Unlocking the goldmine within

Virendra Verma        Print Edition: November 15, 2009

URGE TO MERGE & DEMERGE
Why business groups are restructuring.
Restructuring can create short-term value with the promise of a sharper focus over the longer term.
Pure-play businesses (eg: just cement or just petrochem) get better valuations from investors.
Operational and financial synergies between businesses can be enhanced.
Sale of non-core businesses can allow for more focus on the core.
Proceeds of sale can be used to retire high-cost debt.

Bad times have a scientific value. These are occasions a good learner would not miss.
- Ralph Waldo Emerson

The 19th century American philosopher might have not had a credit crisis or a global recession in mind when he held forth on the benefits of adversity, but for the cream of India Inc., Emerson couldn’t be more relevant. Fiscal 2008-09 was indeed a “bad time” but there was some wisdom to be gained for the “good learners.” Just one of those lessons: Go easy on inorganic growth and instead focus on putting your house in order.

Against a backdrop of softening demand conditions and slowing economies, India Inc. had to look beyond cash flows and profitability to continue creating value for shareholders. Restructuring has proved to be the stone that kills two birds: Not only does it help make the company betterplaced to ride an upturn, whenever it comes, it also helps unlock value that would otherwise have stayed hidden. Promeet Ghosh, Managing Director (Investment Banking), DSP Merrill Lynch, feels that companies resort to restructuring when the business case for it is compelling and not just because a slowdown has impacted their stock prices. He adds that synergies and cost-savings are two big triggers for restructuring the portfolio.

India’s biggest conglomerates - the Tatas, the Aditya Birla Group, and Mukesh Ambanis’ Reliance Industries Ltd. (RIL) - have been re-jigging their sprawling empires precisely for those reasons. Mergers, demergers and acquisitions of stakes are being orchestrated, the big difference being that they’re all intragroup transactions. The benefits: A sharper focus, higher valuations, and enhanced synergies. At the same time, promoters who chased organic and inorganic growth in the gung-ho times—often with dollops of debt in tow—are beginning to clean up their acts. Non-core businesses are being either hived off or sold, and in more than a few cases those proceeds are being used to retire high-cost debt.

Grasim Industries
RESTRUCTURING PLAN: De-merge cement business into a subsidiary, Samruddhi Cement. Eventually merge Samruddhi Cement with group cement company, UltraTech.
THE BENEFITS:
a. Allow investors to participate in a pure cement company.
b. Use cash generated by Grasim for cement business expansion.
“The restructuring is designed to ensure continued support to the rapidly growing cement business and simultaneously provide Grasim shareholders direct participation in the pure-play cement company”
KUMAR MANGALAM BIRLA
Chairman, Aditya Birla Group

Let’s start with the Aditya Birla Group, which has hived off group company Grasim’s cement division into a subsidiary company. Grasim now becomes a pure-play producer of viscose staple fibre (VSF), a man-made fibre with cotton-like characteristics that is used to make apparels and dress material. The subsidiary, Samruddhi Cement, in turn will be, at a later date, merged into Birla’s cement company UltraTech, thereby creating two distinct and sharplyfocussed entities. “The cement business will enjoy a better valuation outside of Grasim rather than as a part of a Grasim that has multiple businesses (VSF and cement),” says Kumar Mangalam Birla, Chairman, Aditya Birla Group. Analysts agree that the new structure will help in improving the valuation of the cement business, and is a positive for UltraTech. Also, by virtue of UltraTech being a 54.78 per cent-owned subsidiary of Grasim, it can rely on the financial strength of the VSF producer.

While Birla’s aim is to create value by building a cement colossus via a demerger, Mukesh Ambani’s RIL has gone the other way, opting to merge a group company in a bid to become a global energy giant. There was always speculation that Ambani would eventually merge Reliance Petroleum Ltd. (RPL), the company floated to build a second refinery of 5.8-lakh barrels of oil per day in Jamnagar, into RIL. And Ambani eventually did oblige. “It is a significant step in our goal to be among the largest global corporation,” said Mukesh Ambani, Chairman, RIL, at the time of the merger. Most analysts tracking the firm say the merger was the need of the hour as sharp fluctuations in global crude prices were resulting in unstable refining margins. RIL’s cash flows from its petrochemicals business—which is a natural hedge to refining—will help neutralise the slowdown.

Other than the financial implications, the merger puts RIL among the top 10 private sector refining companies in the world, controlling a fourth of the world’s complexrefining capacity. “RIL will have improved cash flows, a stronger balance sheet and lower cost of capital post-merger,” says Deepak Pareek, research analyst at Angel Broking.

Reliance Industries
RESTRUCTURING PLAN: Merger of Reliance Petroleum with Reliance Industries.
THE BENEFITS:
a. Make Reliance Industries an integrated global energy company.
b. Reduce earnings volatility for Reliance Petroleum due to fluctuating oil prices.
“This follows Reliance Industries’ philosophy of creating enduring value for all our stakeholders. It is a significant step in our goal to be among the largest global corporations”
MUKESH AMBANI
Chairman, Reliance Industries

The Tatas, meantime, have shifted focus from global acquisitions to consolidating the group’s myriad businesses— or at least those in which synergies exist. The first step in this direction was taken when Tata Chemicals increased its stake in group company, agrochemicals major Rallis India, from 9.4 per cent to 46 per cent. The aim is to have a common pool of customers using both the companies’ products. “There is some synergy and a team is being built to derive more synergies,” says R. Mukundan, Managing Director, Tata Chemicals. Some of the synergies Tata Chemicals and Rallis will try to exploit are the marketing of agrochemicals of the latter through Tata Chem’s 600 rural retail outlets.

Restructuring at India Inc. is also being driven by promoters who’ve been singed by slowing consumer demand. This, coupled with mounting high-cost debt, have called for streamlining operations and attempts to extract value by creating standalone entities for different businesses. Future Group’s Pantaloon Retail (India) is one such company. High real estate prices and mounting debt have made cash-generation difficult. One option for Kishore Biyani, Chairman, Future Group, is to restructure the overall operations. “Our plan is to have three separate businesses: Retail, financial services and others (like brands, media and logistics) and raise cash by selling stakes in each of them,” says Biyani. The businesses under flagship Pantaloon Retail could also be carved out, with the hypermarkets arm, Big Bazaar, being hived off into a separate company, leaving Pantaloon as a pure-play fashion & lifestyle retailer. Earlier in the year, the group had a plan to attract private equity via the foreign direct investment route, but some policy issues have to be sorted out. Biyani declines to elaborate on the revised plan. “There are several technical issues and these are being sorted out,” he says.

Tata Chemicals
RESTRUCTURING PLAN: Increase stake in Rallis India; perhaps merge it over the longer term.
THE BENEFITS:
a. Increased focus on agriculture sector.
b. Reach out to common customers - the farmer - and use Tata Chemicals’ rural retail outlets to sell agrochemicals.
“Our effort will be to support Rallis in whatever way we can as a large shareholder. There is some synergy and a team is being built to have more synergies. We will work together to make Rallis even more stronger”
R. MUKUNDAN
MD, Tata Chemicals

Clearly, the economic slowdown provided big Indian businesses with a great opportunity to align its businesses in line with its overall vision. All the value-unlocking in a difficult year will come handy once the going gets good, and the benefits of synergies and cost-cutting begin to reflect in valuations.

Urge to purge
A few promoters have been forced to sell non-core assets to protect their flagships.

For some of India Inc., restructuring was also necessitated after they were caught by the global meltdown. Whilst some, like pharma major Wockhardt, took a hit because of their exposure to currency derivatives, others, like Unitech, got steamrolled by mounting debt and plunging real-estate prices. Selling non-core assets to retire or restructure debt was the only option.

For Wockhardt, the spoilers were a provision of Rs 866 crore for mark-tomarket losses in the forex derivates market, and interest payment of Rs 439 crore for the 18 months ended June 2009. However, the company has disputed some of the forex derivatives contracts with the respective banks. “We have advisors and legal experts in India and the UK to advise us on the mark-to-market situation,” says Habil Khorakhiwala, Chairman, Wockhardt. To overcome these losses and high interest cost, Wockhardt had to sell some of its non-core businesses like nutrition, animal healthcare and a German subsidiary Esparma, from which it raised Rs 770 crore. It has also been able to restructure debt of over Rs, 1,100 crore from the Indian bankers, with lower interest rates.

Unitech was forced to sell some of its hotel properties, commercial complexes and also a majority stake in its telecom venture Unitech Wireless to Norway’s Telenor Mobile Communications. In its core business, it is now focussing on affordable housing. The priority today is not adding to the land bank but generating cash pronto. The divestments, coupled with the focus on improving cash flows, helped bring down the debt position from Rs 10,900 crore at the end of December 2008 to Rs 8,900 crore by March, 2009. Company officials were not available for comments on the restructuring, but clearly Managing Director Sanjay Chandra would like to echo Khorakiwala, who told BT: “We believe we can emerge successfully out of this situation soon.”

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