K.M. Birla, Chairman, A.V. Birla Group: In the eye of a controversy

The Raider GRASIM

» Denies seeking control of L&T at any stage. Reason for increasing stake is to average out its cost of acquisition » Justifies offering Rs 306 to Reliance and Rs 190 to small investors (via open offer) since the former is a negotiated purchase and the latter is only an option to exit » Has complied with all regulations for open offer, even when increasing stake up to 15 per cent » Has appealed to the Securities Appellate Tribunal to allow open offer to go through, pending SEBI's investigations » Maintains that Rajashree Birla and Kumar Mangalam Birla were appointed directors by the L&T board » Says there is no question of insider trading, with or without Reliance

The company's efforts to get a strategic partner for its cement business have been delayed on account of various international events affecting the business outlook and the financial flexibility of the potential candidates. The competing opportunities in regions of interest to the potential partners have also contributed to the delay. The shortlisted bidders from time to time changed the level of interest in the transaction due to these and other factors. At his juncture, the company is not certain as to when the discussions with potential partners would consummate.
An excerpt from a letter from L&T to the Securities & Exchange Board of India, dated December 31, 2001

For almost three years now, A.M. Naik, the firebrand chief executive of engineering and construction giant Larsen & Toubro (L&T), has been trying to find a suitor for his cement business that, at last count, was all of 16 lakh tonnes in terms of volume and contributed roughly 30 per cent to the company's net sales of Rs 8,358 crore last year.

In January 2000, Boston Consulting Group had recommended, amongst other things, that L&T spin off its cement division into a separate entity. By mid-year, the company announced that its cement business would be demerged from the core activities. L&T was to appoint an investment banker that would have the mandate of scouting for a suitable partner for it.

It's now December 2002, and Naik still hasn't been able to find a suitor for cement. What, however, added a completely new twist to the demerger saga last fortnight was the market watchdog SEBI's suggestion that partner-come-lately Grasim could have stalled the demerger.

This, in turn, indicates the A.V. Birla company exercised "control" of the professionally-run engineering giant. This alleged exercise of "control" over L&T assumes huge significance: If Grasim did even attempt to do so at any stage after acquiring a 10.5 per cent holding from the Ambanis last November, the Birlas would have had had to make an open offer. Grasim did make an offer for an additional 20 per cent of L&T shares, but that was only when it triggered the takeover code by crossing the 15 per cent ceiling. Did the A.V. Birla Group violate the takeover code much earlier?

Grasim's apparent sabotage of the demerger was just one contributor to the decision of the one-man Securities Appellate Tribunal (SAT)-to which the Birlas had appealed when SEBI shot down its open offer proposal-to block the cement and textiles major's open offer, pending the regulator's investigations.

Grasim it would appear has its reasons for blocking the demerger, because the entry of a multinational giant into L&T's cement business would put paid to its own plans of benefiting from its acquisition of L&T shares.

A.M. Naik, CEO, L&T: Sitting on the fence

The Target L&T

» Publicly maintains that as a professionally-managed company, it can't block any potential acquirer » Has been suspicious of the Birlas' attempts to gain control of the company, say observers » Has been unable to push through the demerger of the cement business for three years now » Feels, say observers, that the Birlas were attempting to block the demerger to suit their own interests » Is not too keen on cross-marketing and cross-branding initiatives suggested by the Birlas, say sources » Refuses to comment on circumstances of the Birlas appointment to the L&T board

If Birla does get L&T into the fold, he would control close to 30 per cent of the Indian cement industry. And if the capacities of his grandfather, B.K. Birla, are eventually handed down, Kumar Birla would become the No. 1 player in the sector by far, with a cement production capacity in excess of 40 lakh tonnes.

Mention the word "control" to senior Birla officials, and they'll probably recoil violently. They'll be at pains to point out that the investment in the company is strategic and is more of an attempt to enhance long-term shareholder value, that the open offer does not seek a change in control, and that the real objective of the open offer is to average out the cost of the initial acquisition of L&T shares.

SEBI, on the other hand, feels investigations are necessary-into how the Birlas (Kumar Mangalam and his mother Rajashree) got onto the board, that if the Birlas did indeed stall the demerger that's a surefire sign of exercise of control, and that if the Birlas don't want control, why on earth are they attempting to increase their holding in L&T by making the open offer?

In many ways, on the surface, the brawl under way appears unreal: In one corner you have L&T that publicly maintains it isn't averse to an acquirer coming in.

In the other corner there's Grasim, which insists it isn't interested in controlling L&T, despite making the open offer which, if successful, will take its stake in L&T up to 35 per cent. There's the referee SEBI, which in its ostensible objective of protecting minority shareholders, duly shoots down the A.V. Birla Group company's efforts to hike its holding in L&T. And then there are the cheerleaders on the ringside, the financial institutions (FIs), who are reportedly totally uninterested in selling their chunky 37 per cent stake in the cement major to the Birlas or, for that matter, to any other prospective acquirer-not at least at the price on offer.

The Price Dilemma

"Price" and "control" are two words you will encounter, with almost nauseating repetition if you're drawn into a discussion on the Grasim-L&T-SEBI fracas. Simply because that's what the brouhaha is all about.

Consider "price," which is a pretty straightforward issue. Kumar Mangalam Birla, Chairman of Grasim, forked out Rs 306 per share to the Ambanis for the 10.5 per cent holding in L&T. Now, that deal was at a whopping 47 per cent premium to the then prevailing market price of Rs 206.

Eleven months later, Birla decides that investors offering their shares will get only Rs 190 for each of them. This has got the goat of a clutch of investor grievances' forums, which in turn is adequate fodder for SEBI to consider dustibinning the open offer.

G.N. Bajpayee, Chairman, SEBI: Turning on the heat

The Regulator SEBI

» Wants the open offer to be stalled in the interest of small investors because of the huge difference between the negotiated price and that of the open offer » Claims to have enough material to investigate complaints from investor grievance associations that Grasim flouted takeover regulations, but isn't sure what the outcome of the investigation will be » Has to ascertain when exactly Grasim took control of L&T-Was it in November 2001 when the shares were acquired from Reliance, was it when the two Birla directors were appointed, or was it when cross-branding was reportedly suggested? » Wants to know why, if the Birlas weren't interested in control, did they make the condition that the Ambanis step down, and that they should stay away from L&T for five years? And why was Grasim making a public offer for 20 per cent if control wasn't the main priority? » Maintains that if open offer is allowed to go through when investigations were in progess, investors would suffer

The Birlas justify the huge gap in the two prices by contending that the deal with the Ambanis was "a negotiated purchase," which is completely different from an open offer. "A negotiated purchase reflects the exit value at which a person is willing to exit. An open offer provides the option to exit at the offer price or stay the course in expectation of better times," explains a senior Birla executive.

But price, of course, was just one problem SEBI had with the open offer. As R.A. Dada, Senior Advocate representing SEBI puts it: "Factual data has to be unravelled, for which investigations have to go on." Grasim's counter, according to G.E. Vahanvati, Advocate General of Maharashtra: "SEBI cannot stop an open offer when its investigations are not complete."

But SEBI managed to do exactly that. And much more. Having found a vulnerable area in Grasim's open offer-the unattractive price offered to shareholders-the regulator is now seeking to deliver the knockout punch with some hair-splitting interpretations of the word "control."

Other than the Birlas' alleged obstruction of L&T's cement demerger, SEBI is also investigating two other events that are being considered evidence of Grasim taking control of the engineering giant way before the open offer was made.

One of these incidents occurred immediately after the deal with Reliance, when the Ambanis gave up their two directorships, and Kumar Birla along with his mother were appointed directors. The L&T brass refused to reply to an emailed question regarding who was responsible for the nomination of the Birla directors (since L&T has no chairman).

Grasim officials maintain their directors were appointed by the L&T board. SEBI isn't too sure. It wants to investigate the process by which the Ambanis went out and the Birlas came in, who was responsible for their nomination, the role of a former General Insurance Corporation (GIC) Chairman in the appointment of the Birla directors, and the reason for the Birlas wanting to keep the Ambanis away from L&T for five years. If control wasn't on Birla's mind, why did Birla want to see off the Ambanis, is the SEBI argument.

Control Freaks

It doesn't end there. SEBI's contention is now that the Birlas had got a foot in, they might have exercised control-difficult as it may seem for the group's two board representatives to influence a 17-member board-by making, or even attempting to make, policy decisions. One such "decision" is the cross-branding and cross-marketing initiatives reportedly suggested by the Birlas.

This meant that since the two partners had multiple locations all over the country, instead of duplicating efforts, one partner could sell cement in a particular region where the other had a plant, using the cement of the other partner.

In other words, the Birlas could often end up selling L&T-made cement and vice-versa, thereby using the synergies to save on freight and octroi costs.

L&T officials refused to comment, but sources indicate that Naik was not comfortable with this arrangement perhaps because he wasn't convinced about the quality of Grasim's cement.

That's not so important. What is, is that the cross-marketing suggestion made by the Birlas can be construed as a possible attempt to exercise control over L&T, ridiculous as that may sound. For, as chartered accountant Arun Goenka, an avid takeover watcher and a Director of ANG Resources, points out: "Even if the Birlas are seen to be in a position to influence policy decisions, that can be construed as control. And the day you take control, you need to come out with an open offer."

The moot point here, though, is for two board members to influence 15 others calls for feats of miraculous proportions, whether it pertains to the cross-marketing initiative or the much-bandied demerger proposal.

Birla officials point out that since picking up Reliance's stake, Kumar Birla attended at least five board meetings, during which the demerger proposal never came up.

At the time of writing, the Birlas were still weighing their options, the obvious one being to appeal in the higher courts. The good news for L&T shareholders, though, is that the staying of the open offer may be just the goading Naik needs to finally lift the demerger blueprint off the drawing board and create some shareholder value. Meantime, Grasim's biggest competitors must be cheering too...