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L&T: Restructuring the Cement Business

L&T Restructuring the Cement Business

What factors motivated Grasim to acquire RILs stake in L&T at a hefty premium? Was the open offer price of Grasim Reasonable?

Will the proposed de-merger unlock the shareholder value of L&T?

L&T Restructuring the Cement Business

What are the options before L&T Shareholders? Will the proposed acquisition change the industry dynamics?

How will you justify the role of various stakeholders in the episode?

Determinants of Value
Return Growth Cash Flow

Capital Risk Cost of Capital

Company Value

Matching with First Principles


Reduce Risk Restructuring enhance value through strategies that...

Enhance life of assets with potential


Enhance growth of assets with potential

The Value Creation Matrix


Improve management Replace inefficient one

Managerial Dimension

Financial Dimension
Redeploy capital Increase ROI

Risk Dimension
Cost of capital reduction

Value Creation

Operational Dimension
Scale Economics Improve margins

Release Value

Market Valuation

De-merger
Placing Value in the Shareholders Hands

De-merger Concept
Shareholders
Shares

Company AB
Business A Business B

De-merge

Company B
Business B

Post De-merger
Shareholders Shares

Company AB
Business A

Company B

De-merger - The Aptech Case


Immediate results
Market Capitalization in Rs. crores

165.6
71.1 Apple 124.4

TOTAL
Aptech

94.5

Apple(Finance)

L&T De-merger of Cement Division Background


% share Cost Total (Rs/Cr)

Per Share Purchase of L&T from RIL (at 47% premium) on Nov.18, 2001 Purchase of L&T from Open Market

10.05 5.65 15.7

306.6 166.5

776 234 1010

L&T: Restructuring the Cement Business

October 14, 2002: Open offer for 20% equity of L&T at Rs 190 per share (at 10% premium) Shareholding Pattern of L&T at the end of September 2002 LIC (18.6% stake): offer price lower than the intrinsic value

Banks/ FIs/ Insurance Mutual Funds / UTI FIIs

26.53%

Grasim

14.15%

11.98%

Indian Public

31.68%

6.35%

NRIs

0.75%

Private Corporate Bodies

18.08%

Others

4.63%

Response of L&T Management

Price was not beneficial to the shareholders of L&T Worried over losing control over the company Approached FIs to oppose the open offer L&T Valuation at close to Rs 300 a share
(Business Standard, November 15, 2002)

Kumar Mangalam Birlas Response


The main objective of the offer is to bring down the Grasim Industries cost of acquisition of the cement and engineering major. Shareholders of L&T have several options. The groups open offer for Larsen & Toubro is not a mandatory offer, and hence L&T shareholders are free to decide whether they want to accept the offer price.
Take it or leave it, says Birla on L&T Offer. Business Standard, November 22, 2002

Indian Cement Industry


Largely fragmented with an installed capacity of 130 MTPA as on March 31, 2002 120 cement plants & 54 companies L&T: 16 MTPA Grasim Industries: 12.9 MTPA Ambuja Group: 12.5 MTPA ACC: 14.93 MTPA High leverage, debt-to-equity ratio of 2.32:1

Possible Synergies: Grasim & L&T Combine

Considerable presence in the western & southern markets


Cluster that consume 42% of total cement Grasim & L&T combine will be number 1 L&T Plants have low costs per ton of cement Better logistics and inventory management

Operating costs reduction


Enhanced Financial Flexibility

CDC Capital Partners Plan

L&T Cement Division


70% stake with L&T 25% stake with L&T shareholders 5% stake with CDC Capital Partners $75 per ton or Rs 156-158 per share

Valuation of Cement business

Valuation Methodologies

Relative valuation using Market Multiple Approach

Discounted Cash Flow (DCF) Methodology


Real Options

Relative Valuation Market Multiple Approach

Multiples of earnings paid

= Purchase price per share / Targets fully diluted EPS before extra-ordinary items = Purchase price per share / Targets fully diluted CFPS before extra-ordinary items

Multiples of cash flow paid

Relative Valuation Market Multiple Approach

Multiples of EBIT paid

=(Aggregate purchase price of equity + Market value of debt assumed) / Targets EBIT before extra-ordinary items =(Aggregate purchase price of equity + Market value of debt assumed) / Targets EBITDA before extra-ordinary items

Multiples of EBITDA paid

Relative Valuation Market Multiple Approach

Multiple of book value paid

= Purchase price per share / Targets book value per common share = (Purchase price per share - Targets share price pre-merger)/ Targets share price premerger

Premium paid

Relative Valuation Market Multiple Approach

Multiples of replacement cost paid

= (Aggregate purchase price of equity + Market value of debt assumed) / Replacement cost of targets assets

What has happened ?

Three-Step Process

L&T hive-off Cement business into a separate company Ultra Tech CemCo where it will hold 20% stake; balance 80% held by the L&T shareholders proportionately Grasim would buy 8.5% in Ultra Tech CemCo from L&T at Rs 171.30 per share and make an open offer for another 30%

L&T Employee Welfare Foundation will acquire Grasims 15.3% stake in the residual engineering company

Demerger ratio

For every 2 shares (of face value of Rs 10) held in L&T, the shareholders were given 1 share (face value Rs 2) in the new L&T For every 5 shares held in L&T, the shareholders were given 2 shares in the demerged cement company Ultra Tech CemCo

Sale @ Rs 120 Grasim 14.86% Samrudhi 0.87% Others 84.27% Restructuring 1:2 De-merged Company L&T Trust 15.7% Others 84.27%

Shareholders of L&T

Shares 2:5*

L&T Limited Assets & Liabilities

FV of Rs 2 each -> FV of Rs 10 each

Pre-open offer Ultra Tech CemCo Ltd Grasim 12.6% L&T 20% Others 67.4% Open Offer Buyer Grasim Grasim Total Seller L&T Others % 8.5 30 38.5 Cost 362 cr 1278 cr 1640

Post open offer Grasim 51.1% L&T 11.5% Others 37.4%

*2 equity shares of Rs 10 each for every 5 shares of Rs 10 each in L&T

Net Outflow
% share Per Share Purchase of L&T from Reliance Ind Purchase of L&T from Open Market Purchase of CemCo from L&T Open Offer for CemCO Sale of shares in existing L&T Net Outflow 10.05 5.65 8.5 30 15.7 307 167 171 171 120 Cost Total (Rs/Cr) 776 234 362 1,278 (468) 2,182