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Hindalco’s Novelis acquisition: Our view - Views on News from Equitymaster

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Hindalco’s Novelis acquisition: Our view

Feb 13, 2007

After Tata Steel, the AV Birla group’s Hindalco industries created a big splash in the global metals industry by acquiring Atlanta-based Novelis- the largest flat rolled aluminium maker (provided there is no counter bid made). Hindalco's offer for Novelis will be the second-largest overseas takeover by an Indian company after Tata Steel’s recent acquisition of Corus. The logic behind the acquisition is similar to that of the Tata-Corus deal, which is to create a powerful combination of low cost upstream production in India and high-end downstream processing facilities in end-user markets. The combination of Hindalco and Novelis will establish a global integrated aluminum producer with low-cost alumina and aluminum production facilities combined with high-end aluminum rolled product capabilities. Hindalco has a 60% share in the currently small but potentially high-growth Indian market for rolled products. Hindalco's position as one of the lowest cost producers of primary aluminum in the world gives it the requisite leverage to become a globally strong player.

Though the Novelis acquisition will provide Hindalco with immediate scale and a global footprint, it is acquiring a company that is two and half times larger in size in terms of revenues and whose performance was not at all impressive as the company was unable to pass on the price increase in the value of aluminium. Moreover, the company is a spin off of Alcan, one of the world leaders in Aluminium and during the spin off, Alcan’s debt was transferred to Novelis’s business, leading to a highly leveraged balance sheet. The company undertook a business-restructuring programme in 2005, wherein it closed its plants in the UK, Belgium and Italy, sold its operations in France and reorganized its operations in Germany. It has lowered its debt from highs of approximately US $ 2.9 bn to US $ 2.4 bn currently.

Due to high financial charges and inability to completely pass on the rise in aluminium prices, the company reported loss for nine months ended September 2006.

Particulars Unit Hindalco Novelis
Net Sales US$ m 3,083 7,377
Operating Profit US$ m 674 739
EBITDA Margin % 21.9% 10.0%
Net Profit US$ m 419 (170)
Net Profit Margin % 13.6% -2.3%

Company overview:

Hindalco: Hindalco, an AV Birla Group company, is India’s largest aluminium producer and has the distinction of being one of the lowest cost producers of the metal in the world. The company is currently structured as two strategic businesses, aluminum and copper, with 2006 revenues of approximately US$ 2.6 bn. Hindalco's integrated operations and operating efficiency have positioned the company as Asia's largest integrated primary producer of aluminum and among the most cost-efficient producers globally. Its copper smelter is the world's largest custom smelter at a single location. It is an integrated player, having captive bauxite mines, power units and high value-added output comprising semi-fabricated aluminium products.

Novelis: The Atlanta-based Novelis was spun-off from Canadian aluminium giant Alcan Inc. two years ago. The spun off of Novelis came into effect to satisfy the critical anti-trust divestment requirements associated with Alcan’s acquisition of Pechiney, the France based aluminium player. Novelis is the global leader in aluminum rolled products and aluminum can recycling, with a global market share of about 19%. The Company operates in 11 countries, has approximately 12,500 employees, and reported revenues to the tune of US$ 8.4 bn in 2005. Novelis has the unrivaled capability to provide its customers with a regional supply of technologically sophisticated rolled aluminum products throughout Asia, Europe, North America and South America. Through its advanced production capabilities, the company supplies aluminum sheet and foil to the automotive and transportation, beverage and food packaging, construction and industrial, and printing markets.

Acquisition details: As far as the deal structure is concerned, Hindalco will acquire Novelis in an all-cash transaction, which values Novelis at approximately US$ 6 bn, including approximately US$ 2.4 bn of debt. The deal requires approval from shareholders of two-third of the company's total equity capital. The US$ 6 bn imputed value of Novelis includes a cash payment worth US$ 3.6 bn to Novelis’ shareholders and debt worth US$ 2.4 bn. While US$ 2.8 bn of the funds required will come from debt financing with recourse to Hindalco’s cash flow, the balance of US$ 0.8 bn will come from Hindalco and group company Essel Iron Ore Mining.

On the valuations front, the sum of US$ 3.6 bn that will accrue to the shareholders of Novelis translates into a price to book value multiple of 11x, going by the company’s latest balance sheet (Sep 30, 2006). While prima facie this looks expensive, if one adds the expenses that the company has incurred over the past few years to strengthen its R&D capabilities and build up its strong customer relationships or alternatively, if one were to look at what Hindalco will have to cough up to achieve the current size and capabilities of Novelis, then the multiple might come down a bit.


To Hindalco:

  • The Novelis acquisition will provide Hindalco with immediate scale and a global footprint.

  • The deal will give Hindalco an entry into value-added aluminum products and will transform the company into the world’s largest player in the downstream business of aluminum products.

  • It will also catapult Hindalco to the fifth position globally as an integrated aluminium player.

  • This would give them ready access to technology and global markets and will provide Hindalco with access to marquee U.S. customers such as General Motors Corp. and Coca-Cola Co, etc.

To Novelis:

  • The company has reported a loss of US$ 170 m for the nine months ended September 2006 on account of fixed-price contracts with customers. As a result of ceilings on some of its contracts, it had not been able to pass on the rise in alumina prices to its customers. Acquisition by Hindalco will give the company access to raw materials at cheaper rate as the former owns vast resources of bauxite and alumina.

  • Novelis has a highly leveraged balance sheet and interest obligations arising out of the same is causing a heavy drain on its financials. Synergies with Hindalco will enable the company to improve its cash flow and consequently, clean up its balance sheet.

Our view

The complementary expertise of both these companies will create and provide a strong platform for sustainable growth and ongoing success. The deal will create the world's largest aluminium rolling group, providing cost synergies to Hindalco, which is one of the biggest producers of primary aluminium in Asia. The combined entity will also create an integrated aluminium player with low-cost metal sourcing from India and access to some of Novelis' biggest customers like Coca Cola, General Motors etc. There are significant geographical market and product synergies.

As far as the financial implications are concerned, the move is likely to lend stability to Hindalco’s earnings as earlier, it was exposed to price volatility that exists at the end user market. Novelis’ has long term contracts with several of its customers, which in turn would lead to greater earnings visibility. However, Hindalco has stretched its balance sheet to acquire Novelis and as a result, cash flows will come under pressure until it retires most of the debt, that currently sits on the books of the latter. Until this debt is brought down to more manageable levels, we will remain cautious with respect to Hindalco’s stock.

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