CMP: Rs 2701
Target Price: Rs 2649
Grasim Industries under the proposal of restructuring of its cement business is looking to consolidate its cement business under single entity by hiving off the cement assets into an SPV and eventually merging it with Ultratech.
We believe that the eventual consolidation of cement business into Ultratech, leading to creation of India's largest cement player (capacity of 48.8 mtpa) could be a big re-rating trigger for Ultratech. Consequently we are upgrading our price target for Ultratech from Rs832 to Rs950, valuing it at par with our target valuation for ACC. Further as we do not see the restructing creating any significant value for Grasim, we maintain our HOLD rating on the stock with the price target of Rs2649.
Under the restructuring proposal Grasim will hive off its cement assets into SPV named Samrudhhi Cement Ltd (SCL) (100% held by Grasim). Subsequently SCL will issue one equity share of face value Rs5 each to Grasim Shareholders for every one share held by them in Grasim. Eventually Grasim shareholders will directly hold 35% in SCL and 65% through Grasim (indirectly). Eventually SCL will get merged with Ultratech and in consideration of merger of its cement business, SCL will receive Ultratech shares.
We estimate swap ratio to be 1:2 for merger between Ultratech and SCL, based on networth of Ultratech (Rs42 bn) and SCL (Rs40 bn) as on 30th September 2009. Based on our estimated merger ratio, Grasim would eventually hold 60 % of combined entity, Grasim shareholder would hold 17.5% and Ultratech minority stakeholders would hold the balance 22.5% in the combined entity. We note that at our assumed merger ratio of 1:2, the economic interests of the all stakeholder in the combined cement entity more or less remains same.
As far as financials are concerned, the restructuring of cement business will not result in any material changes in our earnings estimates and SoTP value for Grasim on a consolidated basis. However as Grasim's principal business segment now will be VSF and Chemical and for Cement it will just remain the 'holding company, we believe that investor now might ascribe some holding company discount to the value of its Cement business. For example in our earlier SoTP estimate of Rs2649, Grasim core business (standalone cement + VSF & others) comprised Rs1598/share or 60% of total SoTP. In our new SoTP as per the proposed structure, the value of core business, which now remains only VSF & Others, stands at Rs423 i.e. just 16% of our total SoTP value of Rs2621.
Hence given that such a large portion of the Grasim's total value would comprise of subsidiaries value & investment value, it is akin to attracting holding company discount. If we assume a 20% holding company discount the value of Grasim works out to Rs2217 which is approximately 20% lower than its last closing price.
Net-net we believe that the proposed restructuring is negative for Grasim shareholders since the structure derives significant portion of Grasim value from subsidiaries & investments. We also believe that the deal eventually would be positive for Ultratech as it provides significant re-rating triggers for the stock.
