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Making a metal monolith

It was a casual meeting between the Rs 270 billion A V Birla Group chairman Kumar Mangalam Birla and Hemendra Kothari, the pipe smoking head of investment bank DSP Merrill Lynch, that helped to get the ball rolling.

As the two swapped ideas the brainstorming session became more intense. The question before them was one that has been troubling Kumar Birla for a long time: what's the next move to make his group globally competitive with scales to match.

Having consolidated his cement business, Birla has now turned his attention to the non-ferrous metals business. And after a hectic month of tying up loose ends, on Sunday, when he announced that aluminium major Hindalco Industries would acquire the copper business of diversified fertiliser group company Indo Gulf Corporation Ltd (IGCL), he had wrested the metal king mantle from outsider Sterlite Industries' Anil Agarwal.

With both copper and aluminium under one roof, Birla is creating a Rs 100 billion balance sheet with annual cash flows of over Rs 17 billion, catapulting it to seventh from the 19th rung in the listed private sector corporate sweepstakes in terms of sales.

Going by yesterday's market closing, Hindalco's market capitalisation bloats from Rs 46.8 billion before restructuring to Rs 58.71 billion now. With a considerable reduction in IGCL's equity, its market capitalisation is down from Rs 12.57 billion to Rs 2.5 billion. The promoter's holding in Hindalco will be marginally down from 22.8 per cent to 22.4 per cent.

Making the announcement, Birla said that simultaneously, Hindalco, with a 74.5 per cent stake, will make an open offer to the shareholders of Indian Aluminium (Indal), to acquire the balance 25.5 per cent of non-promoter holdings. The Rs 120 per share offer, which is at a 24 per cent premium to the one month average price of Rs 97, will have an outlay of Rs 2.18 billion. If it is successful, it would see Indal being delisted from the Indian bourses, thus paving the way for its subsequent merger with Hindalco.

At the same time, IGCL, rechristened Indo Gulf Fertilisers (IGF), will revert to its original avatar and become a stand-alone fertiliser company, pursuing its own growth potential. And Hindalco - which had an 8.7 per cent stake in IGCL - will park the shares in a trust instead of being extinguished.

"Size is an enduring advantage and has its own enduring edge. We expect both Hindalco and the focused fertiliser company would be better valued by the capital markets now. Global trends have shown that multi-resource metal companies are better valued," said Birla.

May be. But as of now, with metal prices depressed, the bourses are not looking enthusiastic. The Hindalco scrip has slid from Rs 684 on July 18 to Rs 640.20 on Thursday. Indo Gulf was down from Rs 61.85 to Rs 57. Says Debu Bhattacharya, managing director, IGF: "The market price has held and I am very positive about IGF." Adds Sumant Sinha, president and head, group corporate finance, A V Birla Group: "If you look at the market as a whole, it has gone down by 4 per cent. In that scenario, Hindalco has actually stayed firm and I don't think it's bad at all."

But why is Birla taking the circuitous route of an open offer for Indal instead of a straightforward merger? Sinha says that they explored that option as well. "First the transaction costs are very high with regards to a merger, especially given the fact that Indal has facilities in different parts of the country," he says.

Indal's nine assets - mines, smelters, sheet and foil plants - are scattered across the country. This would have attracted a stamp duty close to around Rs 1 billion. "The potential liability could have been quite high, an issue we would have had to grapple with," he adds.

Also, Sinha claims that most of the benefits of Indal could be realised by actually doing a buyout of the remaining shares. "If you want to get the logistics aligned between the two firms, then you cannot do that beyond a point as there is the issue of shareholder conflict. So we tend to realise the benefits - whether a merger or a 100 per cent ownership without having the high transaction costs associated with it," he says.

The acquisition move comes at a time when the government's divestment process is in full swing. And one of the biggest divestments coming up is the Rs 2,400 crore National Aluminium (Nalco), which Birla, like many in the sector, keenly covets. Hindalco has been picking up Nalco shares in the open market this fiscal and currently has a 4 per cent stake in the company.

It was only in January last year that Hindalco was pipped by Sterlite in the race for state-run Bharat Aluminium Co (Balco). In March 2000, Birla pulled Indal, a subsidiary of Canadian major Alcan, from Sterlite's jaws. Also, his businesses are much bigger with a potential to grow even bigger. And with Nalco poised - according to industry experts - for a valuation of around Rs 7,000 crore, and which is likely to double once its expansion programme is complete, a bigger balance sheet would obviously come in handy.

Then again, competitors have been making noises about delisting in India with hopes of donning the honours on the foreign bourses for better valuations. In that respect, the Birla group companies were one of the first to acquire a GDR listing in the early 90s.

Both Hindalco and IGCL had their GDR listings in 1994. "It isn't competition as much as the opportunities before it. The deal opens the floodgates for the group both in India and overseas," says an analyst tracking non-ferrous metals in a domestic broking firm.

Reiterates Amit Chandra, executive vice-president and head of corporate strategy, investment banking and M&A at DSP Merrill Lynch: "What this deal does is generate a menu of options for Birla."

Today, the group's aluminium and copper businesses are in expansion mode. By next year, Hindalco's aluminium capacity will be up from 329,000 lakh TPA to 414,000 TPA riding on a capital cost of Rs 1,800 crore. There are plans to expand the copper capacity of its Dahej plant from 150,000 TPA to 250,000 TPA by the first quarter of fiscal 2004.

Hindalco is also one of the lowest cost producers of aluminium at $869/tonne. In comparison, the 4,213,000 TPA American major Alcoa's costs are the highest at $1,272/tonne. Even Nalco, with a capacity of 232,000 TPA (going up to 342,000 TPA next year), has a production cost of $1,000/tonne.

But where are the ground level synergies for the new Hindalco? Agreed that both aluminium and copper are London Metal Exchange-led (LME) and world over, companies are talking consolidation. Agreed that both copper and aluminium are asset and capital intensive commodity businesses guzzling power.

"It is the management which drives the synergy from one business to another. We believe that yes, you can't replace one with the other, but there are many similarities and we want to exploit those," says Bhattacharya.

Adds Chandra: "The transaction is not just about synergies. Unlike Birla's earlier cement consolidation, here value creation is the key in terms of enhanced earnings per share, visibility, focus and profitability."

In this thrust for size, how vital is it for Hindalco to acquire Nalco? Birla managers say that Nalco is not a do-or-die issue for the group. "It is neither driven by Nalco, nor is Nalco going to be our destination. Nalco is just another opportunity," says Bhattacharya. He reiterates Birla's statement that going by the group's track record, they will not give a price unless they believe it creates shareholder value.

Sinha says that the deal was largely prompted by scale. "I think that if you look at the global environment right now, more and more companies are consolidating. And, secondly, with the scale concept becoming bigger, we can now pursue bigger opportunities. Earlier, we could have just set up a 50,000 tonne smelter for a greenfield opportunity. Now you can't do anything less than 300,000 tonne. For that we require financial capacity of a different kind. So to get to that stage and allow us to pursue those kind of opportunities, we felt we had to do this," he says.

Now look at IGF, which became the vehicle for the group's foray into copper in March 1998. Today, copper accounts for 85 per cent of its turnover. The demerger, says Bhattacharya, will open up opportunities for inorganic growth as it becomes a debt-free company. "The PSU disinvestments in fertiliser companies will help us tremendously. We also believe that if the gas line comes from the east, there will be organic growth," he says.

So where do both Hindalco and IGF go from here? For the latter, a lot depends on monsoons and the deregulation of the sector.

Hindalco expects a 6 per cent growth in demand amid hopes of recovery in the global white metal market. The current LME prices of $1,350 are likely to recover by the end of the year. And domestic demand is likely to hinge on this.

"With all the players expanding capacity, in both the metal and downstream products, they would be under severe pricing pressure. So profitability will depend on Hindalco's ability to cut costs and be even more efficient," says an analyst.

At the moment though, the markets don't see any change in both the companies' share prices. "While Hindalco will gain strategically in the long term, in the short term it will depend on the LME prices. But people will hold on to their IGF shares," says an analyst.

Even so, with Birla aiming for a Rs 180 billion turnover in the next five years, all eyes will be on Hindalco. As Chandra says: "If all goes right, Hindalco could trade at a multiple price earnings ratio three times the size of today."

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