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ACC-Tata Power: What’s the impact?

Oct 8, 2004

Tata Power has sold its Wadi power generation units to ACC, one of the country’s largest cement manufacturers, for a consideration of Rs 2.4 bn. In this article, we analyse the impact of the same on both the companies.Tata Power:
Tata Power’s generation capacity at Wadi is estimated at 75 MW. The consideration thus works out to be Rs 32 m per MW (mega watt). As per our interaction with power companies, it takes around Rs 30 m to Rs 40 m to set up a MW of capacity, depending upon the complexity of the generation unit (only generation or including transmission). In this context, it is a fair deal for Tata Power.

The impact on Tata Power could be two fold. On the negative side, power companies are guaranteed a 14% return on capital employed. This sale of the power plant in one way, will reduce the guaranteed return the company was able to generate, irrespective of whether it was a productive or an unproductive investment (this will be a short-term impact). The impact will also be felt at the topline level in the short-term. However, on the positive side, the return on assets of Tata Power will improve from the current level of 5.7% in FY04 and thus, strengthen the balance sheet. Besides, it will also enable Tata Power to fund its capital expenditure plans (estimated at Rs 27 bn over next 3 years).

The stock currently trades at Rs 333 implying a price to earnings multiple of 13 times FY04 earnings. On a per share basis, the sale works out to Rs 13 per share. According to our view, this is a good deal for Tata Power.

ACC
The rationale for the acquisition from ACC’s perspective is clear. The company has two cement plants in Wadi (the old plant with a capacity of 2.1 MT and the new plant with a capacity of 2.6 MT). This acquisition would enable ACC to meet the power requirements of these plants, to an extent.

ACC, over the years, has been focusing on reducing the power cost as a percentage of sales by setting up captive power generation units. In the past five years, the company’s power consumption has come down by 8% and it has also increased its captive consumption capabilities to 83%, which will result in reduced power expenses. While it is reflecting in its financials (power cost as a percentage of sales has come down from 13% in FY99 to 11% in FY04), this acquisition is likely to pay off over a period of time and secure power supply from internal generation.

The stock currently trades at Rs 277 implying a price to earnings multiple of 24 times FY04 earnings. Overall, it is a win-win deal for both the companies.

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