Arushi Singh (PGP02013)
Ganesh Borude (PGP02017)
Other deals 3
Birla's Corporate Strategy 7
Reliance's Corporate Strategy 8
The Deal 9
Birla Corp 11
Reliance Cement 11
Market Expectation 12
Target Analysis: Due Diligence 13
Deal Structuring: Term Sheet 14
Deal Structuring: Analysis 16
Organisational Issues 16
Success or Failure 17
Market Reaction 18
ABOUT THE INDUSTRY
The cement industry, in any country, plays a very significant role in its economic development, provides important raw material for basic building blocks of a its infrastructural development.
The cement industry in India has, for long, grown faster than the overall economy, making India the second-largest cement producer in the world (just after China) with about 420 million tonnes (MT) of cement production capacity which means 6.9 per cent of world's cement production.
This evolution has been in three distinct phases:
1. Complete government control (1956–1982): In this phase, prices were regulated by the government. This period witnessed modest growth of 6.6%. Entry of new players was restricted due to suboptimal returns on investment.
2. Partial government control or Quota system (1982–1989): To boost growth in the industry and to support developing infrastructure, the government introduced quota system in 1982. By 1988, the ceiling price were increased significantly, leading to a growth increase of 8.2%.
3. Free cement market (1989–present): 1989 saw withdrawal of all price and distribution controls on selling of cement, and 1991 saw the deregulation of the industry. This resulted in a huge expansion in capacity and the growth has only accelerated with the development of the country.
The industry is expected to grow at 5-6 per cent CAGR from financial year (FY) 2017 and 2020. The domestic consumption is expected to outpace domestic supply in next three fiscal years. The capacity addition between the year 2013 and 2016 was of about 109 million tonnes per annum. By June 2017, total installed capacity was about 420 million tonnes which is expected to grow up to 550 million tonnes by 2025.
These developments had been expected for sometime in the country. Aided by friendly government foreign policies, several multinational players such as Lafarge-Holcim, Heidelberg Cement etc. invested in this industry. A significant reason which aids this growth is wide availability of raw materials like limestone and coal.
Industry Structure (Porter's Five Forces Analysis)
Porter's Five Forces Analysis provides a framework to study “competitive forces” that permits us to understand different dimensions governing competition within a particular industry. The five forces are –
1. Bargaining power of buyers (Low): Majorly, housing sector is the buyer of this industry and retail customers form the larger base who do not end up dictating the prices. Lack of substitutes also do not let them have the buying power as well.
2. Bargaining power of suppliers (Moderate): Due to readily available raw materials, almost every company has captive reserves of limestone with them. Due to cement companies looking for alternative sources (other than coal) where suppliers have some bargaining power. The raw material prices have gone up quite much indicating some power resting with the suppliers.
3. Barriers to entry (High): The capital cost (discussed later) is very high which is approximately Rs. 7200 per tonne making it to be a very expensive industry to enter in. Clearances are tough to be obtained making it difficult for for the new entrants to start operating and achieve economies of scale as the incumbent players. The incumbent players generally have wide distribution and marketing channels which prove to be great strategic assets.
4. Competitive rivalry (Moderate): Due to high transportation cost, the rivalry is regional. Also, the incumbent players enjoy economies of scale even though pricing power is not really with the cement manufacturers due to overcapacity.
5. Threat of substitutes (Low): There is no substitute available for cement. Building regulations require steel to be covered with fire-proof material, establishing the importance of cement.
The industry has been witnessing a wave of consolidation for a few years. The cut-throat competition is prevails, however. As per an IIFL Institutional Equities Research report, from the year 2014, 59 mtpa worth capacity has changed hands in the Indian cement industry.
The factors leading to this merger and acquisition spree are as follows:
1. Cement demand has not been revived yet. The survival of smaller unorganized cement firms is very difficult because of oversupply.
2. Amendments to the Mines and Minerals (Development and Regulation) Act were made in the year 2016 that allowed transfer of lease for captive mines as a part of deals to sell cement assets.
3. Capital Cost & Return: Setting up a cement plant takes about US$ 120-140 per tonne which has increased from around US$ 100 per tonne just about 4 years back. The increase can be attributed to increasing cost of land and its unavailability and of equipment and engineering services. This has stimulated acquisition of existing units by bigger players.
Source: Avendus Research
South & East
Barings Asia PE
JP's Gujarat Plant
JPA Bokaro (G)
JPA Panipat (G)
JP's MP Plant
The deal between Birla Corp and Reliance drove the consolidation of top 5 companies to 77% (with capacity market share in central region)
Thus, driving the cement demand higher and more and more consolidation seems to be the only way for incumbent cement companies to earn higher profits going forward.
CORPORATE LEVEL STRATEGY
Corporate level strategy is concerned with those strategic decisions a business that affect the entire organization. Financial performance, human resource management, mergers and acquisitions, allocation of resources etc. all are considered to be a part of this strategy.
It is the flagship Company under the M.P. Birla Group. Birla Corp was incorporated as Birla Jute Manufacturing Company Limited in 1919. The Company has continued to consolidate for profitability, competitiveness and growth under the guidance of Mr. Rajendra S. Lodha, late Chairman of the M.P. Birla Group. Even under the leadership of Mr Harsh V Lodha, the company engages in consolidation as when required. Acquisition (failed) of Lafarge and Reliance cement is also an example to this vision.
Birla Corp had a turnover of Rs 3,768.42 crores in 2015-16 and a net profit of Rs 157.35 crores.
The Company is primarily in cement manufacturing as its core business activity. The Cement Division of Birla Corporation owns 10 plants at seven locations, Satna & Maihar (Madhya Pradesh), Raebareli & Kundanganj (Uttar Pradesh), Chanderia (Rajasthan), Butibori (Maharashtra) and Durgapur (West Bengal). They manufacture different types of cement like Low Alkali Portland Cement, Ordinary Portland Cement (OPC), 43 & 53 grades, Portland Pozzolana Cement (PPC), fly ash-based PPC , Portland Slag Cement (PSC), Low Heat Cement and Sulphate Resistant Cement. The cement is sold under the brand names of MP Birla Cement CHETAK, CONCRECEM, MULTICEM, PERFECT, PSC, SAMRAT, ULTIMATE and UNIQUE, the umbrella brand being, M P Birla Cement.
Acquisition of 100% shares of Reliance Cement Company Private Limited and making it a wholly-owned material subsidiary of Birla Corporation Limited gave them ownership of high-quality assets, increasing its total capacity to 15.5 MTPA.
15.5 Million Tons
52,631 Metric Tons
Iron & Steel Casting
3,750 Metric Tons
The acquisition resulted in Birla Corp owning three cement plants from Reliance
1) An integrated plant at Maihar (Madhya Pradesh)
2) grinding units at Kundanganj (Uttar Pradesh)
3) grinding units at Butibori (Maharashtra)
with a capacity of 5.58 MTPA of cement and 3.30 MTPA of clinker.
RELIANCE ADAG GROUP
Reliance Group is one of India's top private sector business houses. It is serving more than 250 million customers across financial services, healthcare sectors, infrastructure, media and entertainment, power, and telecommunications.
The vision that this group follows is “to build a global enterprise for all our stakeholders, and
A great future for our country,
To give millions of young Indians the power to shape their destiny,
The means to realize their full potential…”
Reliance Cement Company Private Limited used to be a wholly owned subsidiary of Reliance Infrastructure that manufactures and sells cement. It primarily served customers in Bihar, Jharkhand, Madhya Pradesh, Maharashtra, Uttar Pradesh, and West Bengal. The company was founded in 2007. As of August 22, 2016, it operates as a subsidiary of Birla Corporation Limited.
Reliance ADAG has believed in organic growth more than acquisitions. In October, 2015 Reliance Infrastructure announced that it was planning to sell its cement business. It was one side of its plans to cut debt through sale of non-core assets. The debt stood at about Rs 25,000 crore in March,2015.
The sale was expected to help in bringing down debt by 20-25 per cent. Reliance Group had appointed Morgan Stanley to scout for buyers for Reliance Cements. It was looking at a valuation of around Rs 5,000 crore for the company with an annual capacity of 5.6 million tonne.
Reliance Cement was also developing a 5 million tonne per annum greenfield project at Wani in Maharashtra in addition to its already existing plants.
On February 2, 2016 there was the announcement of scraping of the deal between Birla Corp and Lafarge India. The deal didn't get through due to MMDR restrictions under regulatory hindrance. Birla Corp also intended to take legal action against Lafarge India. Below is the market reaction for Birla Corp.
Birla Corp announced to takeover Reliance Cement on February 4, 2016. The deal was settled on Rs. 4800 crore out of which, there was a debt of 2400 and equity of about 2400 was to be brought on. Birla Corp already a plant of 10 million capacity and planned to Reliance 5.5 million plant. On August 22, 2017 Birla Corp announced the completion the acquisition.
Due to anticipation of the deal the market started reacting on February 3, 2016 only and stabled after the announcement of the deal on February and 4 and analysts' report on market expectation from the deal. Please see the attached excel sheet to see the volumes traded of Birla Corp. For Reliance Cement, price movement of Reliance Infrastructure has been considered. Similar was the pattern when the new of completion of the acquisition hit the market.
On August 22, 2016 the prices of Reliance Infrastructure hiked, creating an upper circuit on it on August 25, 2016 and then coming down thereafter. Whereas for Birla Corp, the price dived on the date of announcement and the trend continued till August 28, 2016. The charts are in comparison with the index so as to take into account relative price movements.
MERGER MOTIVES: BIRLA CORPORATION
Merger motives for Birla Corporation are as follows:
¥ Wave of consolidation: The industry had already been witnessing a series of consolidations to overcome the problem of oversupply and take advantage of the regulatory changes. Birla Corp also needed to do the same to survive.
¥ Failed deal with Lafarge: Though Lafarge India was good bet for Birla Corp, regulatory hurdles led the deal right in the ground. To make up for the loss of time, money and to Birla's market image, a successful acquisition was the only solution.
¥ To invest in brand, channel, manufacturing, product and marketing innovations.
¥ To set up a 3 million tonnes per annum (MTPA) clinker plant in Maharashtra that would help it expand its presence in the western India market.
¥ The mining lease at Mukutban would enable the company to set up a clinkerisation unit of 3 MT in the foreseeable future," Birla Corp said in a regulatory filing.
¥ Maharashtra has limestone reserves of around 1,371.43 million tonnes. Mukutban mines are known for its cement-grade deposits of limestone.
MERGER MOTIVES: RELIANCE CEMENT
Merger motives for Reliance Cement are as follows:
• To get rid of non-core business operations.
• As part of the parent company's plans to cut debt.
• The sale would help bring down debt on Reliance Infrastructure by 20—25 per cent.
The market was expecting the combined unit to have operational synergies:
¥ Economies of scale (high) due to larger capacity
¥ Logistics (low) because two of its plants were in the same location
The market also expected the balance sheet of Birla Corporation to be hurt as the net cash of Rs. 4.6 billion would rise to net debt of Rs. 45billion. The market reaction (shown above) is in sync with this expectation. Return on Capital Employed (ROCE) was expected to dilute to 5.8% from 7.5% in pre deal stage. The expected utilization of the Reliance Cement plants were around 70% only. Expected Earnings before Interest Tax Depreciation and Amortisation (EBITDA) was expected to be around Rs. 3.5billion whereas Profit before Tax (PBT) was expected to be negative Rs. 3billion.
Central India exposure was expected to rise from 3.3mt to 8.8mt (which would be 16% in terms of market share). Birla Corporation would become the third largest after JayPakash Associates and Ultra Tech Cement. The increase in capacity after acquisition of Reliance Cement was expected to help Birla by
¥ raising dispatch mix from 40% to 55-60% in central India
¥ offering the much neede growth avenues
TARGET: DUE DILIGENCE
In an effort to reach the concerned person with the deal in the corporate office of Birla Corp, we were told that the concerned person was on leave for 2 weeks and will not resume office till January 1, 2018. They could not share, in much detail, about the deal but on asking about the due diligence they had undertaken with regard to this deal, they said,” Not much due-diligence was required on the financial front but we went into great details about the regulatory aspect. We did not want a repeat of Lafarge deal for us.”
In case of Lafarge India, Birla Corporation had entered into an agreement to buy two cement businesses of Lafarge India in eastern India for and Enterprise of Rs. 5000 crores but the deal could not go through due to regulatory hurdles by the Competition Commission of India.
Birla Corp was initially attracted to the assets of Lafarge India. The plants in Jojobera and Sonadih were the most profitable cement units in India. They had an annual cash flow of Rs. 700 crores. Adding to it was the lure of acquiring the Concerto brand. Concerto commanded a premium of around Rs. 40 per bag of cement.
Birla Corp officials were quite one-minded about Lafarge India and they hired the best brains in the city of Mumbai to vet and structure the deal but the transfer of mining rights could not happen finally and the deal fell apart.
It was at this time when Birla Corp team diverted their attention to Reliance Cement and tried to find out what they had to offer. Birla Corp simply had to acquire something significant in order to grow as organic growth would take too long. On evaluating Reliance Cement, Birla Corp officials realised that the plants were new and produced good quality cement. Reliance also had huge limestone deposits which are spread across India, enjoyed tax exemptions in two states. Reliance Cement had around 1,500 acres to set up new units, and its 5.5 mtpa capacity too had headroom for expansion.
The official also shared that Reliance Cement was that it had shared very little about its business like about the extent to which they enjoyed tax exemptions, Birla Corp. now faced a challenge is to build the business on the strength of its marketing team. Birla Corp. has got Reliance Cement's financial incentives in the form of tax breaks, which would increase margins substantially in the next few years. But in the near future, the firm's finances would be a bit stretched. As already discussed, the acquisition was expected to was not expected add to the EPS (earnings per share) immediately, but should become EPS-positive within a year.
DEAL STRUCTURING: TERM SHEET
TERM SHEET FOR
Dated: Februrary 5, 2017
Birla Corporation Limited
Reliance Cement Company Limited
Nature and purpose
Birla Corporation Limited are proposing to acquire Reliance Cement Company Limited by subscribing to 1 crore preference share (10% redeemable cumulative preference shares of Rs. 100 each), redeemable after expiry of five years.
The purpose is to:
enter into a binding commitment to implement the acquisition;
record the major commercial terms of the acquisition;
record the process and timing by which the acquisition will be implemented; and
the terms and conditions applying to it.
Subject to each of the companies being satisfied with their respective
due diligences hereunder,
They negotiate and enter into a more formal and
Comprehensive Arrangement Agreement (”AA”) by the date set out in the
The Merger is subject to the following conditions precedent:
Both parties' benefits are mentioned
During the Due Diligence Period, and until execution of the AA
each of Parties agree that:
The Parties will not undertake or allow any material business change
to their businesses and activities;
The Parties will not issue any more equity or debt securities or grant
any rights over existing issued capital
The Parties will not participate in any negotiations or discussions with,
or provide any information to, or accept or enter into any agreement,
arrangement or understanding with, any third parties in respect of a
transaction that may reduce the likelihood of success of the Acquisition
Lock Up Agreements
It is a condition that upon signing the AA ( for the benefit of Chalice) that all of
the senior officers and directors of both parties
If any party so requires it shall obtain a Fairness Opinion.
shareholders approve the Merger.
The Boards will unanimously recommend that companies'
shareholders approve the acquisition and
indicate that all Board members will vote their own shares in favour of
No shop, no talk
The AA shall contain customary non-solicitation and “right to match”
A break fee of Rs 4800 crore is payable to Reliance Cement if after the execution of this
Costs and expenses
Each party will bear its own costs and expenses in respect of the negotiation
and execution of the AA and Merger.
The parties must keep confidential the terms and conditions of this Term
Sheet, the AA and status of negotiations and will only discuss or disclose if
required by law or as otherwise authorised by the other party
and then only after appropriate
Binding Nature of the
The Parties intend this Term Sheet to be a binding document which such
Term Sheet and Formal
nature shall continue until such time as the AA is
DEAL STRUCTURING: ANALYSIS
It was an all cash deal with a premium of 140 percent on Rs. 1000 crores of equity of Reliance Cement. Birla Corporation paid Rs. 2400 crores for it and other Rs. 2400 for the debt. The share capital did not change after wards as Birla Corp subscribed to Reliance Cement's preference shares.
No particular issue was faced afterwards as no news of layoffs or cultural conflicts ever broke out and was not shared in the telephonic conversation. The financial performance hereto, also indicates towards it.
SUCCESS (Please refer to excel sheet)
COMBINED ENTITY'S PERFORMANCE (Quarted 4, FY 2017)
¥ Standalone volumes fell 2% YoY to 2.15mt (est. of 2.25mt).
¥ But, BCORP reported a strong recovery sequentially.
¥ Revenues up by 23% post demonetization.
¥ Gross cement realizations rose 2.5 QoQ to INR4,514/tonne (estimated at INR4,446)
¥ due to price hikes in focus markets
¥ Net sales stood at INR9.3b which had increased by 6% YoY; 26% QoQ (estimated at INR9.2b)
¥ Reliance Cement operated at 80% utilization.
¥ EBITDA/t for Reliance Cement is at INR1,135 v/s BCORP's standalone EBITDA/tonne at INR477.
¥ Higher profitability for Reliance Cement is due to sales tax benefits and cost efficiencies.
COMBINED ENTITY'S PERFORMANCE (Quarter 1, FY 2018)
¥ The subsidiary, Reliance Cement has operated at 81% utilization for Quarter 1 of
¥ Maihar unit operating at 95% utilization for 1QFY18.
¥ Eastern operations witnessed good demand coupled with higher share of premium products.
¥ The utilization for other units was impacted due to weak demand in core markets of U.P.
¥ Profitability of Chanderia units to be increased led by cost reduction techniques.
¥ Satna unit of Reliance cement witnessed growth of 40% YoY.
¥ Higher input cost in form of petcoke prices and slag prices impacted margins.
¥ In the AGM, management had indicated at increasing capacity from ~15.5mt to ~20mt by setting up of integrated unit in Maharashtra.
¥ Birla Corporation had invested Rs.100 crore in its wholly owned subsidiary Reliance Cement Company Private Limited during December quarter
COMBINED ENTITY'S PERFORMANCE (Quarter 2, FY 2018)
¥ Volumes impacted due to sand mining.
¥ consolidated volumes were 2.65mt (estimated at 2.85mt) led by ramp up of Reliance volumes. (declined 19% QoQ)
¥ due to sand mining ban in U.P (35% of volumes) and in Bihar.
¥ Revenues declined 15% QoQ due to lower volumes.
¥ Margins declined 2.2 percentage points QoQ due to cost push in form of higher P&F cost.
¥ Hence EBITDA at INR 1.76b which was 26% less QoQ.
¥ Interest cost due to
¥ increase in power and fuel cost led by increase in petcoke prices
¥ Freight cost/t increased 6% QoQ due to change in commercial terms
¥ increased 12% QoQ due to increase in debt levels by INR3bn in
¥ Hence PAT at INR15mn was below estimate of INR216mn.
¥ 14% QoQ increase in power and fuel cost led by impact of increase in petcoke prices. Freight cost/t increased 6% QoQ due to change in commercial terms.
¥ The subsidiary has operated at 67% utilization for 2QFY18 ( vs 81% in 1QFY18) due to ongoing sand mining ban in focus markets of U.P.
Market reaction to announcements and completion have already been shown. Below is the one year performance of Birla Corporation after the acquisition. The steady increase in prices despite market conditions show how favourable the market is towards this company and its performance.
16. Motilal Oswal reports
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