• JANUARY 1, 2003

L&T: Eyeing value

L&T shareholders may finally get their money's worth. The cement division demerger plan seems more a question of 'when' rather than 'if'. The open offer by Grasim seems to have come as a boon for L&T investors. At least it opened the eyes of the majority investors to the potential of their investment in Larsen And Toubro (L&T) . Till the open offer, the demerger plan was more a talk than action as far as the L&T board was concerned.

For the first time since the cement demerger proposal was mooted, the demerger looks more of a certainty. And if the financial institutions (FIs) play their cards right the minority shareholders i.e. the retail shareholders may stand to benefit immensely. Recent developments indicate that FIs have taken a liking to Grasim's demerger plan for L&T's cement division.

The FIs did not seem to particularly like the idea of the L&T board continuing to keep a lion's share of the demerged cement entity, if M/S's Naik & Co.'s plan was followed. Rather, the FIs seem to be looking for an exit option by which L&T's value could be unlocked by selling out the cement business to a strategic investor. The plan to sell part stake in the cement business to CDC Capital Partners did not appeal to FIs as they saw no exit option for themselves. Further, the proposal also involved empowering CDC Capital Partners with a board representation as well as voting rights in the demerged entity.

Grasim on the other hand, proposed a vertical split wherein the existing shareholder will get a stake in the demerged cement entity in proportion of their stake in L&T. So for example, if a shareholder has 1% stake in L&T, he will have a 1% stake in the new cement entity. This proposal seems to be more acceptable to the FIs as they will have nearly 40% stake in the cement entity after the demerger. And thus they will be in a better position to offload their stake to a potential investor like Grasim.

  FY01 FY02
Cement division    
Revenues (in Rs bn) 23 25
% of total revenues 29% 30%
Operating margins 17% 19%
EPC division    
Revenues (in Rs bn) 45 48
% of total revenues 58% 57%
Operating margins 12% 10%
L&T: Cement valuations    
(Rs m) Conservative Optimistic
Enterprise Value (EV/ tonne in US $) 65 70-76
Enterprise Value (EV in Rs m) 47,775 51,450-55,860
EV net of debt* (EV in Rs m) 22,775 26,450-30,860
Value per share 91 106-124
* Assuming a debt of Rs 25 bn for L&T's cement division (almost 50% of total FY02 debt).

If the FIs do accept Grasim's demerger proposal, retail shareholders too stand to gain immensely. For every share they have in L&T they will get an additional share in the cement entity. As things stand Grasim is rumored to have already offered to US$ 76 per tonne for the cement business to the existing shareholders in case the cement division is demerged. As per our valuations, if Grasim offers to increase its stake in the cement entity at US$ 76 per tonne, existing shareholders may get Rs 121 per share for their cement division shares. Even if Grasim pays US$ 65 per tonne (at replacement value), it works out to be Rs 91 per share.

In our story dated December 6,2002 titled L&T: What is the fair value? we had calculated the company's EPC valuation at Rs 191 per share on a conservative basis. This takes the total value of L&T shares at conservatively Rs 191 + 91 = Rs 282 per share.

L&T is currently trading at Rs 211 a P/E multiple of 16x our FY03 projected earnings. L&T's core competency is basically in engineering, procurement and construction, and this division is a strong cash generator for the company. The company's focus in the export markets has paid off in term of higher export revenues. L&T's size compared to other global EPC giants is small but it has still managed to win large contracts abroad. The point being made here is that L&T's cement demerger is not the only way shareholders are going to benefit. The demerger is likely to unlock value for shareholders, as post demerger L&T will be viewed as a focused EPC company and will get rated likewise.

But please remember that 'there is many a slip between the cup and the lip'. So, while looking at L&T, look at its fundamentals with and without cement demerger and make your call.

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