Respite for JP Associates, long-term gains for UltraTech

Since the market already had a whiff of the deal, the impact for their stocks may not be huge

UltraTech's acquisition of Jaiprakash Associates (JPA)' cement units in Gujarat would provide respite to the latter and help UltraTech, part of the Aditya Birla Group, grow at a reasonable cost. After it acquires Jaypee Cement Corporation's (or JCCL, a 100 per cent subsidiary of JPA) Gujarat-based cement plants with a total capacity of 4.8 mt a year, UltraTech's capacity would rise to 59 mt.

However, while the acquisition would strengthen UltraTech's presence in the western region, it could see its debt rise in the interim. For JPA, too, the deal brings much-needed relief, as this would lower its debt and possibly, boost valuations of its remaining cement business.

Given it takes about $140 a tonne to set up a new plant, the deal's valuation of $124 a tonne (at Rs 64 a dollar) is attractive and lower compared with UltraTech's current valuation of $131 a tonne. Moreover, UltraTech, which already has cement plants in Gujarat, would gain from operational synergies (clinker supplies to plants in the coastal belt), as well as access to a jetty that would enable it to ship cement to new markets.

The management expects synergy benefits of Rs 30-40 crore a year. Currently, JCCL's units are operating at 60-65 per cent capacity, with earnings before interest, tax, depreciation and amortisation margins of just five per cent. This is far lower compared to UltraTech's Gujarat facilities, which are operating at 95 per cent capacity and earning 16-17 per cent margins.

For the acquired assets to become earnings-per-share accretive, the company feels it would take three years. Analysts, however, believe if UltraTech is able to increase utilisation to 70 per cent and margins to 10 per cent, the acquired capacity can achieve a cash break-even (after servicing the estimated debt of Rs 2,000 crore). Nevertheless, given the gestation period for setting up similar capacity is four-five years, the deal is seen as positive from a longer-term perspective.

But in the near term, it could put some strain on UltraTech's balance sheet. Analysts say while the acquisition may be beneficial, as it prevents the possible entry of new and aggressive player (if the JCCL units were sold to a competitor) in UltraTech's key Gujarat market, the immediate contribution may be negligible, given the current demand environment.

They also believe the acquisition would increase UltraTech's net debt to about Rs 6,300 crore, taking away the comfort of a relatively unleveraged balance sheet (net debt of about Rs 2,750 crore at the end of FY13). The company has already planned capital expenditure of Rs 4,000 crore for FY14 and this deal would see UltraTech take over debt of Rs 2,000 crore, as well as pay Rs 1,650 crore of third-party debt (both relating to JCCL's Gujarat plants).