According to newspaper reports, Reliance Industries Limited is planning to make an open offer for a 20% stake in the cement and engineering giant, Larsen & Toubro Limited (L&T). Reliance already holds a 9.9% stake in the latter.
Reliance Industries (FY99 Sales Rs 14.5 bn) is India's largest private sector company. Its activities encompass polyester, fiber intermediaries, polymers, chemicals and branded textiles. The new ventures are in the core sectors of oil and gas, power and telecom.
L & T is the largest engineering, procurement and construction (EPC) company (58% of total revenues) in India. The company also has major business interests in cement (24% of total revenues, capacity 12 mtpa), and software.
In order to acquire an additional 20% stake in L&T, Reliance will have to shell out at least Rs 23 bn (based on the closing price on Friday. The actual amount will be significantly higher than this).
From the point of view of Reliance, the deal seems logical. The Reliance Group has over the last couple of years increased its focus on the infrastructure sector including telecom and power. Furthermore, the company has been very successful in executing captive infrastructure projects - power plants, ports, refineries, housing projects included. With L&T, an EPC leader, as a part of its stable, the company would then be completely self sufficient in taking up large projects.
The synergies from this deal are apparent. If the takeover were to go through, Reliance would source its EPC and cement requirements from L&T. Moreover, it would use L&T's skills to steam roll into the Indian infrastructure market. This fits well into its overall strategy.
From the financial point of view too the deal makes sense for Reliance. The company has recently completed the last of its mega expansion plans and is now generating surplus cash (cash balance at the end of fiscal year 1999 was in excess of Rs 48 bn). The takeover would provide it with an avenue to deploy its surplus cash and thus help in improving overall returns.
L&T, which is currently implementing a restructuring plan, may also benefit in some ways. First, it would benefit from the managerial inputs from Reliance, which has become a global player in the petrochemicals industry within a span of 15 years. Also, it would then have access to Reliance's huge cash reserves and superior debt management skills. This would help L&T in pursuing its aggressive expansion plans (cement) and at the same time minimising the burden of interest on its bottomline.
The downside to this deal are few. For Reliance, the takeover would imply heavy investment into an activity that does not constitute its core area of operation - petrochemicals. This could drain it of resources that could have otherwise been used to beef up its retail (petroleum) distribution network. L&T, which is a professionally managed company, could on the other hand witness an increase in employee turnover in view of the different management structures followed by the two companies.
Analysts have rated L&T as a 'BUY' on account of the rising demand for cement. As the other divisions of the company are already performing well, the turnaround in the cement division is expected to give a boost to the bottomline of the company.
Analysts have rated Reliance as a 'BUY'. The reasons in favor of the 'BUY' recommendation are firstly, the upturn in the petrochemicals cycle, following the recovery in Southeast Asia and Japan, and secondly, the fact that the company, having completed its capex plans, is likely to generate free cash flows this year.
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