Aditya Birla Nuvo: Cheaper by the Dozen

SPECIAL STORY

Conglomerates are not in. But that has not deterred the management of Indian Rayon from adding to its already cluttered portfolio. It announced last week that the businesses of group companies Indo Gulf Fertilisers (IGFL) and Birla Global Finance (BGFL) will be merged with Indian Rayon.

Shareholders of IDFL and BGFL will get one share of the new company Aditya Birla Nuvo (ABN), for every three shares they hold in either company. With fertilisers and financial services coming into the fold, ABN will now house a stable of 12 businesess.

The management's rationale for the merger: to use the cash thrown up by IGFL for emerging growth businesses such as telecom and financial services. Peeved shareholders were unconvinced and dumped the Indian Rayon stock - it slumped 6 per cent to Rs 583 the day after the merger was announced.

But the deal may not be that bad. For one, the transaction will mean a sharp increase in Indian Rayon's earnings - its earnings per share (EPS) goes up 90 per cent from Rs 9.8 to Rs 18.6 post-merger.

The equity dilution would be to the extent of 40 per cent with the paid-up capital going up to Rs 83.5 crore. Numbers apart, what's important is that the idle cash will be better utilised to drive the telecom and insurance businesses.  

Merged entity
(Rs crore)	FY05	% change post restructuring
Sales	3980	25
Networth	150	150
Net profit	1835	60
Standalone EPS	24.2	27
Consolidated EPS	18	89

Shareholders of Indian Rayon may have been disappointed with the swap ratio. Going by the prices of the three companies before the announcement, the merger ratio should perhaps have been somewhat different.

Indian Rayon was trading at Rs 620 while IGLF was quoting Rs 160 and BGLF at Rs 143. If one goes by market wisdom, shareholders of IGLF should have got one share of the merged entity for every 3.9 shares that they held while the ratio for BGFL should have been 1: 4.3 shares.

In that sense, shareholders of IGFL and BGFL have paid less for their stake in the merged entity. Interestingly, the promoters have been the biggest gainers, given that they had big majorities in both companies, 74 per cent in BGLF and 58 per cent in IGFL while they held only 28 per cent in Indian Rayon. That will now go up to 38 per cent in ABN. However, analysts believe that Indian Rayon gained from the 15 per cent stake that it bought in Idea Cellular at an attractive valuation of EV/subscriber of $400.

According to them, a more realistic valuation for the business would be an EV/subscriber closer to $600/subscriber. So, viewed from this perspective, the restructuring, they believe, is value neutral for Indian Rayon.

The restructuring has been almost a bail-out for shareholders of IGFL - the stock climbed 9 per cent post the announcement. IGFL makes urea, a product that is highly regulated and therefore has limited growth potential. Indian Rayon has paid around Rs 870 crore for IGFL.

The company should have about Rs 400 crore in cash on its books by March 2006, which was depressing valuations for the stock. Now that the cash will be used to buy the 16 per cent stake in Idea Cellular, the valuation attributed to the cash will be much higher, since the returns would be assumed to be higher.

Besides, its incremental cash flows of around Rs 90 crore annually can also be used to fund the growth of the telecom business since IGFL does not really need the entire amount for its capex plans.

Moreover, it would not be out of place to assume that the management would at some stage list Idea Cellular at the exchanges, which again would call for a re-rating of the cash flows.

Idea Cellular, which posted a net profit of Rs 74 crore in FY05 is expected to have around 7 million customers by March 2006. Analysts also believe that the valuation paid for the acquisition of BGFL of around Rs 500 crore is reasonable, given its assets under management (AUM) of around Rs 16,000 crore.

At 5 per cent of AUM, the valuation would work out to Rs 400 crore with Rs 100 crore being paid for the remaining businesses. The AMC business, however, is typically one with low margins.

Looking ahead, among the growth engines for ABN will be financial services, garments, telecom and software and IT enabled services. According to the management, these high growth segments will contribute over 75 per cent to the revenues by FY08.

Insurance is a fast-growing sector and Birla Sun Life is among the top players today with premium income of around Rs 1,000 crore. Analysts expect that the business will break even in FY07. The company's market share in the mutual funds is today 7 per cent and the management has indicated that it would like to enter pension funds and banking segments.

The garments business, which today has gross revenues of around Rs 450 crore, would be driven by menswear, the addressable market for which is estimated at Rs 13,000 crore by 2010, growing annually at 15 per cent. Indian Rayon today has 2.5 lakh square feet of retail space (including franchisees), and plans to double this in three years.

With the BPO market growing exponentially (estimated to touch Rs 65,000 crore by 2008), the management believes that it's outfit, Transworks should manage revenues of around Rs 160 crore by FY06. It has projected revenues of Rs 3,000 crore in FY06 for Idea Cellular in which it have a total stake of 20.5 per cent.

According to Hemant Patel of Enam Securities, a sum of parts valuation results in an intrinsic value of Rs 745 per share. Of this Rs 192 is accounted for by telecom, Rs 183 comes from insurance, Rs 104 from IGLF and Rs 59 from BGFL.

The remaining businesses account for Rs 207 per share. At the current price of Rs 590 therefore, there is an upside of Rs 155, or 26 per cent.