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Kanoria Chemicals: Deal contours explained - Views on News from Equitymaster

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Kanoria Chemicals: Deal contours explained
Apr 18, 2011

Kanoria Chemicals & Industries Ltd (KCIL) has announced divestment of its Chloro-Chemicals division to Aditya Birla Chemicals Ltd (ABCL), a sister concern of Aditya Birla Group of companies. In this article, we first explain the mechanics of the deal and then present our revised view on the company.

Contours of the deal:

KCIL has decided to sell off its Chloro Chemicals business division to ABCL for a consideration of Rs 8.30 bn. It is an all-cash deal. The transaction is expected to be completed by May 2011. It may be noted that Chloro-Chemicals segment is the core business of the company. The following table will give you an idea about the weightage/importance of Chloro Chemicals business division in the company.

Segmental Break-up
(Rs m) 3QFY10 3QFY11 Change 9MFY10 9MFY11 Change
Chloro Chemicals**
Revenues 866 1,091 25.9% 3009 3092 2.8%
PBIT 80.2 122 52.0% 402.3 372.8 -7.3%
PBIT Margins 9.3% 11.2%   13.4% 12.1%  
Alco Chemicals**
Revenues 261 403 54.2% 866 1080 24.7%
PBIT 13.6 18 30.9% 52.7 49.4 -6.3%
PBIT Margins 5.2% 4.4%   6.1% 4.6%  
** Excluding inter-segmental sales

Money raised via the division sale will be used for expanding the existing businesses and to focus on new opportunities through both organic and inorganic ways. It may be noted that the Management does not intend to pay any dividends to the shareholders from the windfall achieved through the division sale.

Why did the stock price appreciate?

After the news of division sale doing rounds in media, the stock price has appreciated by approximately 40% in two trading sessions. The company has managed to strike the deal at Rs 8.30 bn. Even after paying off the debt belonging to the Chloro Chemicals division and the capital gains tax on the division sale, the company would be left with cash of approximately Rs 3.5 to 3.8 bn. This translates into cash per share in the region of Rs 62-67. Thus, the street has reacted positively to the large cash influx which resulted in stock price appreciation.

What's in store for minority shareholders from here on?

  • The current market capitalization of the company is Rs 2.7 bn. And as per the deal the Chloro-Chemicals division of the company itself is valued at Rs 8.3 bn. This might seem to be a great value unlocking opportunity for the minority shareholders. However, it may be noted that the company has resorted to slump sale (a sale of particular division) here rather than stake sale. If the company had gone for stake sale, open offer would have been triggered. And considering the kind of valuation the company has managed to garner for the Chloro Chemicals division, the open offer price would have been considerably higher than the kind of share price appreciation one has witnessed in the last two days.

  • Secondly, as this is a slump sale, the company will have to pay a capital gains tax on the said transaction. Thus, this will further reduce the total cash available to shareholders!

  • It may be noted that the company has decided to sell off its principal Chloro Chemicals business division. Management is of the view that the money garnered through this transaction will be used for further expansion and acquisitions. Now, considering acquisitions are subjective in nature, the company might utilize all the money (Rs3,500-Rs3,800 m) for further capacity expansion on Alco-Chemicals business, a secondary business division of the company. We believe there is high amount of subjectivity involved with respect to future expansion plans as the principal segment itself is sold off. Again, the valuations would get re-rated after the sale. It may be noted that the current valuations are not an accurate reflection of the company's future prospects. Lastly, concerns with respect to the potential utilization of cash on the balance sheet also prevail. However, the cash per share on the balance sheet offers sufficient margin of safety.
Our View

The average cash per share on the company's balance sheet after divesting Chloro Chemicals division would be approximately Rs 65 (This is excluding the current cash on the company's balance sheet). Right now, the current debt on the company's balance sheet is Rs 3.8 bn (Source: 1HFY11 Results). Management has earmarked Rs 2.5 bn for retiring the entire debt of Chloro-Chemicals division which effectively means that the explicit debt for Alco Chemicals division is Rs 1.3 bn. The total capital employed of Alco Chemicals division is in the region of Rs 2 bn as per the latest financials of the company. Hence, the implied equity invested in the Alco Chemicals division is Rs 0.7 bn. Even if we assign a P/BV multiple of 0.8x to the Alco Chemicals business division it effectively yields a value of Rs 10 per share. As a result, we raise our target price for the company to Rs 75 per share (Rs 65 cash per share + Rs 10 per share from the Alco Chemicals business) and advise you to "HOLD" on to the stock.

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