Should Alco Merge?

A merger of Alco with Sunrise may not be an immediate necessity. But it may well be a long-term imperative. Whatever the new organisation structure, enhancing shareholder value should be the basic driver of reorganisation initiatives. Since cost-structures within Sunrise vary from one plant to another, it is important to ensure that there is no hangover. For instance, a customer in central India is best serviced from the Alco plant at Orissa because it saves on freight costs. But the Chennai plant might be offering more advantages-like low costs of procurement or of working capital-leading to a lower total delivered cost (TDC). While bringing costs in line, it is important to ensure that a poorly-run plant like Alco does not erode the competitive advantages of an efficient plant in Chennai. A hangover of this kind cuts at the very root of synergies. This often goes unnoticed in a merger. Khanna should avoid that risk. His efforts, to start with, should focus on getting answers to some simple questions: Who are our customers? What do they seek? Which of the three manufacturing centres is best equipped to service them? How can we optimise our overall marketing efforts?

There are a few other issues that should be factored into the reorganisation initiative early on. Communication, for example. Whenever an enterprise is undergoing a structural change of the kind happening at Sunrise and Alco, the winners and losers syndrome is bound to prevail in the minds of people. Khanna should take an upfront role in diffusing it from the beginning. That is the only way to ensure that he does not lose the key people at Alco. Yet another thing to keep in mind is the paralysis-by-analysis syndrome. At one level, it is important not to rush through things. But at another, you must ensure that you move in quickly before positions are taken, people get labelled, and camps are formed. The important thing is to identify the key value-drivers where integration, however piecemeal, can yield quick hits. Khanna should work on areas where synergies are not only possible, but which are demonstrative in terms of value-addition. He does not have to wait till he gets everything right. Equally, it is important to work within a time-frame-like, say, achieving substantial integration in 100 working days of the closure of the deal.

A major risk in integration is that instead of creating value, you end up creating bureaucracy. The only way to prevent it is by ensuring that while policy-making is centralised at the top, the execution is decentralised. Khanna might shortlist a dozen vendors nationwide for each of the critical items used in the three plants based on parameters like quality, price, and delivery period. The plant management must be free to choose its own vendor within that approved list. Thus, while procurement could be centralised, it should also allow for enough freedom at the operations level.

The easy part of an acquisition is signing the cheque. The difficult part is harnessing the synergies. A majority of acquisitions don't create value for shareholders because of ineffective integration.

Khanna has set an objective of being the lowest cost producer. Acquiring Alco can prove to be a right step in this direction as it would give economies of scale. However, to realise his objective, Khanna needs to fully exploit the synergies and bring costs under control at Alco.

Alco is in the entire value-chain of mining, refining and smelting, and making end-products. Sunrise seems to have a similar portfolio. Since there is substantial overlap, there would be significant synergies achievable by merger. However, an immediate merger would be difficult. Alco has been a government-owned entity and carries a baggage of legacies. There would be severe cultural differences that must first be sorted out. Taking tough decisions like manpower reduction won't be easy due to pre-emptive clauses.

Khanna should, therefore, focus on reducing direct costs at Alco. His first priority should be to secure efficiencies in all operations linked to yield, efficiency, and capacity utilisation of the plant. This can be done by transferring and establishing best practices from Sunrise. The second step is to control the overhead costs. This can be brought down by cutting flab, streamlining support functions, and eliminating duplication. This initiative can be taken in full earnest in a year, as soon as the pre-emptive clause expires. A two-year target must be set to streamline the operations of Alco.

Simultaneously, Khanna should start exploiting synergies in procurement, distribution, and marketing. Procurement costs can be reduced by leveraging higher volumes of the combined entity. Distribution synergies can be exploited by optimising logistics. Marketing synergies can be tapped by having common brand management, cross-selling and presenting a single face to customers.

After Alco's clean-up, a merger with Sunrise is necessary to realise the full benefits of acquisition. The relative valuations will result in the government equity falling below 26 per cent in the merged entity. With that, the issue of government influence would become irrelevant.

To facilitate a smooth merger, Khanna must take immediate steps to align the culture at Alco with that in Sunrise. Standard hr and it practices will help integrate their systems. Post-merger, SBUs can be created around different stages in the value chain. This would help, as the critical success factors of each stage are distinct. Mining requires optimum capacity utilisation. Smelting and refining requires technology inputs and cost control. Selling end-products requires customer focus and brand-building expertise. In the long term, aluminium business can be organised into multiple SBUs: one for mining and alumina operations, second for smelting and refining operations, and one or two more for various end-products.

The acquisition of Alco is aimed at creating an integrated, global size, and lowest-cost aluminum producing company. Cost reduction should therefore be the single-largest driver of reorganisation at Sunrise. Whatever the organisational contour that finally takes shape at Sunrise-merger, break-up, SBU et al-Khanna and his team should focus on the following initiatives:

Reduce the cost of power: This is crucial because power is the basic raw material. This can be achieved either by reducing the cost of captive power generation or outsourcing. Options here are limited. But the latter is preferable because Khanna can release cash by selling the power plant. It is better to outsource all non-core activities.

Lower the employee cost: Employee costs would have to be considered a fixed cost for at least a year or two. But, offering a VRS is an option that Khanna should consider some time down the line. In the interim, the focus should be on improving the efficiency levels of particularly those working in the mines. Those working in the refineries must be put through training, job rotation and reallocation programmes.

Upgrade technology: Appropriate steps need to be taken to improve technology for both refinery and smelting. But it is possible that immediate fallout here is that employees at some levels would become surplus and even redundant. The timing of technology upgradation would therefore have to coincide with the launch of VRS.

Eliminate duplication in costs: It is necessary to take a firm decision on the sale of physical assets that are rendered surplus post-acquisition. This step will not only release cash, but send out the right signals that the new management is serious about securing synergies and focusing on the core business. What needs to be looked at here is the efficiency of the group as a whole. Considering the restrictive clauses pertaining to Alco acquisition, it is better to sell non-core facilities at Chennai and Maharashtra and use the cash so generated for rationalising facilities at Alco. The important thing is that all this should lead to an increase in efficiency and quality and secure higher price realisation.

Minimise finance costs: Working capital is a major element of cost in a situation like Sunrise. By concentrating on improving working capital management, the company would be able to achieve some reduction in finance cost. That, in turn, should form the basis for renegotiating loan facilities after getting them re-rated.

The above steps would provide the basis for further steps towards reorganising the combined operations at Sunrise. Clearly, unless and until proper systems are put in place, it is not advisable for Alco to be merged with other group companies.

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