Demystifying Grasim-Aditya Birla Nuvo merger

The Street clearly is unhappy with the way the Grasim–Aditya Birla Nuvo merger has been announced. Their unhappiness is reflected in the share price of Aditya Birla Nuvo which is down 17.5% to Rs 1,288.

Grasim, however, trades flat at Rs 4,548, though it already fell by 12% when the market sensed an announcement of the deal was in the offing.

In order to understand the market’s grouse with the deal, we first need to look at the transaction closely and understand the management’s reasoning behind it.

The two companies, Grasim and Aditya Birla Nuvo (AB Nuvo), have entered into a two-way merger. The first step involves merging the two companies and the second would be a spin-off of the financial division.

 

For every 10 shares held, the shareholders of AB Nuvo will receive 3 shares of Grasim. Post-merger when the financial services business is spun off, the shareholders of the merged Grasim will receive seven shares of Aditya Birla Financial Services – the arm which holds the insurance and asset management companies.

From a Grasim’s shareholders point of view, he would continue to hold the same number of shares of the company and will also receive seven shares of Aditya Birla Financial Services. Thus a Grasim shareholder has nothing to lose, which explains why the stock has held on though it did fall about 12% ahead of the announcement.

Considering the current share prices, 10 shares of AB Nuvo which trades at Rs 1,288 a share will cost an investor Rs 12,880. In place of his current holding he will be given three shares of Grasim which trades at Rs 4,534 and valued at Rs 13,602. There is a clear arbitrage opportunity where because of the mispricing. The Grasim shares also has in it the embedded shares of the financial services arm which will be listed at a later date for which the shareholder will receive seven shares of the new entity. AB Nuvo price has fallen to re-align with the merged ratio.

Explaining their rationale for the merger, the Birla group management has said the transaction would result in consolidation of a fast growing businesses with a strong, stable cash-flow portfolio. It will also unlock value for the shareholders via the listing of its financial arm and simplify the group structure.

However, shareholders do not buy this rationale.

One of the main concerns is that the new entity will be a holding company which will have various businesses under it. Holding companies do not get the kind of valuation a normal company does. Holding companies derive their revenues by way of dividends only.

Grasim which already had a 60.2% holding in Ultratech Cements apart from its viscose fibre and chemicals division in it will now have to bear the burden of the debt-laden Idea Cellular and other slow growing divisions like Rayon, insulators among others that were present in AB Nuvo.

AB Nuvo shareholders also have lost out on the opportunity of getting a better ratio for the financial services had the split taken place before the merger. As part of the much larger Grasim, they are now entitled to a fewer number of shares of the financial division.

Analysts have openly voiced their concern over the deal aimed at helping the group’s telecom venture ahead of Reliance Jio’s launch. Aashumi Mehta of Motilal Oswal said: “We feel that it is being done to raise funds to scale up Idea Cellular to compete with Reliance Jio.” But Kumar Mangalam Birla has denied that funding Idea Cellular was the reason behind the merger. 
 

However, the complex structure of Grasim which will now be pulled down by slower growing businesses would find it difficult to get investors who like to bet on a particular business. Rather than buying every business that Grasim holds, they would rather buy the individual businesses which are listed separately. Though in the short term – till the arbitrage exists and shares of financial services are not listed -- one can find investors sticking around with the company.