Consolidation in the cement industry has taken a much-anticipated turn. Grasim, the Aditya Birla group company, has made an open offer for the cement and engineering conglomerate Larsen and Toubro (L&T). Grasim had earlier acquired 10% stake in L&T from Reliance at a price of Rs 306 almost a year ago. Since then Grasim has been able to increase its stake in L&T to 14.5%, which is just below the take over code limit of 15%.
So is this deal fair to the retail investors or is it a raw deal. In this article, we look at benefits or otherwise for retail investors and the impact this move is likely to have on the cement industry. Grasim and L&T are two of the largest cement manufacturers in the country. They have a combined capacity of nearly 29 m metric tonnes (MMT) mainly concentrated in the southern, central and the western regions of the country. Grasim mainly has interest in the cement capacity of L&T, which is the second largest after ACC at 16 MMT. The open offer is for a 20% stake in L&T for which Grasim is offering a price of Rs 190 per share. Though this price is 10% higher than L&Tís last traded price, it is much lower than what Grasim paid to Reliance to obtain a 10% stake in the company i.e. Rs 306/ share.
According to our calculations the L&T stock based on replacement cost basis is Rs 282. Our calculation takes in to account individual valuations of the cement and engineering divisions. The reason for poor valuations on the street is that L&Tís cement business is ailing due to heavy debt burden, which is dragging down the profitability of the company. Even currently when the cement demand is robust in the country, L&T has not shown a healthy dispatch growth relative to its peers ACC and Gujarat Ambuja. This is mainly on account of the fact that the cement plants of L&T are mainly located in the southern and western regions of the country where the demand has not been as good as the northern and eastern regions. Further, intense competition in these regions has kept realizations subdued.
In the recent past the company had proposed to hive off its cement division in to a separate entity. The hive off would have helped L&T unlock considerable value and reward shareholders in the process.
Keeping in mind our conservative estimates, Grasim is likely to gain immensely as it will get controlling stake in L&T for far less than estimated fair value. If Grasim is able to control a combined capacity of nearly 29 MMT, the company will be in a good position to control prices in Western and Southern regions where it has significant presence. Both L&T and Grasim are likely to benefit, as there will be a better understanding on pricing issues as well as better operational efficiencies that can be realised from joint procurement of raw materials, cross branding and improved logistics understanding.
For shareholders of L&T the open offer does not seem favourable. Dithering by L&T management on demerger of cement business and eventual sale of stake to strategic investor has denied shareholders an opportunity to enhance wealth. Grasim, on the other hand, has taken advantage of depressed market prices, especially keeping in mind the offer price to Reliance group.
As for the cement industry, the move by Grasim, which seems to have been initiated to counter the threat of ACC - Gujarat Ambuja combine, could lead to better prices in the Southern and Western regions. It is too early to say whether the move may affect the strong position of ACC - Gujarat Ambuja combine in the high growth and comparatively higher realisation regions of North and East. But one thing seems certain; consolidation in the cement sector has just received a shot in the arm.
LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.
SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India. Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: firstname.lastname@example.org. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407