Grasim Industries’ decision to restructure its cement assets into a separately listed entity, with the ultimate aim of merging it with UltraTech’s cement business, is seen in a positive light. However, while the deal looks beneficial from a long-term perspective, analysts believe that there are no immediate gains. But, they expect shareholders of UltraTech Cement to gain marginally from a possible re-rating in the near-term.

The scheme
Grasim plans to hive-off its cement assets, excluding its 54.78 per cent stake in UltraTech Cement, into Samruddhi Cement effective October 1, 2009. The shareholders of Grasim will get a share each of Rs 5 each in the new company, aggregating to 35 per cent (or 9.17 crore shares), while Grasim will continue to control Samruddhi with a 65 per cent stake (17 crore shares).

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The logic
The management believes that the scheme will serve some key issues. Firstly, in a release, Kumar Mangalam Birla, the group’s chairman, says, “The move is designed to ensure Grasim’s majority stake in, and continued support to, the rapidly growing cement business; while simultaneously, providing Grasim shareholders direct participation in the pure play cement company.”

Currently, Grasim is seen as a diversified entity with businesses like VSF, chemicals, cement and equity holding in group companies besides, its stake in UltraTech. Secondly, it improves the flexibility to raise resources. Adesh Gupta, whole time director and CFO, Grasim, says “Whilst Grasim’s commitment to fund growth of cement business remains unabated, the demerger opens up new choices for financing this growth.” Eventually, it will also help create a platform for potential consolidation. All of which, should help maximise shareholder value in the long-run.
 

Near-term gains limited
In terms of operational synergies, there is little to gain from the restructuring scheme as Grasim and UltraTech already share their resources and largely sell under a common brand, UltraTech Cement. While the consolidated EPS of Grasim may be impacted by 10-15 per cent due to a lower holding in cement business (now it fully owns Grasim’s standalone cement business), analysts believe that combined cement business could gain from better valuation.

Compared to the valuations enjoyed by ACC and Ambuja, the market has accorded lower valuations (by 5-10 per cent) to Grasim and UltraTech’s cement businesses. Post merger, as the new entity will emerge as India’s largest with clear focus on cement, analysts believe that it should trade at an enterprise value per tonne (EV/tonne) of $120, as against about $100 and $105 for UltraTech and Grasim, respectively.

In Grasim’s case however, some of these gains could get offset. Since its exposure will become indirect, the market is likely to attribute a 5-10 per cent discount to the value of its holding in the cement subsidiary, as it typically does for holding companies. “Post the restructuring, value for a Grasim shareholder will be the sum of direct 35 per cent holding in Samruddhi and the value of Grasim stock post the demerger,” says Archana Khemka and Akash Patel of Edelweiss Securities in a recent note.

The two analysts say that considering various valuation scenarios for listing of Samruddhi, at EV/tonne of $120 (considering the same valuation for UltraTech as well and holding company discount of 15 per cent) they have arrived at a value of Rs 2,631 for a Grasim shareholder. Most analysts have pegged Grasim’s fair value between Rs 2,400-2,700 per share, which includes the value of shares of Samruddhi that will be allotted to minority shareholders.

Meanwhile, for UltraTech, the restructuring scheme should have a positive rub-off on its valuations, in terms of re-rating from the current EV/tonne levels of $100. The longer-term benefits are expected to emanate from the enhanced flexibility to fund the cement business’ growth plans. This would help, especially given Grasim’s aim of growing faster than the industry-- either organically or through acquisitions. The company believes that it will need to set up 25 mtpa of new capacity over the next five years to maintain its capacity share, which would roughly require $3 billion in funding. The increased funding flexibility and cash-profits of over Rs 2,000 crore for the combined entity would help in this direction.
 

Conclusion
Grasim, meanwhile, would continue to focus on its VSF business, which so far provided a large part of the cash-flows to grow the cement business. Grasim is setting up a new Rs 1,000 crore project in Gujarat, which will increase its VSF capacity by 80,000 tpa. VSF, along with other businesses accounted for a third of profits of Grasim’s standalone numbers in FY09. Post demerger, Grasim will operate the VSF and other small business and have cash and investments worth Rs 1,500 crore. Analysts say, its ability to effectively utilise this cash and operating profits of over Rs 700 crore annually, will have a bearing on the value accretion for its shareholders, going ahead.

What needs to be watched is the merger ratio between Samruddhi and UltraTech. While the market is currently according similar valuations to the cement business of the two companies (adjusted for the different face values), in Grasim’s case, a few believe that there could be some upside in the form of a slightly better valuation given to Samruddhi due to its larger size and ownership of a profitable white cement business.

While the move is in the right direction, the concerns regarding the potential over-supply situation and soft cement prices loom large for the cement industry. In this context, many analysts believe that Grasim is fairly valued while they see gains of up to 10 per cent for UltraTech from current levels.

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