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Grasim in BIG league

Nov 19, 2001

In what can be termed as a coup of sorts, the Aditya Birla Group has bought out Reliance's over 10% stake in Larsen & Toubro for a total consideration of around Rs 7.7 bn. The deal was consummated at a strike price of Rs 306.6 per share of L&T. This price is at a 47% premium to the L&Tís ruling price in the stock market. The Birla Group is buying the stake via its flagship company, Grasim Industries.The deal makes business sense for both the concerned parties Ė Reliance and Grasim. While, Reliance gets an opportunity to encash an investment that didnít quite turn out the way it was meant to (Reliance did try to mount an unsuccessful takeover on L&T several years ago), Grasim gets to consolidate its presence in the cement sector.

The pricing of the deal, although at a sharp premium to the market price, is not out of line with the L&Tís fair price, which has often been put at around Rs 330 per share (using an enterprise value per tonne of cement capacity of US$ 80 and a market cap to sales of 1 for its EPC business). Grasim, it is reported, proposes to pay for the deal from internal accruals.

How does Grasim stand to benefit from this deal?
Letís look at the macro picture first. The Gujarat Ambuja Ė ACC deal resulted in an alliance, which now controls roughly 25% of effective cement capacity in India (27 million tonnes). The L&T Ė Grasim alliance too will control another 25% of the market (over 29 million tonnes). In other words, the large players will account for over 50% of the market i.e. consolidation. With lesser competition, this will have its benefits in terms of better realisations. The deal will also, possibly, block the entry of a large MNC cement company.

Although it is yet unclear what kind of an alliance will develop between L&T and Grasim, significant synergies could be unlocked by working more closely in terms of raw material procurement and sharing technological know how.

One other scenario needs to be considered. Grasim does not have any interest in the EPC business, in which L&T is a leader. There is no reason to doubt that the main driver of this deal is L&Tís cement business. Grasim may be looking at a possibility of selling off its stake in the EPC company post the demerger of the cement business. Subsequently, Grasim could initiate steps to increase its stake in the cement company. This would bring in greater focus into its operations (also unlock funds used to purchase EPC business).

Apart from cement, Grasim directly benefits from L&Tís other interest areas. L&T has presence in finance, leasing and software through its subsidiaries L&T Infotech and L&T Finance. With Birla Global Finance and PSI DataSystems under its belt, the acquisition bodes well for Aditya Birla Group in the long run. In effect, as these business interests are aligned, the overall cost of acquisition for Grasim would reduce.

However, there are some concerns. A 10% stake in L&T does not give Grasim effective control of the company i.e. it is just an investment. The Rs 7.7 bn investment will earn a dividend yield of just 2.1% based on L&Tís last declared investment. Although there are likely to be benefits (as discussed above), the true value can be realised only with the effective restructuring of L&T i.e. demerger of its businesses.

What are the implications for L&T?
L&Tís cement division would ofcourse benefit from the better economies of scale and pricing environment. However, the main issue will be the impact of this transaction on the demerger process that the company had undertaken over a year ago. If the process were to be expedited the markets would surely look positively at both the companies.

While L&T presently trades at Rs 208.5, implying a price to earnings ratio of 12.2x (FY02 earnings), Grasim trades at Rs 285.9, at price to earnings ratio of 5.4x (FY02 earnings).

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