Kumar Mangalam Birla, Chairman A.V. Birla Group: Adept strategist

It's just about a fortnight since the curtains came down on one of the longest takeover battles in corporate history. And one that seems to have pleased all concerned: A.V. Birla group's Grasim, Larsen & Toubro (L&T), and, of course, their minority shareholders. Over the past 15 days, the Grasim stock shot up smartly by 20 per cent to Rs 525, whilst L&T too inched upwards, by close to 5 per cent to Rs 248. The two-and-a-half-year-long tug-of-war appears to have been worth the wait.

On June 17, 2003, the Rs 2,200-crore deal was sealed between L&T and Grasim at L&T House in Ballard Estate, Mumbai's old-world financial district. Grasim will now own a 51.5 per cent stake in l&t's 16.5 million tonne cement business, which is to be hived off into a separate company, Cemco. For A.M. Naik, Chief Executive of the construction and engineering giant L&T, the sale means finally finding a suitor for the cement business after a three-year long search. For Grasim, acquiring a capacity higher than its own of 14.4 million tonnes per annum (TPA) takes it to the top of the heap of cement producers in India. Grasim is now the seventh largest cement producer in the world, with the largest capacity, of 31 million TPA, in one single geographic territory.

Clearly the 36-year-old Kumar Mangalam Birla, chairman of the Rs 30,000-crore Aditya Birla group, managed to do what the Ambanis couldn't in the 80s-get the better of the professional management at L&T. All along, Birla played a hands-on role in the negotiations, ably assisted by D.D. Rathi, Group Executive President and CFO, Grasim, Saurabh Misra, the cement business head, Sumant Sinha, President (Corporate Finance) and Jagdish Bajaj, Senior Vice President, Grasim.

The action has now shifted to the ninth floor of Sakhar Bhavan, in Nariman Point, Mumbai's commercial hub, where the Grasim offices are located. Five days after the deal, when this writer asked Rathi if the company had paid a higher price to gain management control, he admitted: ''Grasim has paid an aggressive price. We do not look at this as a mere acquisition of 16.5 million TPA capacity, but as a long-term proposition for the company.''

Flashback

It all began in November 2001, when Birla saw an opportunity on being sounded out that Reliance Industries wanted to sell its 10.5 per cent stake in L&T. Grasim paid Rs 766.5 crore at the rate of Rs 306 per share for the stake, which at that time was a pure financial investment. The company augmented its stake in phases till it reached 14.5 per cent in October 2002. Stresses Rathi: ''Till this stage, it was a strategic investment. The idea was to derive strategic benefits by our association with the company.'' However, having spent over Rs 1,000 crore, no company would be satisfied with just two board positions (Kumar Mangalam Birla and his mother Rajashree), points out an investment banker.

Things started to speed up only in August last when Commonwealth Development Corporation (CDC), a private equity investor, floated a proposal to pick up a 6.8 per cent stake in L&T. Grasim felt that the CDC proposal would affect its plans for L&T's cement business. So Birla put forth a proposal to the L&T board for a vertical demerger of the cement business.

In November last, Birla hit a roadblock when capital markets watchdog, the Securities and Exchange Board of India (SEBI), blocked the open offer by Grasim for 20 per cent of L&T and initiated an enquiry into whether Grasim had grabbed management control of L&T via the backdoor. The L&T management tried to put through a structured demerger proposal and at that stage the financial institutions, the largest shareholders in L&T, appeared to be backing the L&T management. Indeed, it was a tough period for the Aditya Birla group. A senior group official points out that what kept the group going during those trying times was the persistence of Birla and a conviction that the proposal would be beneficial to the shareholders. It wasn't long before the tide turned. In April this year, SEBI gave Grasim a clean chit.

But there was also the matter of making Birla and Naik see eye to eye. Enter S. Gurumurthy, the Chennai-based chartered accountant, who helped ''bring an understanding'' between the various shareholders. It was in the middle of last year that Gurumurthy was introduced to Naik by a common friend, an ophthalmologist from Shankar Netralaya in Chennai. Points out Gurumurthy: ''I had an ideological interest in bringing an understanding between the two, since I did not want the cement capacity to go to an MNC.'' Remember, L&T at one time was talking to international cement majors like Lafarge of France and Cemex of Mexico.

Gurumurthy, who came to Mumbai 10-12 times in the last eight months and at his own expense (as he insists on informing us), says it took a lot of persuasion for Birla to move away from the vertical demerger proposal and Naik from the structured demerger proposal. And finally, the partial demerger proposal emerged. To de-risk L&T engineering from any future takeover attempt, it was agreed that Birla should sell shares in L&T to a foundation created by the employees. As Gurumurthy says: ''It was more of spending time with them and counselling.''

Sure, it was crucial for L&T, Grasim and the FIs to come to a fair, neutral and equitable resolution of the problem. As late as March 2003, credit rating agency ICRA was invited by the L&T board of directors to advise on the valuation and to evaluate both Grasim's and L&T's proposals. Says R. Raghuttama Rao, Joint Managing Director, ICRA Advisory, who led the ICRA team: ''We whittled down the issues and sub-issues of disagreements between the stakeholders, by segregating the facts from opinions and judgements. This enhanced clarity on all the issues facilitating focussed negotiations amongst the parties."

Sample the issues that were points of confrontation: Would the engineering business of L&T be impacted by erosion of net worth if the cement business was demerged? Then, whilst L&T did not want to transfer the brand, Grasim was keen on ownership. The mid-route was transfer of the L&T cement brand for a year and to compensate Grasim for the brand. Also, should the ready mix cement (RMC) plant, which was a part of L&T's ECC business and not a part of the cement business, be transferred? Grasim considered RMC a part of the cement division, as is the case globally. Finally the deal resulted in RMC remaining with L&T.

Observers feel that the ICRA report presented to the L&T board on May 23, 2003, favoured the Grasim plan. While ICRA put forth a range of valuations based on different methods, including the current value, comparative transactions and the discounted cash-flow method, the final valuation of around $75 a tonne, or Rs 171.30 a share, was lower than ICRA's highest range of $85 (Rs 3,910) a tonne although it was higher than Grasim's first proposal of $65 (Rs 2,990) a tonne and the industry average of $60 (Rs 2,760) to $65 (Rs 2,990) a tonne.

Compare the valuation with other deals that happened in the past: Gujarat Ambuja paid Rs 900 crore for 14.5 per cent stake in acc, which has a capacity of 16 million TPA. A few years ago, India Cements had paid Rs 445 crore for acquisition of Raasi Cements. Or consider Grasim, which had paid Rs 32 crore for the acquisition of Dharani Cements and Rs 34.4 crore for acquisition of Shree Digvijay Cement. However, as Rao of ICRA puts it: ''This deal is a benchmark for future deals (no significant cement deals have happened in the last two years).'' Going ahead, Rao doesn't see valuations going below this level.

True. Investment bankers agree that Grasim paid a price for management control. Rathi attributes the aggressive pricing to various strategic gains for Grasim. Apart from a strong national presence, it gives leadership position in key states, including number one position in eight states that consume 42 per cent of the industry volumes and number two in four states that consume 14 per cent of the industry volumes. And as Rathi explains: ''We realised it won't give us immediate returns. But in the long run, it will be a perfect fit in strategy.'' In the meantime, according to a Crisil study of the deal, the impact of the acquisition of L&T's cement business on the financial profile of Grasim is expected to be marginal. The cash outgo for the acquisition is estimated at around 30 per cent of its net worth in 2002-03, which will be funded by a mix of internal accruals and borrowings.

Industry Dynamics

Increasing consolidation will also improve the pricing flexibility of cement manufacturers. With Grasim gaining effective control of L&T cement capacity, the share of the top five players will increase considerably in south and west India. The balance capacity is divided among 44 players with a median capacity of 1.2 million tonnes. Any potential player would have to make several acquisitions to gain marketshares comparable with the top Indian players. According to the Crisil study, since the top two Indian cement groups-Grasim-Cemco and Gujarat Ambuja-acc-are financially strong and compete for capacities on sale, the foreign players are not expected to increase their marketshare significantly in the long term.''

Now that Grasim is sitting pretty, the challenge going ahead is to make the investment work. The task is clear-cut: Hit a return on the investment of around 15 per cent by around 2006-07.