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L&T: Restructuring rewards…

Jan 2, 2004

Going by the spate of decisions that the management of the company has taken in recent times, engineering giant L&T seems to have finally decided to mend its ways. Close on the heels of the company deciding to demerge the cement division, it has announced that it now also plans to exit the glass container business. Given the company's track record of going adrift on quite a few occasions in the past (L&T had plans to enter the steel making business but decided against it at the last moment and the shipping business was also sold in 1998), the current restructuring is likely to appease the shareholders. After all, what is the need to digress when you are one of the best in the country in your core business of engineering.

Amidst all this, what really took the cake was the company's decision to exit the cement business and in the process unlock value for its shareholders. Let us see how.

Last year, L&T decided to demerge the cement business into a separate company known as CemCo and sell it to the A. V. Birla Group Company, Grasim. Following is the transaction structure.

Step 1: L&T gets 20% holding in CemCo and balance 80% to existing shareholders proportionately.

Step 2: Grasim gets 12.6% holding in CemCo; retains 15.7% holding in L&T (EngCo)

Step 3: Grasim buys 8.5% holding in CemCo from L&T

Step 4: Grasim sells its 14.95% stake to Employee Welfare Trusts and exits L&T

Step 5: Grasim to make an open offer for 30% of CemCo and get management control.

Thus, the demerger is planned in such a way that it gives the L&T shareholder a chance to decide whether he wants to stay invested in the business of engineering or wants to have a share of the cement business pie or a combination of both.

Moreover, Grasim has valued the equity of the cement division at Rs 43.5 bn, which at current stock price of L&T comes to around Rs 171.3 per share and implies that the investing fraternity is valuing the engineering business of L&T at Rs 363 per share (current share price (Rs 534) subtracted by the valuation accorded by Grasim for L&T's cement division).

Is the value of L&T's engineering division justified? Let us try and find answer to this question by comparing L&T's valuation with that of rival engineering companies such as BHEL and ABB.

ABB BHEL L&T*
Market cap 28,926 127,214 90,387
Sales (FY03) 11,758 78,147 82,262
Mkt cap/sales 2.5 1.6 1.1
*Figures excluding cement divn

On the first look, what is evident from the above table is the fact that despite being one of the best engineering companies in the country, L&T is trading at a significant discount as compared to its peers. The statistic becomes all the more telling when one considers the fact that the company was sitting on a huge order book of Rs 157 bn at the end of the second quarter of the current year. However, globally, the average market capitalisation to sales is estimated at 0.4 times. If one were to value the order book of the company on this basis (i.e. (Rs 157 bn * 0.4)/number of shares), the per share value works out to Rs 252, which is significantly lower than current price. This means that the engineering division is valued.

The caveat to this argument is the growth potential both the Indian and other SAARC countries offer in the long-term. Also, if the management of the company is to be believed, the IT division of the company is going to be a significant contributor to L&T's prosperity on a consolidated basis going forward. Moreover, now with the cement division gone, the company's balance sheet will look even stronger (the engineering business is cash rich). Overall, one has to take a balanced view between the long-term growth potential and the ability of the management to deliver in the future for its shareholders who have borne the burnt of past diversifications.

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