De-merger of UltraTech Cement by L&T and its acquisition by Grasim
by Rohan Jain
Category Strategy


The story of the takeover battle between Grasim and L&T had its roots in another takeover battle in early nineties. In the late 1980s, Reliance Industries Limited (RIL) had acquired 10.05 percent stake in L&T. Armed with this, RIL was aspiring to acquire L&T as a whole, and not just its cement business. Established in 1923, L&T had been (and even today is) a truly professionally managed company with core competence in turnkey engineering projects. Acquiring L&T very well fitted in RIL’s plan that was setting up mega projects one after another.
For L&T management, however, it was a life and death issue for had RIL taken over L&T, the top management of L&T would have certainly lost their freedom and control over the company and in all probability their jobs too. So L&T management fought back tooth and nail and managed to successfully ward of RIL attack.
The story of that battle is quite thrilling but not the subject matter of this case. It may be sufficient to say that RIL could not manage to get support from the government, public at large and financial institutions. At that the time, the largest shareholders of L&T were financial institutions which collectively held 40 percent stake in L&T. LIC and UTI held approx. 27 percent and the rest was held by other FIs. FIs backed L&T management and RIL had to step back.
Finally, on November 18, 2001 RIL sold its entire 10.05 percent stake (25000000 equity shares) to Grasim, an A.V. Birla group company for Rs. 766.5 crore, The price of Rs. 306.6 that Grasim paid was approx. 46 percent higher than the then prevailing market price of around Rs. 208 – 210 per share.
Thereafter, an investment company that was a subsidiary of Grasim acquired another 4.48% stake (1.112 crore equity shares) at an average price of Rs. 176.75 per share taking Grasim’s stake to 14.53 percent.
Thereafter on October 13, 2002 Grasim made a public announcement of open offer to acquire 20% stake (4.973 crore shares) in L&T at Rs. 190/- per share. While Grasim had paid Rs. 306.6 per share to RIL, it had waited for more than six months to make an open offer. The highest price paid by Grasim for L&T’s shares in twenty six weeks prior to October 13, 2002 was only 188. 15 and the average of twenty six weeks and two weeks was 174.93 and 170.08 respectively. Grasim filed the draft letter of offer with the SEBI on October 24, 2002.
On November 8, 2002 the SEBI asked the merchant bankers JM Morgan Stanley (JMMS) not to proceed with the open offer since it (i.e. the SEBI) wanted to investigate the matter of an alleged violation of Takeover Regulations in regard to Grasim’s acquisition of 10.05 percent stake from RIL. Grasim, ON November 18, 2002, preferred an appeal the Securities Appellate Tribunal (SAT) against the SEBI order and gave a public notice to that effect on November 20, 2002. Thereafter the investigation by the SEBI went on till almost third week of April 2003.
Meanwhile in December 2002, L&T management tried to outsmart Grasim by mooting a proposal to carve out its cement business into a subsidiary wherein L&T would have retained around 75 percent stake and the shareholders of have got balance 25 percent or so. This would have brought down Grasim’s direct stake in the cement business to about 3.75 percent as against its 14.53 percent stake in L&T. Grasim managed to get a stay from the court on this proposed de-merger.
Further, on January 27, 2003 Grasim made a counter proposal of vertical de-merger of cement business to L&T board, Grasim valued L&T’s cement business at Rs. 130/- per share and engineering and other businesses at Rs. 162.5 per share thereby valuing L&T as a whole at Rs. 292.5 per share. Grasim also proposed that upon de-merger it would like to make an open offer to acquire control the cement business / company.
By April 2003, the SEBI came to conclusion that Grasim had not violated Takeover Code, and that its offer was valid subject to making some additional disclosures. The SEBI then offered its comments to the draft letter of offer of Grasim on April 22, 2003. Finally Grasim’s open offer for L&T’s 20 percent stake opened on May 7, 2003 and closed on June 5, 2003. Grasim, accordingly, withdrew its appeal before SAT.
The offer failed miserably and Grasim could get only 9.44 lac shares or 0.38% stake in the open offer. However, post announcement of open offer, Grasim, through its subsidiary, had purchased another 20.56 lac shares or 0.83% stake from the open market thereby taking its total holding to 15.73 percent of L&T’s equity capital. This paved way for Grasim to make creeping acquisition without making an open offer as also to get board seats on L&T’s board.
Thereafter, in June 2003 itself the L&T management and Birlas hammered out a deal to carry out a structured de-merger of cement business of L&T and about further terms and conditions of Grasim’s takeover of control of the resultant cement company.
·         With effect from April 1, 2003, the cement business of L&T was vested in a separate company (UltraTech Cement Limited). It was decided that post de-merger, Grasim will acquire the control of the resultant cement company. However, L&T managed to retain certain key assets like L&T brand, ready mix cement (RMC) business, the gas power plant in Andhra Pradesh, and the entire residential and office property of the cement division.
·         As a part of the scheme of de-merger / arrangement, L&T’s equity capital of Rs, 248.67 crore, consisting of approx. 24.88 crore shares of Rs. 10/- each was reduced. L&T’s paid up capital was brought down to Rs. 24.88 crores consisting of 12.44 crore shares of Rs. 2 each. Accordingly shareholders of L&T received one share of Rs. 2/- face value of new L&T for every two shares of Rs. 10/- face value of old L&T.
·         UltraTech’s paid up capital was fixed at Rs. 124.91 crores consisting of approx. 12.49 crore shares of Rs. 10/- face value. L&T was allotted 20 percent of UlraTech’s equity.
·         The remaining 80 per cent was allotted to shareholders of L&T in the same proportion as the stake held by them i.e. for every five shares held in L&T shareholders got two shares of UltraTech. With this Grasim would receive approx. 12.5 percent stake in UltraTech against its 15.73 percent stake in L&T.
·         It was decided that out of L&T's 20 percent stake in Ultra Tech, L&T will sell 8.5 percent stake to Grasim at a price of Rs. 171.30 per share as against the earlier offer of Grasim at Rs. 130/- per share. With this, Grasim will hold approx. 21 per cent in UltraTech. Grasim would then make an open offer for 30 percent of the UltraTech’s equity at the same price and would take its stake to 51 per cent.
·         The open offer by Grasim was meant for not only taking control of UltraTech, but to give a chance to FIs to bring down their stake, in the process making hefty capital gains.
·         In subsequent developments, Grasim bought L&T’s stake actually at Rs. 342.60 per share and made an open offer at the same price. Grasim, thus, had to shell out Rs. 362 crores to L&T and Rs. 1298 crores in the open offer.
·         It was also decided that the residual stake of L&T in UltraTech of approx. 11.5 percent would be liquidated by L&T in small trenches and to non cement entities by 2009, if Birlas do exercise their right of first refusal in negative.
·         In turn, Grasim sold approx. 14.93 percent of its 15.73 per cent stake in L&T to an employee's trust of L&T at Rs 120/- per pre de-merger share or Rs. 240/-per post de-merger share. The remaining approx. 0.8 percent would be sold when the employee trust would dilute its stake by 1 percent or so.
Why were Birlas so desperate to acquire L&T?
As on 31st March 2003, the total cement capacity in India was approx. 135 mn tonnes. There were over 400 plants in the country consisting of 120 or so large plants and the rest mini cement plants. In terms of company wise capacity, L&T had the largest capacity of 18mn tonnes, followed by ACC at 15 nm tonnes, Grasim at 13 mn tonnes and Gujrat Ambuja at 12.5 mn tonnes. In acquiring L&T’s cement business, Birlas had a simple motive of ‘growth through acquisition’. After acquisition the combined capacity of Grasim and UltraTech went up to 31 mn tonnes, making Grasim the largest producer in India and the eighth largest in the world.
L&T was also considered as a premium brand and used to fetch higher price. Though this brand would not be available to Grasim in the long run, L&T allowed Grasim to use it for more than a year post acquisition. Later on, through an ad blitzkrieg Grasim managed to transfer brand equity of ‘L&T cement’ to ‘UltraTech cement’.
While Grasim was strong in the Southern markets, L&T was strong in the rest of India. L&T’s strong distribution network was very vital to Grasim to push its own brands also.
Last but not the least, around 2002-03, the economy had just started coming out of woods. Stock markets were still bearish and valuations low. A look at Exhibit 1 tells us that in 2003-04, the first post de-merger year, on the gross turnover of Rs. 2700 crore, UltraTech posted a PBT of just Rs. 49.20 crore. In fact, considering that other businesses of L&T grew by 32 percent in 2003-04, engineering division  turnover in 2002-03 would have been around Rs. 7500 crore and that of cement division around Rs. 2000-2100 crore. Cement division must have made losses in 2002-03. However, Birlas were aware that in the next immediate 4 to 5 years cement business would turn highly profitable and valuations would skyrocket. So they were in a hurry to acquire while they could still get it cheap.
The first and foremost reason was survival. At the time RIL tried to takeover L&T, FIs had backed L&T management to control over L&T. However, this time around the situation was a bit different. It is believed that while the open offer for L&T was going on, Birlas had succeeded in convincing FIs about the structured vertical de-merger and about FIs selling their shares in the resultant cement company either directly or through open offer. It is also believed that, if L&T management had continued to be adamant about not agreeing to vertical de-merger, FIs were willing to sell their stake in L&T to Birlas provided the price was ‘right’. Also, now Birlas could up their stake in L&T through either creeping acquisition or through another open offer. So in order to keep their control over L&T, which by then was a ten thousand crore empire even sans cement, L&T management had no choice but to agree to give away the cement business.
However, having accepted this fate accompli, L&T management did a very good job of negotiating. They managed to retain ready mix cement business and other key assets of the cement division as stated earlier. They also managed to allot to L&T 20 percent of the new company’s equity and sold 8.5 percent stake at a whopping Rs. 362 crore. Considering that the first offer of Birlas was for Rs. 130/- per share of cement company (including RMC business and all assets), the price of Rs. 346.60 per share was extremely good at that time. They also got for themselves time upto 2009 to sell the balance 11.5 percent. Considering that during October 2007, UltraTech share crossed Rs. 1100/-, this was a very good negotiation on behalf of L&T management. Also they made Birlas sell approx. 14.95 percent stake at Rs. 120/- per share to employees’ welfare trust, in the process achieving two things – getting Birlas off their backs permanently and increasing their own stake without having to shell out any money from their own pockets.
L&T management also used de-merger to strengthen L&T balance sheet. (See Exhibit 2).
In de-merger, L&T’s paid up capital was reduced to 10 percent of what it was prior to de-merger. The number of equity shares was reduced to half and face value to one fifth. This resulted into EPS shooting up.
In de-merger, while L&T had to transfer reserves worth approx. Rs. 790 crore to UltraTech, and L&T also suffered loss of paid up capital of Rs. 225 crore, debts amounting to Rs. 1900 to 2000 crore got transferred to UltraTech, due to the formula of splitting common loans specified under section 2 (19AA) of the Income Tax Act, 1961 which is mandatory if the de-merger has to be tax neutral. Due to this L&T’s Debt: Equity ratio sharply improved to 0.5: 1.
All in all the deal had a lot of positives for L&T and its management. However, a look at the performance of UltraTech for the year 2007-08 (see Exhibit 1) will show that the real winners were Birlas and not L&T.