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Tuesday, Jul 23, 2002

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Hindalco - Indo Gulf: Merger moves and the larger picture

Krishnan Thiagarajan

THE proposed merger of Indo Gulf Corporation's copper business with Hindalco Industries' is poised to create a non-ferrous metals powerhouse in the country.

There is no doubt that this merger is dictated by considerations of "size" and aimed at capitalising the "combined earnings potential" of both businesses.

But the timing seems to suggest that through this merger, Hindalco has fired the first salvo in the high stakes strategic sale of National Aluminium Company (Nalco) slated for the latter part of this year. Considering Nalco's market capitalisation of over Rs 6,400 crore, acquisition of a 45 per cent stake (25 per cent from the Government and 20 per cent under the open offer) will entail an outgo of nearly Rs 3,000 crore.

Though Hindalco's shareholder funds position (excluding revaluation reserves) at nearly Rs 5,000 crore is fairly strong, it may not be financially geared if the Government were to disinvest a larger equity stake.

Following this merger, the combined balance sheet strength of Hindalco, Indo Gulf and Indal (which may be merged with Hindalco after an open offer) is slated to provide it adequate financial strength to be a serious contender for Nalco.

Timing apart, the other reasons for the merger are:

  • Strategic intent: Hindalco's aim appears to be to overtake Sterlite Industries, its only key rival in the long- term non-ferrous metal stakes. It is a well-known fact that Sterlite Industries has been attempting to consolidate its entire non-ferrous metals operations consisting of copper and aluminium under one roof.

    This proposed mergeris likely to confer a significant advantage to Hindalco vis--vis Sterlite on the financial front.

  • Right timing: This merger is being put through at a time when both international aluminium and copper prices are passing through a relatively sluggish phase.

    This downturn in prices has kept the stock prices of both the companies under pressure for almost a year or so. Hence, this merger aims to take advantage of this bearish phase in the non-ferrous metals business.

  • Size matters: In the long run, "size" is likely to play a key role in non-ferrous metals segment in the country. And this merger is probably the first significant step in that direction. Apart from the merger of the copper business, Hindalco also proposes to make an open offer for a 20 per cent equity stake in Indal and if it succeeds,it may delist the stock from the bourses. The combined entity will have revenues of over Rs 6,000 crore and post-tax earnings of over Rs 1,000 crore.

    In addition, the merger may help the two businesses derive some cost savings from the use of complementary resources.

    However, leaving "size" aside, the synergies arising from the deal for the combined entity may be limited. In the non-ferrous metals scene worldwide, there have been a separate class of players in aluminium and copper. Even consolidation, which has taken place over the past year, has been along these two lines of businesses separately. Hence, worldwide consolidation may not be adequate justification for this deal.

    The senior management of Hindalco has indicated that this merger is likely to correct the undervaluation of nearly 30-40 per cent in both Hindalco and Indo Gulf. But this is likely to happen only over the medium term. Based on the share swap ratio of 1:12 (one share of Hindalco for every 12 shares of Indo Gulf), preliminary indications are that the Hindalco stock may get a near term boost as this deal is a positive for the aluminium major.

    For the Indo Gulf shareholders also, this merger is favourable. Despite good performance from the copper business, the policy uncertainties of the fertiliser business have acted as a drag on the stock for quite some time.

    It is only recently that strong performance from the copper business, accounting for 81per cent of its revenues and 91 per cent of its profit before interest and tax for 2001-02, has unlocked some value in the stock.

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