Cementing a deal

When Grasim chairman Kumar Mangalam Birla hosted a celebration dinner on Thursday night he should have raised a toast to an unknown librarian.

Why is that? Because it was the librarian who recollected seeing some notes written in the early 1980s during former L&T chairman N M Desai's era about L&T employees owning shares in the company.

And, it was the same librarian who pulled out the crucial correspondence on the subject from L&T's archives. Without those notes the Grasim-L&T deal might have been much tougher to pull off.

Unusually, this is a deal that should leave all sides happy. A little more than three years ago management consulting firm Boston Consulting Group advised that the Rs 8,000-crore (Rs 80-billion) engineering company L&T should exit cement.

BCG's prescription is being followed and the Rs 2,200 crore (Rs 22 billion) deal was finally sealed on Tuesday.

Grasim will own 51.5 per cent stake in L&T's 16.5 million tonne cement business, which is to be hived into a new company.

Kumar Birla has finally got what he had coveted for a long time. And L&T is happy as it is now free to focus on its core strengths in engineering and construction, with the cash-draining and low-profit cement off its back.

"By this year end, we should be able to bounce back to 95 per cent of our original turnover. The demerger of the cement business will not impact us, such is the backlog in our order book," says A M Naik, L&T chief executive officer and managing director from his first floor office in L&T House in Mumbai's Ballard Estate.

The fact is that two days after the deal, the mood at both Grasim and L&T is much cheerier than the leaden grey sky outside. The L&T management says it has been warning cement division staff for a long time that a sale might be a possibility.

"It is like a daughter you know, she has to be married off one day but still you feel sad when she is gone," says a senior L&T manager.

In Grasim's offices on the ninth floor of Sakhar Bhavan in Mumbai's Nariman Point, the implications of the deal are just sinking in.

As Grasim group executive president and chief financial officer, D D Rathi candidly admits: "We have bid very aggressively and it will take quite sometime to digest this (acquisition)."

Rathi is talking of absorbing L&T's 16.4 million tonne capacity into Grasim's own 14.5 million tonne capacity. There are serious financial implications.

The Rs 4,000-odd crore (Rs 40 billion) acquisition cost (including the Rs 1,860 crore debt liability) will start yielding respectable returns only after three years.

Rathi says he will be happy if the acquisition only pays for its interest burden in the initial years.

The acquisition has forced the Birla group to rework some of its capital expansion plans, though Rathi still maintains that "essential capex at other units will not be derailed due to this acquisition."

In the middle of this churn, Rathi reiterates that the deal still makes good sense because "Kumar Mangalam Birla is very clear in his mind that Grasim is in the cement business for the long haul."

When the A V Birla group set its sights on L&T's cement business three years ago, Birla is reported to have said that it wanted to be the undisputed leader in cement.

"Cement is linked to the future of this country. It is a replica of growth in the economy be it residential construction or infrastructure. The employment multiplier in the sector is much larger than in other sectors," he told an unbelieving group of senior managers.

"Cement is our strength," Birla repeated to group finance executives when they pulled out spreadsheets showing that the returns on investment in cement in the last three years were negative.

Even L&T's cement business was clocking an ROI of a meagre four per cent, they said.

But Birla was gambling big on size. The cement acquisition now catapults him to top of the heap in the country's 31 million tonne per annum combined cement capacity. He is also the seventh largest cement producer in the world.

What's more, Grasim now becomes the world's largest cement producer in a single geography.

So what was initially a pure financial investment with 10.5 per cent of L&T in November 2001-- when it bought out Reliance Industries' stake in the company -- became a rallying point to get full management control.

A top merchant banker in Mumbai rationalised: "Having spent Rs 1,100 crore (Rs 11billion) on acquiring a 15.74 per cent stake (including the open offer to L&T shareholders), Birla couldn't have been content with just board nominees on the parent company."

Rathi concedes the point: "We had the option of being a financial investor in the parent company or angle towards a position where we got management control over the cement business."

Meanwhile, the L&T management was moving to a different beat. BCG had advised L&T way back in 1999 to stick to its knitting in engineering and divest the cement business.

BCG even chalked out a timeline: bring in a strategic investor by 2001 which would bring in the funds required for investment and put the cement business on a firm footing.

By 2007, BCG said, L&T should look at exiting the cement business completely.

L&T's compulsion was time. The cement business was sucking in a lot of money that could otherwise have gone into growing the core businesses.

"It was only because of cement that the company's financial parameters are depressed. L&T could have grown much faster without the cement business," says Naik.

Birla's entry into the company came at a time when L&T was talking to international cement majors like the German Holcim (earlier Holderbank), Lafarge of France and Mexico's Cemex to divest a 37.5 per cent stake in the demerged cement company (L&T and the foreign partner were supposed to take a 37.5 per cent stake each, with the rest going to the public).

L&T's condition that the acquirer would have to merge its own capacities with L&T's proved to be a stumbling block for Birla to come in directly.

But all the foreign players wanted management control, which L&T was unwilling to cede. The discussions petered out and the L&T management started looking for strategic financial investors in the last quarter of 2001.

Nothing moved till about August 2002 when private equity investor Commonwealth Development Corporation, floated a proposal to pick up a small equity stake in L&T.

Though the proposal was for CDC subscribing to L&T's to-be-issued foreign currency convertible bonds, the conversion clauses said CDC's $60 million investment could be converted into 6.8 per cent of domestic stock in December 2004.

The proposal raised hackles all around as Grasim found too many restrictive covenants in the CDC proposal. These, it felt would block its own plans for the cement business.

Armed with two board positions, Grasim made its annoyance with the piecemeal solutions obvious to all.

Thus, the battle lines were drawn with no apparent ground for reconciliation, with each side pushing the merits of its own proposal.

Enter the redoubtable S Gurumurthy, the Chennai-based chartered accountant and one-time fiery columnist, around mid-2002.

L&T's Naik concedes Gurumurthy was referred to him by a common friend in Chennai after he pored his heart out to him over the imbroglio.

Asked specifically, why he needed the services of a mediator, Naik only says, "When two parties have violently opposite views on a subject, it is only honourable to get a mediator to make the other party see your point of view." He claims he didn't want to lose a valuable customer like Birla.

"Each and every corporate house in the country is an L&T customer, and we didn't want this small issue to endanger a long business relationship. So I said there is no harm in talking to Gurumurthy," he adds.

The diminutive number cruncher, who recently helped to settle the Bajaj family feud, must have worked wonders. By January 2003, both parties were talking constructively after the last irritant -- the CDC offer -- had been buried a month earlier.

By the first week of January, Grasim came back to the table with an "alternative proposal". It entailed Grasim swapping its 15 per cent stake in the parent L&T with the 40 per cent stake held by the financial institutions in the cement company.

Thus, it would be left with a clean, indisputable 55 per cent stake in the cement company while making an honourable exit from the core company. Things were falling into place.

Naik agrees that he saw the possibility of "an integrated solution" by late-January.

So much so, that he personally called upon the only surviving but ailing founder of L&T, Horck Larsen in hospital to explain to him the possible integrated solution. Larsen gave the go-ahead.

"If the core engineering business is going to be independent (after this swap) and you get a good price for cement, it is worthwhile going ahead," he said.

Armed with that crucial mandate, Naik began working out the implications. But there were some serious problems about the proposal.

For a start, if institutions were going to get another 15.7 per cent in L&T, over and above their current 37 per cent stake, then L&T would become a government company, an overwhelmingly FI-owned company, Naik argued before the top L&T management.

On the other hand, if the FIs were allowed to sell the 15 per cent there would also be problems.

First, there was a fear that the L&T scrip would crash, if Birla's 40 million shares were added to the floating stock.

"The small shareholders would have got hurt, and because of the high floating stock, the share price would never have reflected the company's financials," says Y M Deosthalee, L&T's chief financial officer.

There was also a fear of yet another corporate raider capturing that 15.74 per cent lot of shares. A merchant banking source who has worked closely with L&T in the past says, "The company has been lucky as only two parties ever nurtured ambitions for it."

He was obviously referring to the Ambanis' attempt in the 1980s and the Birlas now. "Both were gentlemen and saw the worth in the company before attempting something outrageous," he adds.

That's when somebody remembered the employees' stock scheme and figured out that it could be ingeniously put to use.

And the final turning point came when the unidentified librarian pulled out some notes penned by erstwhile chairman N M Desai, suggesting an employee stock option scheme to the government.

At a time when stock options were not part of the Indian way of doing business, Desai had argued before the government that L&T employees be given 10 per cent of the equity to further strengthen their sense of belonging to the company.

Desai wanted the employees to feel that they owned the company and not the government or the FIs. The L&T stock then was quoting at around Rs 20 and its highest price was Rs 32.

This time, however, the aim was slightly different. Naik calls the employee stock option formula "immediately appealing, and the final solution to the problem was staring at us."

That's how the idea of putting the 15.74 per cent Birla stake into an employee trust came about. "It addresses all our concerns," says Naik.

The shares do not come into the market; they can't be sold to a third party and they don't go to FIs.

By June 14, the final outline was in place, though the board approved of the deal only on Tuesday.

As Naik puts it, "Even though the promoters -- Larsen and Toubro -- had at most 1.5 per cent stake each, it would never have occurred to them that L&T would ever be vulnerable." But now L&T is ready to move forward into another era.

Additional reporting by Rumi Dutta