Divestures

Case:L&T:Restructuringthe CementBusiness

ChronologyofMajorEvents
18Nov01
Grasimbuys10.05%of L&TStakefromReliance atRs306.6pershare Twodirectorsnominated byGrasiminductedon theL&Tboard SEBIseeksdetailsof GrasimReliancedealon chargesofinsidertrading GrasimholdinginL&T raisesto14.15%through openmarketpurchases

13Oct02

Grasimmakesopenofferfor20%atRs.190 pershareafterraisingtheirshareholdingto 14.52%throughopenmarketpurchases.Offer scheduledtocommenceon9December2002 andcloseon7January2003

24Nov01

20Oct02

SEBItakesnoteofinvestorscomplaintson openofferpricing

27Dec01

18Nov02

SEBIdirectsBirlastoputopenofferonhold

18Sept02

20Nov02

CDCapproachesL&Tmanagementwitha proposaltoacquirea15%stakeinitsde mergedcementdivision

ChronologyofMajorEvents
27Jan03 22Nov02
GrasimfilesanappealagainstSEBI directiveinSAT

Grasimproposesverticalde mergerplanforL&Tcement businessandoffersRs.130per shareforthedemergedentity

14Mar03

SEBIclearsGrasimonchargesof managementcontrolofL&T.Asks tocomeupwithrevisedopen offer

29Nov02

SEBIadvisesGrasimnottoacquire anyfurthersharesofL&Tinthe openmarketorthroughnegotiations orotherwiseuntilfurtheradvice 18Dec02 SEBIdecidestotake legalopiniononL&Tplansofde mergertoascertainwhetherit amountsofviolationoftakeover code

24Apr03

Grasimannounces7May2003,as itsdateofopenoffer.Keepsthe offerpriceunchangedatRs.190 pershare

7May03

GrasimsopenofferforL&T shareholdersopens

SharePriceMovementofL&Tand Grasim

L&TsBusinessSegments

EngineeringandConstruction(ECC)

L&T

ElectricalBusinessGroup(EBG) Cement

LocationofCementPlantsofL&TandGrasim (IncludingSubsidiaries)

L&Twasamajorforceincement businessinthewesternpartofIndiaand tosomeextentinthesouthernpartof thecountryaswell

Cementbusinessaccountedfor around27%duringtheyear 20022003

By2002,Grasimhadbecomethethird largestplayerintheIndiancement industrywithaninstalledcapacityof13 milliontonsperannum(MTPA)

MarketShare(%)ofMajorPlayers

ImpactifL&TsCementBusinessGets AcquiredbyGrasim
Top6playerswould control~57%ofthe installedcapacityof thewholeindustry Marketleaderin cementinIndia

1/4th MarketShare

22%ofInstalled Capacity

Worlds7th largest producerofcement

L&TsShareholdingPattern

StateownedLifeInsuranceCorporation(LIC),thelargestshareholderinL&Twitha18.6%

GrasimsShareholdingPatternatthe EndofMarch,2003

Currentoffer priceofRs.190 pershare Grasimpaidin 2001toReliance: Rs.306

L&TsReactiontoGrasimsOpenOffer
Approachednancial institutionsthatheld about44%ofstakein L&Ttoopposethe openoffer Intrinsicvalueofthe stockwasatleast40% higherthanGrasims offerpriceofRs.190a share

Underthevarious valuationmethods,the L&Tscripwouldbe valuedatclosetoRs. 300ashare

GrasimsReply
Rs.190pershareisafair valuationofL&T Anyincreaseinpriceisnot intheinterestofGrasim shareholders

Grasimshareholderspaida premiuminitiallytoenter thecompanyandtheoffer pricewasintendedtobring downtheiraverageholding costofL&Tshares

OpenofferforLarsen& Toubroisnotamandatory offer,andhenceL&T shareholdersarefreeto decidewhethertheywant toaccepttheofferprice

GrasimsReply
PriceofRs.306.60persharepaid toRelianceIndustrieswastoa largelotofsharesthroughasingle transaction,wherethesellerhad agreedtoofoaditsentire stockholdinginL&Tandwithdrew itsnomineesfromtheL&Tboard Grasimwasoftheopinionthatthe 10%premiuminopenofferprice wasmorethantheexpectedvalue ofsynergypershare

Grasimwasunwillingtoputany valueonnonquantiable synergies

WhatwillbetheStatusofCombined Entity?
Considerablepresence inthewesternand southernmarketsand thusenjoygreater pricingpower Dealwillgiveaboostto industryconsolidation Betterlogisticsand inventorymanagement Reducetransportation costs

Clustersthatconsume 42%ofthetotalcement inthecountry

Willbenumberone

Gainingscaleadvantages

Operatingcostreduction

Relativelynewplant

Crossbranding

Reductioninfreightcost

Enhancedfinancial flexibility

Inpricingterms,thecombinedentitywasexpectedtogrowatarateof2%perannumduetothe increasingpowertheywouldhaveindeterminingthepricesinthecementmarket,asagainstthe currentpricegrowthof1%

Grasim'sSuggestionofDemergerof CementBusiness
MaydiluteGrasimsholding inthecementsubsidiary Birlaspreferredavertical split givingexistingL&T shareholdersashareinthe newcompanyinproportion totheircurrentholdings

Birlasservedlegalnotices onL&Tagainstproceeding withtheproposedde merger

Birlasmaintainedthatde mergerofthecement businessamountedtoasset stripping

Grasim'sSuggestionofDemergerof CementBusiness
Grasimverticallysplitthecement business,itwaswillingtomake anotheropenofferforthenew cementcompany Secondofferwouldnotonlymatch CDCsvaluationofabout$75/ton,but alsoseektobuyabout20%ofthe newcompanyinsteadofthe6.8% nallyproposedbyCDC

Birlasstressedthefactthattheir secondofferwouldenhancethe returnFIswouldreceive,asthey wouldbebuyingahigherquantityof sharesthanCDC

GrasimsnalproposaltoL&Tboard on27Jan2003envisagedavertical demergerofL&Tscementbusiness intoaseparatecompanyandanopen offerforacquiringcontroloverthe proposednewcementcompany(New Cemco)atapriceofRs.130pershare

ComparisonofMajorCementIndustry AcquisitionsSince1997

CorporateRestructuring

Demerger
Pros
Segregationofbusinessverticalsinto independententities ROCE,RONWseparatelycapturedfor eachbusiness Market/regulatorperceptionfriendly AutomaticlistingofTransfereeCompany Demergertobetaxneutralprovided prescribedconditionsarefulfilled

Cons

Limitedleveragingcapacityondemerger oflistedentities Twinlistedentities Classicaldemergerrequirestransfereeto reflectassetsatbookvalue

ShareholdersPosition
UltraTechCement
20 % 100 %

L&TEPCDivision

L&T 20%UltraTechCement 100%inEPC

80% 100%

L&TShareholders100%

L&TCementAcquiredbyGrasim
Percentageof Acquisition AcquisitionofL&TStocksbyGrasim 18thNov2001 JuneOct2002 20Oct02 AcquisitionofUTCStockbyGrasim 4Feb04 4Feb04 4Feb04 15Mar04 10.05% 4.80% 20% 11.88% 4.50% 4% 30% 50.38% FromWhom? Reliance OpenMarket OpenMarket L&T L&T L&T Market No.ofShare Face Aqcuired Value 250,00,000 119,40,000 497.51 147.79 55.98 49.76 373.2 10 10 10 10 10 10 10 Price 306 184.5 190 How? OTC Market OpenOffer

RestructuringProcess 342.6 Swap 342.6 Swap 342.6 OpenOffer

Openofferfailedfetching0.38%stake

EffectsofDemerger
ShareholdersgetanOptiontostaywiththe company
Retainedearningsmayturnnegative

Ensuredsurvivaloftheexistingmanagement

Cementbusinessasseparateentitycan createmorevaluetoshareholderby attractinggoodacquisitions

Fetchinghigherpriceatrighttime

D/Emaylookbetterduetodistribution ofdebt
It is desirable to attract Industry specific investors

EPSlikelytoincrease

Better valuation &liquidity There was notax implication inthe hands ofthe companies involved or the shareholders

ModesofDemerger
Spinoff Splitup EquityCarveout Divestitures

NeedforDemerger
Corporateattempttoadjustto changingeconomicandpolitical environmentofthecountry Strategytoenableothersto exploitopportunityeffectively tooptimizereturns whenthe parentcompanyisunabletodo so Tocorrecttheprevious investmentdecisionswherethe companymovedintothe operationalfieldhavingno expertiseorexperiencetorun theshowonaprofitablebasis

Tohelpfinanceanacquisition

Torealizecapitalgainsfromthe assetsacquiredatthetime whentheywereunder performingandnownobetter performance,capitalgaincan berealized

Tomakefinancialand managerialresourcesavailable fordevelopingothermore profitableopportunities

Sellingunwantedandsurplusor unconnectedpartsinthe businessasarestructuring strategytogetridofsickpartof thecompany

TaxBenefitsonDemerger
Dividend Nodividendincome shallariseinthehandsof shareholdersofdemerged companyondemerger Capitalgains nocapitalgains shallarisetoshareholdersof thedemergedcompanyon accountofreceiptofany sharesfromtheresulting company Expensesincurredforthe purposeofamalgamationor demergershallbeallowed @20%everyyearfromtheyear inwhichthedemergertakes place

Depreciationshallbe apportionedbetweenthe demergedcompanyandthe resultingcompanyintheratio ofnumberofdaysforwhich theassetswereusedbythem

Theaccumulatedlossesand unabsorbeddepreciationina demergershallbeallowedto becarriedforwardbythe resultingcompany

Benefitsavailablefordemerger arealsoextendedto authoritiesorboardssetupby CentralorStateGovt

ConditionsforTaxNeutralDemerger
Allpropertiesandliabilitiesof undertakingbeing transferred,shouldbe transferredtotheresulting companyandtransfershould beatbookvalue Liabilitiestoinclude Liabilitieswhichariseoutof activitiesoroperationsofthe undertaking Liabilitiestoinclude Specific loansorborrowings (includingdebentures)raised, incurredandutilizedsolely foractivitiesoroperationsof theundertaking;and

Liabilitiestoinclude Considerationfordemerger shouldbemetbyissueof resultingcompanyshares

Atleast3/4thofdemerging companyshareholders shouldbecomeshareholders ofresultingcompany

Sharestobeissuedas considerationtoshareholders onaproportionatebasis

Undertakingshouldbe transferredonagoing concernbasis

Demerger
ListedCompany demergingintotwo companies(both couldbelisted)

Division of a Company with two or more identifiable business units into two or more separate companies

The Company to obtain inprinciple approval for listing from the exchanges having nationwide trading terminals where it is listed, before issuing shares or other securities to the shareholders of Transferor Company

Types
Distributionof shareholdingina Whollyowned Subsidiaryamong shareholders ListedCompanyis demergedintotwo companiesand anotherunlisted entityismerging withtheoneofthe demergedentity.

Recapitalization
Distribution of accumulated profits by Payment to shareholders apart of sharecapital.

Writingofflossesand fictitiousassets

Correctionofover capitalziation

Cleanupbalancesheet

RevivalofaCompany

BuybackandEarnings

Earnings Shares outstanding Months 0-6 Months-6-12 Average shares outstanding EPS Change in EPS

Year 1 100 100 100 100 1.00

Year 2 100 100 50 75 1.33 33.33%

Year 3 100 50 50 50 2.00 50.00%

Year 4 100 50 50 50 2.00 0.00%

85

BuybackandEarnings

Earnings @ 20% growth rate Shares outstanding Months 0-6 Months-6-12 Average shares outstanding EPS Change in EPS EPS if no buyback Change in EPS

Year 1 100 100 100 100 1.00 1

Year 2 120 100 50 75 1.60 60.00% 1.2 20.00%

Year 3 144 50 50 50 2.88 80.00% 1.44 20.00%

Year 4 172.8 50 50 50 3.46 20.00% 1.728 20.00%

86

BuybackNeednottoIncreaseEPS Always
Year 1 No. of Shares 1000 @ 1 Operating profit Interest Income on Excess Cash@10% interest Earnings EPS After Buyback of 100 shares for 3 per share Operating profit Interest Income on Excess Cash@10% interest Earnings EPS After Buyback of 300 shares for 1 per share Operating profit Interest Income on Excess Cash@10% interest Earnings EPS 100 30 130 0.13 100 0 100 0.11 100 0 100 0.14 Year 2 100 30 130 0.13 100 0 100 0.11 100 0 100 0.14 Year 3 100 30 130 0.13 100 0 100 0.11 100 0 100 0.14 Year 4 100 30 130 0.13 100 0 100 0.11 100 0 100 0.14
87

BuybackofShares
MayincreaseEPSbutmaynot affectPEratio Priceincreasewillbetotheextent ofincreaseinEPS TreasurystockdontenterintoEPS calculation

Opportunitycostassociatedwith buyback..,Interestincomeloston netcashaftersavingondividend paymentsandInterestincurredon debtobtainedtofundthe purchase

PositiveimpactofbuybacksonEPS andROEisgreaterintheyear followingbuybackbecause Averageweightedbytimeare usedtomakeEPScalculationand Reacquiredsharesaremeasuring stockforfullyear

Ifacompanysearningare growing,buybackcangivea addedboosttotheearnings growthrateforalongerperiod thaninthecaseofstableearnings company

Positiveimpactofbuybackon earningsgrowthoccursforafinite periodoftime

Duringtheinitialyearsofbuyback eachyearsROEandimplied growthratewillbemisleading indicatorofthefuture

BuybackofShares
Managementtryingto squeezeoutafewmore EPSindeteriorating situationtomeetthe marketsforecast Maynotbeagenuine changeinmanagement attitudetowards maximizingstockholders value

Maynotbeameaningfull restructuringofthe company

Simplyacyclicalattemptto retaincontroloverthe stockholders investment

DEratioincreasesleading torunningoffwithdebt capacity maybeonlyat bookvalue

MaybethechangeinDE ratiooverstatesthechange incompanyslevelof financialriskandreduction ofborrowingcapacity

ExcessCash
Interestoncashbalanceistaxed.., Onceatthecorporatelevel Secondwhenitsdistributedto shareholders Doubletaxationondividend Makesequityacostlyformofnew finance

ExcessCash
Option1
HoldanextradollarofTreasurybondsand distributeitwithinterestatlatterdate Meantimecorporatetaxratehastobe paidonthereturn Aftertaxvalue=(1td)(1+r(1tc)) td=taxondistribution(eitherasdividend orcapitalgain) r=returnearned tc =corporatetaxrate

Option2
Distributeanextradollarrightaway Aftertaxvalue=(1td)(1+r(1tp)) td=taxondistribution(eitherasdividend orcapitalgain) r=returnearned tp =personaltaxrate Assumed:typeofinvestmentconstant insideandoutsidethefirm

Ifthedistributiontaxisnotexpectedtochange;distributionnoworafterdependson differencebetweentc andtp Distributenowiftc >tp

91

TheoriesofDividends
(Effectof$1DividendonSharePrice)
Announcement Day Price Change MM Theory Taxes Signaling Agency Clientele effects Market conditions Ex-day price change

0 + +
Depends on clientele demand Depends on sentiment

-1 -(1-td) -1 -1
Possibly less than -1

-1
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ESOP
PayingdividendreducesvalueofESOPs

ESOPsarenotdividendprotected Payingoutcashbalanceleadstolargevalue losses