Birla Group’s yet another Restructuring favoring Whom?

Aditya Birla Group always tries to expand their business inorganically. From the acquisition of cement business from L&T to the consolidation of retail business in last year, Aditya Birla group relentlessly tries to create a value for ‘themselves’ and for minority shareholders.

Continuing their legacy, Aditya Birla Group decided to merge Aditya Birla Nuvo Limited into Grasim Industries Limited and then to de-merge financial division of Grasim (which Grasim will get through this merger of Nuvo) into Aditya Birla Financial Services Limited. Becoming umbrella for many unrelated businesses, in future Grasim will also be likely to trade at much more discount than its intrinsic value.

Aditya Birla Nuvo Limited (Nuvo) is a conglomerate operating in the service and manufacturing sectors. Its service sector businesses include Financial Services (Life Insurance, Asset Management, NBFC, Housing Finance, Private Equity, Broking, Wealth Management, online money management and general insurance advisory) and Telecom through investments in Idea Cellular Limited. Its manufacturing businesses comprise of Textiles (mainly Linen), Agri, Rayon and Insulators businesses.

Last year Nuvo consolidated their Branded apparels business. In the composite scheme, Nuvo along with its subsidiary demerged[i] their branded apparel business into Aditya Birla Fashion & Retail Limited. (Earlier known as Pantaloons Fashion & Retail Limited).

Figure 1: Note — Financial Services Division contains underlying investments. Source: Company’s Corporate Presentation

Grasim Industries Limited (Grasim) is another conglomerate of Aditya Birla group having a presence in the businesses like Cement[ii], Chemicals and Viscose staple fibre. The Company is a leading global player in viscose staple fibre and is the largest manufacturer of chlor-alkali and epoxy resins in India. Its subsidiary, UltraTech (Grasim holds 60%) is the largest manufacturer of cement in India.

Current shareholding Pattern

Currently, Grasim holds 2.57% stake in Nuvo. Hindalco Industries Limited holds 3.27% & 6.64% respectively in Grasim & Nuvo while Grasim and Nuvo hold 2.64% and 1.62% stake respectively in Nuvo.

During the period Jan-March, 2016, the Promoters increase their holding in Nuvo by more than 1%.

Aditya Birla Financial Services Limited (ABFSL) is an umbrella company for all the financial services business other than investment in Life Insurance Business and Payment bank. Currently, ABFSL is WoS of Nuvo.

Last year Nuvo merged its WoS Madura Garments Lifestyle Retail Company Limited (MGLRCL) into ABFSL. Last year before merger into ABFSL, MGLRCL retail apparel division got de-merged into Aditya Birla Fashion & Retail Limited.

Current Transaction

The above said transaction will be executed in two steps: -

Merger of Nuvo into Grasim

Upon implementation of the merger, de-merger of its Financial Services business.

Upon de-merger, Financial Services Business will get listed on nationwide bourses.

Exchange Ratio

For merger of Nuvo with Grasim, each shareholder of Nuvo will get 3 equity shares of Grasim for every 10 equity shares held in Nuvo.

For de-merger of Financial Services business into ABFSL, each shareholder of Grasim (Post-merger) will receive 7 equity shares in ABSFL for every 1 equity shares held in Grasim.

Promoter holding in ABFSL is structured in such a way that they can exercise greater control and voting powers despite having a low equity stake. In aggregate, each shareholder of Nuvo holding 100 shares will receive 30 shares in Grasim and 210 shares in ABSFL.

Financial Services Business is a division of Nuvo engaged in the financial services business, active in fund based lending, making and holding investments in financial services sector along with investment in payment bank and Life Insurance Business.

The Effective date shall be the appointed date for the transaction.

Further,

Conversion of compulsorily convertible preference shares of ABFSL into 3,36,50,000 equity shares of Rs.10 each fully paid up.

Issue of additional equity shares/convertible instruments of ABFSL to Nuvo aggregating to up to 38,25,80,000 fully paid up equity shares of Rs.10 each on the right basis.

Issue of additional equity shares by ABSFL to one or more financial investors, aggregating not more than 5% of fully diluted share capital of ABFSL.

Rationale

Some of the rationale’s as mentioned in the deal presentation: -

Consolidation of fast growing businesses with a strong, stable cash flow portfolio.

Value unlocking for shareholders via the listing of financial services.

Simplifies Group Structure

However, the transaction will result in consolidation of different businesses where risk and return are totally different under one roof. Definitely, the listing will result in unlocking the value for shareholders. However, de-merger before the consolidation would have resulted in more value unlocking for the shareholders. Consolidation of different businesses and the de-merger can create more mess for Grasim.

Post-Transaction Grasim Structure & Shareholding Pattern

Figure 2: Source Company Presentation

Table 1:Segment-Wise Performance (All Figures in INR Crore.)

GRASIMPARTICULARSREVENUEEBITEBIT %CAPITAL EMPLOYEDROCEViscose Staple Fibre7,65678710.3%7,08811.1%Cement25,5512,59410.2%32,5888.0%Chemicals3,43654415.8%3,82314.2%NUVOPARTICULARSREVENUEEBITEBIT %CAPITAL EMPLOYED RoCELife Insurance5,7001402.5%1,6868.3%Other Financial Services3,59783723.3%4,47818.7%Telecom8,3601,48417.8%18,1838.2%Textiles1,4591449.9%41634.6%Agri-Businesses2,4971767.0%1,52411.5%Rayon Yarn92822324.0%71431.2%Insulators5809616.6%40024.0%

Financials

Table 2: Current Financials for Grasim and Nuvo. (All Figures in INR Crore)

PARTICULARSGRASIMNUVOCOMBINEDRevenue36,63623,12859,764EBIT4,7784,3939,171EBIT %13.0%19.0%15.3%PAT2,3591,8854,244PAT %6.4%8.2%7.1%Capital Employed51,38128,99280,373RoCE9.3%15.2%11.4%Networth25,83014,52940,210RoE9.1%13.0%10.6%Borrowings9,73133,95943,690Interest Cost7512,3173,068Interest Coverage Ratio623Cash & Cash Equivalent2,4248903,314Current Investment3,0681,3244,392Market Cap
(As on 19.08.16)43,50017,000NANotes:-
1. The above working is made considering the financial business of Nuvo.
2. Intercompany transactions are also included in the above working.
3. Networth of the combined entity may change.

If we study Table 2, we can see that Nuvo operates in high growth emerging businesses, Grasim functions in traditional commodity sectors. In terms of margin, Nuvo is in much better position than Grasim. Businesses in Nuvo are growing much faster than that of Grasim.

Table 3:Cashflow for Grasim and Nuvo (All figures in INR Crores)

ParticularsGrasimNuvoTotal cash available (Cash & cash equivalent + Current Investment)5,4922,214Total Operating Expenses less Depreciation29,94817,009Expenses per day8247Day’s Cash on hand6748

Considering the day’s cash on hand left to both the companies, it is unlikely that cash of one company can be used by other to grow the business as we can see from the cash flow details in Table 3.

Valuation

In the last couple of months, both Grasim and Nuvo share prices soared significantly. Nuvo’s share price has almost doubled as shown in Table 4.

Table 4:Share Prices & Market Cap of Grasim and Nuvo (Source : BSE)

PARTICULARSAverage last 3 monthsAs on 10.05.16Grasim share price (INR)4,7004,214Nuvo share price (INR)1,300857Value assigned to Nuvo (based on Grasim share price, INR Crores)18,36016,462Market Cap (INR Crores)16,92811,160

Ignoring the huge jump in the share price of Nuvo, value assigned to Nuvo in the merger is much more than its market cap as on 10.05.16.

Consider this.

SR.NO.PARTICULARS aPost-Merger stake of promoters in Grasim38.82%bPre-Merger stake31.28%cIncrease in stake (a-b)7.54%dPre- Merger stake of promoters in Nuvo58.40%eDilution (d-a)19.58% As on 10.5.16As on 10.08.16fAmount required to buy 7.54% stake in Grasim (INR Crores)30003224gAmount would be realised by promoters by selling 19.58% stake in Nuvo (INR Crores)21853855

De-Merger of Financial Division

Effectively, promoter will hold 17% + 22% (Indirectly through Grasim) = 39% share in ABFSL post de-merger. Grasim’s investment (Earlier in Nuvo) of 51% in Life insurance business and investment in payment bank will get de-merged into ABFSL. It seems that the swap ratio for de-merger is designed in such way that the promoter will hold 74%, which is almost equal to maximum permissible promoters holding of 75% in any listed company.

Holding Company Discount

The Merger will result in a consolidation of unconnected businesses into Grasim. Grasim, which already has 3 business verticals, will be having 5–6 business verticals post-merger. Currently, there are no overlapping businesses in both companies except textile business, which is currently contributing less than 10% of the revenue of Grasim. Further, demerger of financial business, ABFSL will continue to remain a subsidiary of Grasim.

Holding company normally trades at 30–70% discount. Becoming umbrella for many unrelated businesses, in future Grasim will also be likely to trade at much more discount than its intrinsic value. Current shareholders of Grasim may not be comfortable with this.

Conclusion

Post transaction, all the businesses will be different in terms of risk and return. Losses of one division can hamper the profitability of other division. It’s rapidly growing finance division will continue to be the subsidiary of Grasim. From the minority shareholders’ point of view, the merger will have ended up with ownership in different businesses. One who likes to invest only in cement or telecom business will definitely fret with the announcement.

Currently, as there is no financial business in Grasim, direct de-merger of financial business from Nuvo would have created much more value for the shareholders of Nuvo. However, if they would have done that, financial business which constitute 40% of the revenue of Nuvo, would have impacted Nuvo’s valuation and promoters’ shareholding in Grasim post-merger would have been much lesser than proposed 38.82%. Nuvo’s shareholders will have to share the listing benefits of financial services business with the shareholders of Grasim. Grasim shareholders will get shares of Nuvo’s financial business without paying anything. Further, promoter holding in ABFSL is structured in such a way that they can exercise greater control and voting powers despite having a low equity stake.

Post announcement, the share price of both the companies plummeted which shows that investors are not really cherishing Birla group’s decision. Definitely, the deal is going to be a cherry on the cake for the promoters but for minority shareholders it is going to be a roller coaster ride. To get the transaction through, Aditya Birla group will require a majority vote from the minority shareholders. Now the ball is in the institutional investors’ court. Probably going ahead, we can see another ‘Vedanta[iii]’ story happening with Grasim.

[i] Check out detail analysis of Composite Scheme in our June 2015 Issue article

[ii] Check out Aditya Birla Group recent Cement Acquisitions (Ultratech buys JP Cement, Birla Corp buys 2 Lafarge Plant, Birla Corp buys Reliance Cement.)

[iii] We have recently update the Vedanta Cairn Merger Holdup due to minority shareholder. Check it out on our website.