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Hindalco: Caught on the wrong foot? - Views on News from Equitymaster

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Hindalco: Caught on the wrong foot?
Oct 16, 2008

Hindalco is India's largest aluminum and copper producer. It is ranked as world's 11th largest aluminium producer. In 2007, it acquired Novelis, which is the world's largest aluminum rolled products producer. Hindalco had to pay US$ 3.6 bn for the acquisition and assume responsibility of an additional US$ 2.4 bn worth of debt on Novelis' balance sheet. The deal was financed through internal accruals of US$ 0.45 bn and a bridge loan of US$ 3.02 bn. The company, as a stopgap measure, had raised the bridge loan through its different subsidiaries and it is due to be paid back by November 2008.

After the acquisition, the immediate concern for the company was to replace the bridge loan of US$ 3.02 bn. The company could have paid back the bridge loan by taking a debt but this might have increased the debt to equity ratio and would have increased interest costs for the company substantially. So the company decided to raise 1/3rd of the bridge loan amount through rights issue and remaining by debt.

Hindalco offered around 525 m equity shares at a ratio of three for every seven equity shares held at a price of Rs 96 per share, thus making it the biggest ever rights issue in India. The net proceeds from the issue after the expenses was around Rs 49.26 bn (US$ 1.03 bn).

When the company declared its plans for the rights issue, the stock was trading at a price of around Rs 140. However, the recent meltdown in global financial markets battered the company's stock, taking it below the offer price of the rights issue. This led to a rather lukewarm response for the issue.

As per the exchange filings, the company has received a subscription of 56% of the issue size while as per the agreement with underwriters; the latter have decided to together subscribe to 34% of the size. All this means that the rights issue might have raised Rs 5 bn less.

It may be also noted that the company had issued 80 m preferential warrants to its promoters in April 2007 in order to raise money for the Novelis acquisition. Each warrant was entitled to one equity share at the rate of Rs 174 per share on or before 10th October 2008. However, the promoters have not exercised the warrants as Hindalco's share price was trading below the conversion price. This means that even this source of funding has been effectively shut.

The Hindalco saga is a classic case of some well laid out plans gone horribly wrong. The culprit, we believe, lied in the company's assumption that slightly higher leverage for a short period of time will do the company no harm. But the markets situation became so bad that even a well-capitalised company like Hindalco is struggling to make ends meet. The time is ticking away. Interest costs on the bridge loan is piling up while the company has still not firmed up plans to raise the remaining US$ 2 bn or thereabouts to pay back the loan. In all likelihood, given the current turmoil, Hindalco might have to defer its plans a bit. Shareholders in the meanwhile, face a double-edged sword. On the one hand, higher interest cost is eating into the profits while on the other hand; falling asset prices globally might eat into their ownership share in the company.

Good times or no, it indeed pays to adopt a conservative stance when it comes to leverage. Sadly, the management of the Hindalco seems to be learning this the hard way. Although the company might come out of this unscathed, shareholders will have to live through the medium term pain.

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