Kumar Mangalam Birla, Chairman, A.V. Birla Group: Upbeat on getting the go-ahead from SEBI

Over the past 15 days, key executives from the mergers and acquisitions (M&A) team of Larsen & Toubro (L&T) and the corporate finance function of Birla Management Corporation, the apex body of the Aditya Birla Group, have been busy meeting up with representatives of Life Insurance Corporation (LIC). No, they aren't looking for insurance cover; it's just that LIC is the single largest shareholder in L&T, with some 17.5 per cent-Unit Trust of India and the other nationalised insurance companies hold the rest of the institutional stake totalling roughly 40 per cent. What's more, stockbrokers reveal that since the time Aditya Birla group company Grasim attempted to make an open offer for the engineering, construction and cement giant in November to increase its holding from 15 per cent to 35 per cent, LIC's stake has inched up a percentage or two. Clearly, LIC will play a major role in determining whether this professionally-run Rs 7,918-crore infrastructure jewel becomes an owner-driven company led by Kumar Mangalam Birla, Chairman of the Aditya Birla Group.

Here's the latest equation in the long-drawn-out, highly dynamic battle for the control of L&T. The tension on the faces of executives from both companies BT met is palpable. Words are carefully measured, and no stone is left unturned in attempts to convince the listener about each camp's respective point of view. After all, there's plenty at stake, Rs 11,000-12,000 crore of value to be more specific-for that's what analysts peg the value of this premier infrastructure megacorp.

Dogged By Controversy

Grasim, whose attempts to become L&T's largest shareholder, have been temporarily stymied by SEBI's pending investigations into whether it violated takeover regulations, is attempting to convince LIC (and the other FIs) to opt for a vertical split of L&T's cement business. This simply means once the division is demerged, L&T Cement's shareholding will be a mirror image of the pattern in the holding company. L&T, meantime, is trying to persuade the institutions that a structured split makes more sense-not just for the company but also for the institutions and the minority shareholders, as more value can be unlocked this way. Via this route, a strategic partner will be sold a stake in the demerged entity based on the valuation of L&T's 16.5-million-tonne capacity, and L&T's M&A honchos point out that this will result in a higher value for shareholders than via a vertical split. For L&T, a structured split also considerably reduces its chances of losing control in the demerged cement entity-something that's a very real threat if the division is split vertically.

To decide the fate of L&T, the FIs need to find out the precise value of L&T's cement division. L&T sources point out that it could range from $80-100 (Rs 3,840-4,800) per tonne, and if the vertical split is resorted to, the value emerging from a demerger will be just around $53-55 (Rs 2,544-2,640) per tonne, thereby shortchanging all shareholders. JP Morgan's equity research cell recently pegged the value of the cement business at $41 (Rs 1,968) per tonne (assuming a valuation for the non-cement businesses at 1x sales). "The decision the FIs have to make is whether they want to cash in now, or at a later stage at a much higher price," points out a senior L&T source, who adds that a strategic partner could be tied up in another one-and-a-half years.

Birla's corporate finance managers for their part say that if push comes to shove they would consider the structured deal, but certainly not at the price L&T is talking about. But the way things stand currently, they don't feel push would come to shove, and that a vertical split is indeed the FIs' best bet. Although SEBI investigations are on into whether the Birlas did violate the takeover code when acquiring their first 15 per cent in L&T (10.5 per cent from the Ambanis), Grasim sources are upbeat that the watchdog will give them a clean chit. That, in turn, will allow Kumar Birla to go ahead with his open offer, although he might have to revise the proposed price of Rs 190 per share; the L&T share on January 13 was quoting well over that figure, at Rs 205. If the open offer does go through, and the Birlas are able to garner close to 35 per cent in L&T, along with a little help from the financial institutions (FIs) Grasim could become the largest shareholder in the company. Eventual result: Grasim gets majority control not just in L&T but also in the demerged cement business. One option-which Grasim says it hasn't considered-is that it could swap some of its stake in L&T with the FIs for a controlling holding in L&T Cement.

Birla group sources also point out that the likelihood of a structured deal happening in the near future are remote because the structure itself-L&T had proposed a 37.5-37.5 per cent equal stakes deal, with the rest being held by the other shareholders-is flawed. And that's why no MNC partner has been willing to tie the knot, as they're uncomfortable with such an arrangement. Indeed, since early 2001, a few months after the L&T board green-signalled the demerger, the company's top brass kicked off negotiations with three global cement majors, Holcim of Switzerland, Cemex of Mexico and Lafarge of France. By September of that year, L&T Managing Director A.M. Naik and his A team shifted the spotlight on to financial investors. A beauty parade was lined up, with the likes of Citiventures, JP Morgan, amp Harvard, HSBC Private Equity and the Commonwealth Development Corp (CDC) taking part. By November, Reliance and Grasim stalled the contest, when the Ambanis sold their stake in L&T to K.M. Birla. The equity investors took a step back. By September 2002, however, CDC was back with an investment proposal, which at the time of writing was still awaiting the L&T board's blessings.

A.M. Naik, MD, L&T: Rough weather

The delay in cement demerger could mean a possible exit fromt he cement business for L&T and its future as a professionally-run company would be in doubt

Fly In The Ointment

Now the cdc proposal has come in -too coincidentally perhaps, the Birla camp could deduce-roughly around the same time the Birlas were seeking to up their stake in L&T. For, CDC and L&T have their own plans for the cement business, which are of course pending that crucial board go-ahead. According to this proposal, CDC will pick up 6.8 per cent in the demerged entity for Rs 291 crore, with L&T holding 70 per cent, and the rest offered to the financial institutions, the A.V. Birla Group and the public. The cement subsidiary will have an equity capital of Rs 170 crore, and L&T shareholders will be issued 6.25 crore equity shares of the newly-created outfit in a 1:4 ratio.

Sounds good? L&T head honchos for their part think so. "Till we are able to find a strategic partner, this investment will provide us with the much-needed capital infusion required for acquisitions and growth," says a senior L&T manager. Tell that to anybody at Industry House, the Birla headquarters in Mumbai's commercial district, and they'll scoff at the CDC proposal. And not just because it puts paid to their own gameplan for L&T and its cement business. "The proposal is extremely flawed and needs to be dustbinned. For just Rs 291 crore, and with just a minority stake of 6.8 per cent, CDC will get complete control of the cement entity," says a key member of the Birla group A team.

Here's how, and why: According to the proposal, L&T cannot take any decision in the affairs of L&T Cement without CDC's consent. CDC's nod is also required when constituting the board, appointing directors, as well as in the appointment or removal of senior management and the fixing of their remuneration. Then, CDC's approval will also be needed for tapping the capital markets, appointing advisors, making acquisitions or sell-offs, borrowing from banks and for making bonus or rights issues and paying dividends. More significant, point out Birla sources, is a "drag-along" condition that says if CDC decides to divest, L&T would be forced to divest up to 42 per cent of its holding, thereby resulting in a new buyer (with 51 per cent) taking control. "These are tough conditions and distinctly unfriendly," says the Grasim source. "The proposal is heavily tilted in CDC's favour, and is in fact a sellout." The implication: the L&T management is ready to go ahead with any proposal-however flawed it may be-as long as the Birlas are kept at bay.

The L&T camp, meanwhile, is at pains to point out that the CDC investment plan is only a "first-cut proposal that needs more refinement. We haven't accepted it, and are currently refining it". They also add that the only reason Holcim, Lafarge and Cemex didn't ally with L&T is that they were all pre-occupied with major global deals at that point in time, each worth $3-4 billion, thereby fully stretching their balance sheets. Whatever be the reason, though, the delay in the cement demerger could cost the engineering and construction major dear: not only does L&T have to brace itself for a possible exit from the cement business, its future as a professionally-run company appears hazy.