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CASE GAME

The Case of Troubled Diversification

Having invested expensive debt into new projects given to overruns, Peekay Steels must now find a way out of the interest squeeze to ensure survival. A.K. Sengupta of SPJIMR, S. Biswas of Accenture, and V. Sett of Hughes Telecom debate on Peekay's way ahead.

By R. Chandrasekhar

Pravin kumar flicked the TV off as he saw, for the nth time that night, the second tower of the World Trade Center in New York come crashing down. ''What kind of people would plot so meticulously to take thousands of innocent lives?'' he wondered, as a chill went down his spine. ''It hasn't been a good day for me and lots of others in the US,'' Kumar muttered, switching on a lamp next to his king-sized chair, and pulling out a file from his expensive Pierre Cardin portfolio.

A few hours earlier, the 48-year-old ceo of Peekay Steels, which had four other subsidiaries dealing in aluminium, power, oil exploration, and telecom, had emerged from a gruelling four-hour session with Dalal Street analysts. It seemed the analysts thought there was nothing right with his diversified group. The hundreds of crores of rupees that the flagship had raised to fund forays into new growth sectors were proving be a mill round Peekay's neck. The bottomline was bleeding not because the steelmaker was inefficient; rather, the culprit was the staggering interest Peekay had to pay month after month.

Kumar flipped a few pages of his file and got to a section titled 'Competitive Analysis'. He put a finger on the column that read production cost and traced it down to the row where Peekay's prices were given: $260 per tonne. Moving his gaze further down, he looked at the global benchmark: $280 per tonne. Feeling bitter, he picked up a pen and circled the number under the financial charges column. ''We are paying $81 as interest charge for every tonne of steel that we make,'' he said it aloud for the words to sink in. ''So, by the time my steel leaves the factory it costs $341 per tonne.''

Mulling Over The Break-Up

Why It Helps...
Sharpens business focus to just steel-making
Rids the balance-sheet of expensive borrowings
Helps leverage cost leadership in steel manufacture
Raises investor interest and, hence, shareholder value

...And Why It Doesn't
Lowers the promoter's stake precariously
Throws the company open to takeovers
Reduces asset strength in the balance-sheet
Limits growth opportunities for individual managers

In another few hours, Kumar knew he would be seated in the back of his black Mercedes Benz along with three of his key executives, on a four-hour drive outside the city to Peekay's steel plant. But before hitting the sack for a few winks, Kumar decided to call Anirudh Desai, Peekay's director of finance. Desai was watching CNN too when Kumar called him on his mobile. ''Do you think our US exports are going to be affected if there's a war?'' Kumar asked Desai without bothering to say hello or expressing his shock over the attacks.

''It could go either way,'' replied Desai. ''If there's a war, the US may step up imports. But if the business sentiment worsens, purchases may actually fall.''

''Let's talk about it later today,'' said Kumar. ''But, ANI, the reason I called was to find out something specific. Can we lower our interest costs without losing control of any of our subsidiaries?''

''I think so,'' replied Desai. ''But given the complicated shareholding pattern within the group, individual spin-offs might be tricky. The joint venture route is an option we could look for all our non-steel businesses. Even if we were to forfeit the controlling stake, we could still retain a major holding in each subsidiary. I have done some scenario building, but I don't think I can take you through that over the phone. May be I could do that on our way to the plant tomorrow?''

''I guess you could,'' said Kumar, wishing Desai good night, and putting the cordless phone back into its cradle.

Kumar had slept for all of an hour when the electronic clock on the table by his bedside beeped. By quarter to seven, Desai and two other senior execs were at Kumar's house, waiting for Kumar to join them for a quick breakfast before setting out on the ride. ''What's the update on the attacks?'' Kumar asked no one in particular, but Desai replied. ''No news yet on how many dead, but it seems the fatality could run into a few thousands.'' Over the next 15 minutes, the terrorist attack dominated the conversation at the breakfast table.

Getting into the car, Kumar switched to the business at hand. ''We simply have to get our financial costs down,'' he said, turning to Desai. ''Yes, but the question is how?'' countered Desai. ''In the past, we have used the flagship as an investment vehicle for setting up projects in power, oil, aluminium, and telecom. Not only are these businesses capital intensive, but they have been hit by time and cost over-runs. That has sent our interest costs into a spiral.''

''But aren't we trying to swap expensive debt with cheaper funds from abroad?'' questioned Kumar.

''Yes, but this may not be the best of time to do that,'' said Desai. ''Besides, let's face it, our track record at repaying loans isn't exactly blemishless. More than once we've had our loans rescheduled.''

''But can't we convert our inter-corporate borrowings into convertible debentures?'' said Kumar.

''I'm not confident of this happening,'' Venkatesh Krishnan, a nominee on Peekay's board, butted in. ''For one, your stock price has taken a severe beating on Dalal Street, and investors are aware of the financial problems you are facing. Also, where is the market for IPOs?''

''So, what is the solution? Should we, like the analysts want, spin off our four projects into companies and offload the borrowings from our books?'' Kumar asked. ''This would sharpen Peekay's business focus. What do our institutional shareholders think about this?'' continued Kumar, looking to Krishnan.

''The consortium does not favour a break-up,'' the nominee-director replied. All your lenders see merit in a large balance sheet that comes with a diversified portfolio. But, frankly, my own view is different. True, your operational efficiency in steel is comparable to the best in the world. But the profitability-and indeed the survival-of the group is at stake because of its conglomerate nature. And the only option is for you to stick to what you are good at and divest areas that are marginal to your core business of steel.''

''But a break-up has its flipside,'' argued Kumar. ''A single business company could attract the attention of predators with an eye on synergy and cost savings. Our power unit, for instance, which has a capacity to produce 1,000 mw of power might interest a larger power unit. A pure play is more likely to invite a take-over bid which may be good for shareholders-since such acquisitions occur at a substantial premium to the market price-but bad for the incumbent management, because it reflects poorly on their past performance.''

''If we break up,'' Desai added, ''the group would shrink in size. The growth opportunities for individual managers would be reduced. But the overriding rationale against a break-up is that we need balance in our portfolio. We are good at steel, but the future lies in emerging areas like telecom. So, we should be in telecom.''

''And let us not forget,'' pointed out Kumar, ''that our shareholders invested in us because we are a diversified company. I don't think we should be concerned about focus because that is not the reason why investors came to us in the first place.'' As the sprawling steel plant loomed into sight, Kumar knew that answers would be hard to find. Just the same, he had to find them quickly.

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