The acquisition of Larsen and Toubro's cement division by Grasim Industries marks the beginning of the final wave of a consolidation process in the cement industry; it also reflects the cannibalisation of market shares that occurs when dominant companies entrench themselves as monopolies.
WHEN companies strike deals, they are often assessed in terms of what they mean for the shareholder. Rarely is the spotlight focussed on the larger implications of the deals, particularly their economy-wide ramifications. The recent acquisition of Larsen and Toubro's (L&T) cement division by Grasim Industries, the biggest in India's corporate history, is a case in point. Senior officials of the two companies have expressed happiness with the terms of the deal. Industry analysts, who are trained to analyse such deals with an eye on the movements of stock prices, have pointed out that the deal will enable Grasim to "enjoy pricing power". Shareholders of L&T, it was pointed out, would benefit from the "unlocking shareholder value". However, other observers, who are not hampered by a stake in either entity, have pointed out that Grasim's "pricing power" reflects the oligopolistic tendencies in the Indian cement industry.
The deal, struck in mid-June, between the two companies, which are as different as cheese and chalk, will result in the "demerger" of L&T's cement division, resulting in a new entity, Cemco, which will be controlled by Grasim. Grasim (formerly Gwalior Rayon and Silk Mills) is part of the family-owned Aditya Birla conglomerate, which has been strengthening its position in recent years in a range of industrial intermediate commodities such as aluminium and other metals, cement and fertilizers. Founded by two Danes, Holck-Larsen (a national award-winner who died recently) and Soren Kristian Toubro, in 1938, L&T is widely regarded as a professionally managed company, with its core reputation centred on an engineering company with expertise in turnkey contracts.
Valued at Rs.2,200 crores, the complex deal has a layered structure. The first phase will result in the demerger of Cemco, in which L&T will hold 20 per cent; the remaining 80 per cent will be distributed among L&T shareholders. Consequently, Grasim by virtue of its ownership of 15.7 per cent of L&T, will acquire 12.6 per cent in Cemco. In the second phase, Grasim is to buy 8.5 per cent of L&T's stake in Cemco at Rs.171.30 a share, aggregating about Rs.360 crores. As a result, L&T's stake in Cemco will fall to 11.5 per cent. This would trigger an open offer by Grasim to L&T shareholders for their stake in Cemco at the same price. If fully subscribed, this is expected to cost Grasim a further Rs.1,280 crores. In return for the transfer of L&T's cement business, Grasim will set its stake in L&T's non-cement business at Rs.120 a share, earning an aggregate of Rs.470 crores in the process. The net cost of the deal for Grasim, including the Rs.1,020 crores that it paid Reliance Industries under controversial circumstances in 2001, is likely to be about Rs.2,200 crores. For L&T the irony is that its foray into cement, made just after it effectively smothered Reliance's takeover attempt, were beset with problems. In fact, industry-watchers had said then (Frontline, January 3, 2002) that the company was putting too many eggs into one basket.
While these are the bare details of the deal, which was struck after a prolonged, bitter and controversial battle between the two companies, it is significant for three crucial reasons. The first relates to the manner in which regulatory issues, particularly those set out in the Securities and Exchange Board of India's (SEBI) takeover code, were violated or rendered irrelevant by Grasim Industries. The second issue, a vexatious one which has been there for over two decades, pertains to the conduct of L&T's dominant shareholders representing publicly owned financial institutions. The third issue, partly related to the second, is whether publicly owned financial institutions, by virtue of their considerable stake in several companies, also have a public purpose. In particular, should such institutions not be the vehicles for the government to ensure the furtherance of strategic objectives, such as the prevention of the monopoly power in key segments of industry? The fourth issue brings into focus the question whether a professionally managed company can ever survive takeover raids, given the fact that, by definition, the shareholding by the promoters of such companies is likely to be in a minority.
GRASIM has an installed cement manufacturing capacity of 14.5 million tonnes per annum (mtpa). After it takes over L&T's cement manufacturing capacity of mtpa, Grasim will control almost a quarter of the installed capacity in India. The fact that another combine, Gujarat Ambuja Cement Ltd. (GACL) and ACC (formerly Associated Cement Company) controls about 20 per cent of the capacity implies that a duopoly has emerged in the cement business. Soon after the deal was struck, a prominent industry analyst remarked that Grasim's acquisition marked "the beginning of the final wave of the much-awaited consolidation process in the Indian cement industry." He observed that the top four groups controlled 55 per cent of India's cement-manufacturing capacity. "This", he said, "would ensure discipline and (result in) low volatility in cement prices." Although analysts could be excused for their exclusive focus on drawing investors into the industry, the standpoint of consumer interest would be diametrically opposed to this view of what is in store after consolidation.
Cement's characteristic as a bulky product makes its transport over long distances not only inconvenient but also expensive. This is one of the reasons why the import of cement has not been an attractive proposition for multinational companies such as Lafarge, which have been on the prowl for capacity acquisition in India. The vast geographical spread of the Indian market also demands that cement companies have diffused capacities in order to reduce transportation costs. In fact, it was precisely this that led to the emergence of several small players in niche regional markets. This is likely to change dramatically in the wake of the consolidation in the industry. The "discipline" that the analyst referred to implies that consolidation, resulting in greater control by a smaller number of players, is likely to dampen fresh additions to capacities, which have increased sharply during the last few years.
Between 1993-94 and 2002-03, cement capacity has doubled - from 71 mtpa to 141 mtpa. It now appears that the capacity expansion, undertaken with expectations of an industrial boom in the 1990s, has to reckon with dimmer prospects. Industry sources have pointed to the "historic laws" that cement prices touched in October 2002. The consolidation evident in the two big mergers in the industry in the recent past reflects the cannibalisation of market shares that occurs when dominant companies entrench themselves as monopolies. This is done not so much to protect market shares per se, but their ability to maintain their profitability (in fact, even increase) in the face of a recession. The consolidation process, seen from this angle, therefore necessarily implies that many of the smaller units will be driven under. Thus, newer players will be deterred from entering the market even as the existing number of players get pruned; but despite all this, and despite a recessionary situation, cement prices will simply not come down as consumers may expect from a "competitive market". Another interesting dimension of the situation, with a political connotation, is the fact that a "key driver" of cement demand is investment in government-run projects. The fact that these may pick up in a pre-election wave of government spending in the near future can only mean that some companies (read larger) may be better positioned to make high profits because of their greater geographical reach.
THE chronology of Grasim's takeover would be fit for a television soap opera. It is a story of a high-stakes battle that involves big corporate houses and is peppered with anecdotes about investigations by SEBI into insider trading charges, apart from violations of the code governing takeovers. Reliance had acquired a stake in L & T in the late 1980s. Its attempts to take control of L&T were foiled in the early 1990s by regulators and a large section of the company's professionals. In November 2001, the behemoth, having decided to unwind its position in L&T, sold its 10.05 per cent in L&T. On November 18, when it announced its decision to liquidate its position in L&T, the share's price rose sharply to Rs.208 from about Rs.150 a few days earlier. The market was stunned when reports revealed that Grasim had bought Reliance's stake of 2.5 crore L&T shares at Rs.306 apiece. In January 2002, Kirit Somaiya, BJP member of Paliament and head of the Investor Grievance Forum, wrote to SEBI alleging that Reliance had first bought more L&T stock before offloading its entire stake to Grasim. The crucial question he asked was whether Reliance acted in this manner because it had access to privileged insider information. Moreover, there were also allegations that Reliance failed to inform the stock exchanges and SEBI after its stake crossed a threshold of 5 per cent, as prescribed by SEBI. The regulator is still reported to be investigating the allegations of insider trading although it is almost two years since this happened; meanwhile, the targeted company's assets have already been sold. In fact, Reliance's purchases and sale of L&T stock merited scrutiny by the Joint Parliamentary Committee that investigated the market crash of 2001.
Grasim's acquisition of L&T shares from Reliance took its stake in the company to 14.5 per cent. The company had also managed to get two nominees on the L&T board. Meanwhile, SEBI stalled the offer on the basis of complaints from investors who wanted Grasim to pay at least the same price it had paid Reliance a year earlier. Grasim, however, argued that it was not obliged to pay that price. It pointed to the fact that the takeover code only mandated that the company offer a price equivalent to the average prevailing over the previous 26 weeks. In effect, by biding its time after buying the shares from Reliance, Grasim had beaten the price that it would have to offer. But, would the price of the share, which is supposed after all to reflect the intrinsic value of a company, vary so much within so short a time?
In the wake of the threat, L&T tried to hive off its cement unit to make the remaining portion of the company unattractive to the raiding company. But the financial institutions, which are dominant shareholders in L&T, thwarted its moves. Thus, forces within and without buffeted the company. The financial institutions held about 40 per cent of L&T. While the Life Insurance Corporation (LIC) and the Unit Trust of India held a combined stake of about 27 per cent, banks, mutual funds and other financial institutions held the remaining stake. It appears that the financial institutions played a key role in settling the sale at a relatively low price, when compared to the price that Reliance sold its stake in L&T to Grasim in 2001. Was L&T forced into a corner by the public financial institutions? The answer to that will determine whether there can ever be a true-blue professionally managed company in the country.