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Ambuja deal: Did the market over react? - Views on News from Equitymaster
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Ambuja deal: Did the market over react?
Jul 26, 2013

Ambuja Cements, one of India's largest and most efficient cement producers crashed 10% yesterday. Obviously, there was something that made the shareholders upset. Turns out the reason was the restructuring that the company and another group firm, ACC, will be subjected to. Apparently, Ambuja's minority shareholders are not happy with the deal that they have got.

But is this criticism really justified? Understanding the broad contours of the deal will give us some idea we guess. Under the restructuring, Ambuja Cements will now get to own 50.01% of ACC Ltd. And how is it paying for this stake?

Well, Holcim India Pvt Ltd (HIPL), an indirect subsidiary company of Holcim, owns 50.01% stake in ACC Ltd. Ambuja will acquire 100% stake in HIPL through two transactions. Firstly, it will pay Holcim around Rs 35 bn in cash to acquire 24% stake in HIPL. For the remaining 76%, Ambuja Cements will issue 584 m shares to Holcim. In other words, Rs 35 bn cash plus 584 m shares of Ambuja Cements can be thought of as being equal to a 100% stake in HIPL which in turn means a 50.01% stake in ACC. After the restructuring, HIPL will be merged into Ambuja Cements Ltd.

So, having worked out how much is being paid for what, we can now figure out whether the angst of Ambuja Cements shareholders is really justified. It should be noted that ACC has been valued by the management for the purpose of this transaction at Rs 1,222 per share. Thus, it is clear that the 50.01% stake in ACC has been valued at Rs 114.7 bn (1,222 * shares outstanding of ACC*0.5).

Now, what about Ambuja Cements? Well, the share traded at close to Rs 190 per share at the time of the announcement. Thus, the issuance of 584 m shares works out to a total value of Rs 111 bn. However, in addition to this, there's also Rs 3.5 bn in cash that Ambuja would be paying to HIPL. Therefore, in all, Ambuja shareholders seem to be shelling out close to Rs 146 bn for the deal.

So, here you go. Ambuja Shareholders are paying Rs 146 bn for something that's worth Rs 114.7 bn. Thus, this translates into a loss of market value of Rs 31 billion or thereabouts for the company's shareholders!

Please note that the entire calculation is based on our assumption of Rs 190 per share of Ambuja and price of Rs 1,222 per share of ACC Ltd. Although Rs 190 per share was the price at which Ambuja traded at the time of transaction, who is to say that this price is the fair value of the stock. Markets are prone to undervaluing as well as overvaluing companies and hence, may have made a mistake in this case also.

Well, our analysis does suggest that the price of Rs 190 was slightly on the higher side and the fair value based on current fundamentals seems to be somewhat lower for the company. Also, we believe that ACC has been a bit undervalued by the management and thus, there is a slight benefit here for the Ambuja shareholders.

Consequently, if one considers the slight overvaluation of Ambuja and slight undervaluation of ACC, the gap of 31 bn that the market is so negative about does narrow down a bit. Of course, another negative is the discount at which Ambuja would be valued on its ACC stake going forward. Such discounts usually range in the region of 15%-20% and may be even more. But then, we have also not taken into account the synergy benefits that the two companies would derive now that they belong to the same parent and could thus work more jointly than before.

All in all, the deal does not sound as bad as it is being made out in certain quarters. Of course, it is slightly negative for Ambuja Cements we believe but hopefully the gap gets filled up with benefits that come from economies of scale.

So, to conclude, while the deal does not impact our view on ACC as only the mode of ownership of the company changes, we also do not feel the need to revise drastically downwards our view on Ambuja Cements which is already a SELL based on current valuations. Having said that, any more overreaction from the markets could well make the stock attractive from a long term perspective. However, those levels have not been reached yet we believe. ACC on the other hand remains a BUY for us.

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