few percentage points to ACC's profitability over the long term. Despite this factor, given the vintage and nature of ACC's capacities, its margins are unlikely to match the best in the sector for several years.

A poorer deal for shareholders, but... : Through this open offer, the acquirer seeks to pick up 37 per cent of ACC's equity; this will give Ambuja Cement India — in which Holcim will own 67 per cent — a stake that is a tad in excess of 50 per cent. For such a significant shift in stake levels, the price on offer does not offer a premium of the magnitude that the Tatas pocketed and the Ambuja's are poised to.

The Tatas exited ACC by selling their stake to the Ambuja group at an attractive price. The Ambuja group has structured the deal with Holcim in a manner that ensures an annual return of about 20 per cent; it is also likely to enjoy the benefits of a strategic partnership with Holcim.

For shareholders, the open offer price now is the same as what was paid to the Tatas five years ago. If one factors in the higher stake that Holcim wants to pick up, the relatively lower price on offer becomes clear. But shareholders now have no option, as there has been no hostile bid. No global major would also want to enter the fray for ACC as Holcim will have a sizeable stake even if expected level of acceptance does not materialise.

Life at less than 50 per cent: Even if Holcim's offer does not push the stake to over this threshold, it will be in the driver's seat. As the open offer requirement is fulfilled, it would have the option of raising its stake through the creeping acquisition route. Its investment of $600 million in Ambuja Cement to bankroll this offer is also a commitment that is not linked to the level of acceptance.

So Holcim is likely to pursue the creeping acquisition route, if the acceptance level is below expectation as ACC is an excellent entry point into the Indian markets for Holcim; it would give the Swiss MNC an edge over its global rivals such as Lafarge and Cemex in one of the most coveted markets in the world, next to China.

Purchases from the secondary market could then provide support to the ACC stock till Holcim acquires the required number of shares. If the acceptance level is low, shareholders should be careful about timing re-entry into the stock.

To remain a preferred play: As Holcim is likely to get a firm grip on ACC, the stock is likely to be one of the more sought-after exposures in the cement sector along with Gujarat Ambuja and Grasim. Holcim's considerable financial strength is also likely to lead to a lower debt burden and place ACC in a stronger position to pursue growth through acquisitions and new capacities. If the strategic partnership between the Ambuja group and Holcim continues, that, too, would be a positive for ACC.

The emerging trends also point to enhanced investor interest in the industry. The demand-supply equation has become favourable to producers in the northern and eastern markets; in the other regions, it could happen over the next couple of years.

Price stability at higher levels could lead to higher earnings. With its nationwide footprint, ACC would be the prime beneficiary. This is why shareholders who tender in the open offer should eye the stock for re-entry at a later date.

Value in the Ambuja's put option: There is yet another reason for such a course of action. The Gujarat Ambuja-Holcim agreement provides the former with a `put' option to sell its 33 per cent stake in Ambuja Cement India. It could do so at any time between June 2005 and December 2007. If it does not exercise this option, Holcim has a call option to buy the stake after January 1, 2008.

Holcim has a track record of working with strategic partners in a few emerging markets. It may perceive value in doing an encore with Gujarat Ambuja in India, as the combined clout would be difficult for competitors to match. But even if they decide to part ways, Gujarat Ambuja may wait for a couple of years and exercise its put option towards the end of the eligible period.

This may enable it to benefit from a higher price for the ACC stock and a tidy premium on that to clinch the sale. Only then would it derive a higher return than what is available now.

Background to the offer

GUJARAT Ambuja had picked up a 14.4 per cent stake in ACC in 1999. This stake was vested with Ambuja Cement India. Ambuja Cement Eastern, in which the group held a 94.1 per cent stake, was also transferred at a tidy profit for Gujarat Ambuja. A 40 per cent stake in the latter was sold to FIIs to cut the debt burden.

Holcim and Gujarat Ambuja entered into an agreement earlier this year. Holcim is to pick up a 67 per cent stake in Ambuja Cement India. An open offer would be made for a 37 per cent stake in ACC and for 5.9 per cent in Ambuja Cement Eastern. Holcim would have an effective stake of about 33 per cent in ACC and 67 per cent in Ambuja Cement Eastern. The deal could double Gujarat Ambuja's stake in ACC to 17 per cent without any cash outflow.

Holcim has the option to buy out Gujarat Ambuja's stake Imamura Cement India after January 1, 2008. The deal and its implications have been covered in detail extensively covered in the Business Line editions of January 21 and January 23, 2005.

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