Corporate: Hindalco Grabs Indal, Foils Sterlite

CORPORATE
Hindalco Grabs Indal, Foils Sterlite

CEO K.M.Birla needs to improve Indal's operational inefficiencies and, later merge it with Hindalco to reap the full benefits of a shrewd takeover.

By Arijit De

Nine months ago, Kumar Mangalam Birla, the 33-year-old Chairman of the A.V. Birla Group, first examined the possibility of buying out the stake held by Alcan Aluminium of Canada in Indian Aluminium (Indal). But the deal fell through. On March 10, 2000, Birla's Hindalco again received an offer to buy out Alcan's 54.62 per cent holding. This time, Hindalco grabbed the Rs 738-crore opportunity-even as Sterlite was engaged in discussions with Alcan-that resulted from Alcan's strategic shift due to its proposed global mergers with Pechiney of France and Aluisuisse of Switzerland.

Birla's interest in downstream capacities like Indal's was clear from Hindalco's earlier abortive bid to takeover India Foils. As it happened, India Foils was finally gobbled up by Sterlite's Anil Agarwal. Both Agarwal and Birla are today pitted against each other in an intense battle to become the largest domestic player in the aluminium sector. To achieve that objective, Birla, who has already consolidated his cement acquisitions under Grasim, may combine the aluminium operations under the Hindalco umbrella. In that case, a merger between Hindalco and Indal becomes a distinct possibility.

Operationally, a merger makes sense if Birla wants to exploit the synergies between the 2 companies. While Hindalco buys a part of its alumina needs, sells metal ingots, and has a minimal presence in the downstream business, Indal exports alumina, buys primary aluminium, and manufactures downstream products. In 1998-99, Indal purchased 29,000 tonnes of aluminium, while Hindalco sold 11,2367 tonnes of ingots. Says a senior manager in Indal: ''It was a curious way to grow. But Indal has always depended on external sources for its metal requirements ever since its first sheet mill was set up in 1938.''

The Mmerger Dynamics

Most-merger, Hindalco would become a strong player with the capacity to manufacture over 8 lakh tonnes per annum (tpa) of alumina, smelt over 3 lakh tpa of aluminium, and produce 15,000 tpa of foils. Once the proposed expansion plans of Hindalco (investment: Rs 1,800 crore) and Indal (Rs 1,200 crore) are implemented, its primary aluminium capacity could touch 4.50 lakh tpa compared to Nalco's 3.45 lakh tpa, and its foils' capacity of 20,000 tpa could be close to Sterlite's 25,000 tpa. In addition, the takeover will help Birla get a 20 per cent stake in the porposed Rs 4,300-crore Utkal Alumina. Says Hindalco's Birla: ''It is in line with our philosophy of value creation.''

However, the Birlas deny the possibility of a merger. ''We have not yet considered this move. Our aim is to get the best return from the investment in Indal,'' says Askaran Agarwala, 61, Director and President, Hindalco. True, for the trouble is that an immediate merger could pull down Hindalco's financial ratios. While Hindalco's operating margin stood at 40 per cent in 1998-99, Indal's was 30 per cent. And Hindalco's Return on Capital Employed, at 20.24 per cent, was higher than Indal's 11.64 per cent. Agrees Rajesh Mazumdar, 31, Analyst, BNP Prime Peregrine: ''The potential of Indal has not been realised fully.'' Especially since Indal's margins on value-added products are 20 per cent higher than Hindalco's.

Indal's Problem Areas

The problems with Indal are manifold. One is its power cost of Rs 1.68 per unit compared to 55 paise for Hindalco, thanks to the latter's 612.50 mw of combined captive power facilities at Renukoot (Uttar Pradesh). Two, Indal has been hit by the volatile metal prices on the London Metal Exchange; in fact, global aluminium prices had peaked at $1,700 per tonne in 1995-96, before falling to $1,150 during the Asian meltdown. Finally, Indal's 6,500 employees have been extremely militant. But that does not deter the confident Agarwala who maintains that ''the priority is to rationalise Indal's product portfolio, production planning, and new product development.''

At the same time, Hindalco will need to tackle the negative financial impact of the takeover in the short run. At Rs 190 per share, the price is lower than what Alcan paid (Rs 200 per share) to ward off Sterlite's threat and the replacement cost (over Rs 300 per share). But it will imply a minimum outgo of Rs 1,000 crore if Hindalco pays the same price to Indal's shareholders during the mandatory open offer for buying up an additional 20 per cent stake. As Hindalco will pay the entire amount in cash, it would need to sell a portion of its Rs 1,062-crore investment portfolio, which gave the company a Rs 90-crore return in 1998-99. The loss may not be entirely compensated by Indal's dividends, which stood at 40 per cent in 1998-99.

Therefore, a combination of Indal's weak balance sheet and Hindalco's cash outgo may act against a merger in the short term. In the medium term, the merger will prove to be a win-win situation for both companies-even on the financial parameters. BT estimates that, at a swap ratio of 1 Hindalco share for every 5 Indal shares, the investment ratios may improve despite Indal's weaknesses.

The reason: since Hindalco's stake in Indal will be cancelled in case of a merger, at a 1:5 swap ratio, the equity base will increase from Rs 74.47 crore to Rs 80.87 crore, even though Indal's equity capital is as high as Rs 71 crore. If one considers the 1998-99 results, a merger will enhance both the Earnings Per Share, from Rs 76.13 to Rs 79.51, and book value, from Rs 437.22 to Rs 492.52. And that will fit in perfectly with Birla's obsession of creating value for his shareholders.

-Additional Reporting By Dilip Maitra & Rakhi Mazumdar

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