Cash-Stripping from Ambuja by Holcim-VRK100-25Jul2013

Rama Krishna Vadlamudi, HYDERABAD      25 July 2013
www.ramakrishnavadlamudi.blogspot.com

In the last 24 hours, Indian stock market is debating the consequences of a complex capital restructure among Holcim Group, and two listed entities, namely, Ambuja Cements Ltd and ACC Ltd. At present, Holcim holds majority stake in Ambuja and ACC. The proposed restructure is seen as a major loss to minority shareholders of Ambuja Cements, because Ambuja will pay Rs 3,500 crore to acquire 24 percent stake in Holcim India. This parting of Rs 3,500 crore cash is perceived as an indirect way of stripping cash from Ambuja Cements by its promoter Holcim. Let us analyze the proposed restructuring deal and its consequences:

The Details of the Restructuring Deal Are:

o  The boards of directors of Holcim India Pvt Ltd (HIPL) and Ambuja Cements made this announcement on 24 July 2013

o  Ambuja Cements will buy 24% of HIPL for Rs 3,500 crore

o  Afterwards, HIPL will be merged into Ambuja Cements, with the result that the latter will hold 50% in ACC (As of now, majority stake in ACC is owned by Holcim; but after the deal, Ambuja will hold 50% stake in ACC) 

o   The merger swap has been fixed at one Ambuja share for 7.4 shares of HIPL

o   Ambuja Cements will issue 58.4 crore new equity shares to Holcim

o  After the merger, the equity capital base of Ambuja will increase by 28%

o   Holcim will then own 61.4% in Ambuja, which in turn will hold 50% in ACC

o  Over the next two years, Ambuja will invest Rs 3,000 crore to increase its stake in ACC by 10 percentage points

Why this Deal is Seen as a Rip-off by Markets?

Asset-stripping or dividend-stripping is not uncommon in corporate India. The market regulator, SEBI, had in March 2013 barred six promoters of Zenith Infotech after charging them of stripping company assets for personal gains. The matter is yet to be settled. The open offer document of United Spirits Ltd contains a clause that enables the sale of company’s assets and investments by Diageo of the UK (the acquirer of USL) within two years. In 2008, the erstwhile promoter of Taro Pharmaceuticals (Israel) had tried to sell its Irish assets to ward off the takeover of the company by India’s Sun Pharmaceuticals, though Taro did not succeed in its efforts.

Even Government of India often resorts to cash-stripping by forcing public sector companies to declare higher dividends in an effort to shore up its coffers. But in this case, the minority shareholders too are benefited with higher dividends.

The arguments against the restructuring deal among Holcim, Ambuja and ACC are:

• Rs 3,500 crore cash will go out of Ambuja Cements to Holcim of Switzerland
• The deal benefits only the parent company, Holcim
• The deal is detrimental to the interests of the minority shareholders
• Ambuja will become a holding company. Generally, holding companies trade at a significant discount to their intrinsic value.
• It is not that a holding company cannot create value for companies in which it has a stake, provided the holding company has superior financial, technological or managerial capabilities. But in the present case, there is no clarity on the synergies, when both Ambuja and ACC will continue with their own branding and marketing—though Ambuja claims that the deal will result in synergies. Ambuja and ACC will continue to operate as independent companies.
• The deal is not EPS-accretive. The earning per share will be adversely impacted as the company’s paid up capital will go up by 28% after the deal.

The Market Reaction is Brutal:

The stock market has already given a big thumbs down to Ambuja Cements, with its share price losing around 15% of its value in the last two days. Very strong reactions have been expressed by several market participants against the deal.

The current shareholding pattern of Ambuja is as follows: Swiss promoter Holcim: 52%, FIIs: 29%, insurance companies: 9% (out of which LIC of India: 5.6%) and mutual funds (UTI MF, Birla Sunlife and Canara Robeco): 1%.

Reports indicate that Ambuja Cements has not expanded its capacity in the past five years, saving its huge pile of cash on its balance sheet even as the company has lost its market share in cement business.

How to Avoid Such Delinquent Companies?

Is there any way investors can avoid companies that are likely to cause heartburn to minority shareholders in future? The answer is very tricky. It is amazing to note that with only 50% ownership in Ambuja Cements, Holcim has been able to gain access to 100% of cash available in the former’s balance sheet. In such scenarios, small investors have no say in company’s affairs and they are left to fend for themselves. Promoters or top management have full access to a company’s resources, but individual investors have access only to dividends, if any, declared by the management.  

This deal is a wake-up call for individual investors (including the author) who see unutilized cash in the balance sheet as a company’s strength. I think we need to change our view about cash balances with a company. A specific company may have negative operating cash flows, or it may suffer losses in future eroding the cash balances. The only way we can protect ourselves is that we need to analyze the business prospects and other relevant factors thoroughly before making investments in a company’s equity shares.

What Should Investors Do?

Ambuja Cements board of directors consists of some independent directors of repute, namely, Nasser Munjee, Shailesh Haribhakti and Dr Omkar Goswami. Key independent directors on ACC’s board are Ashwin Dani (of Asian Paints) and Shailesh Haribhakti. It will be interesting to watch how these so-called independent directors will react to the negative commentary the company has received among the economic agents.

The companies’ bankers/lenders also will see red in the deal because it may impact their debt covenants. Regulators usually frown upon promoters who resort to asset-stripping that disadvantage the minority shareholders. The European Union and the US SEC have implemented regulatory curbs on asset-stripping, especially, by hedge funds and private equity funds. I would be curious to know how SEBI or for that matter Competition Commission of India will react to the Ambuja deal.

The stock has been punished very severely. The stock may continue its weak trend going forward. Several brokerages have downgraded the stock saying that the merger between Ambuja and HIPL is inimical to the interests of minority shareholders. The stock is down to Rs 171 per share losing 10% of its value on 25 July 2013. In the last one week, the investors have lost 20% of their shareholder wealth (of course, this specific deal is not the only reason for the sharp decline in its share price).

The existing investors may partially offload their holdings in Ambuja Cements and watch the future developments closely for the next few months. It is to be seen how the FIIs and large institutional investors, such as, LIC of India, will react to the deal.

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Notes: Asset Stripping – The process of buying an undervalued company with the intent to sell off its assets for a profit is called asset stripping. 

FIIs – Foreign Institutional Investors, SEBI – Securities and Exchange Board of India, and SEC – Securities and Exchange Commission of the US.

Disclosure: The author does not own any shares in either Ambuja Cements or ACC.

Disclaimer: The author is an investment analyst and freelance writer. His articles on financial markets and Indian economy can be reached at:

http://ramakrishnavadlamudi.blogspot.in/ and www.scribd.com/vrk100