By Rajesh Pandathil and Sunainaa Chadha
Jaypee Associates' Rs 3,800 crore deal to sell its Gujarat cement units to UltraTech is a distress sale. For one, the company has been trying desperately to sell its cement business in order to cut its debt pile of Rs 55,000 crore.
Moreover, the valuation is at a huge discount to the earlier estimates of Rs 4,500 crore. The fall in valuation has been attributed to the slowdown in economy and concerns over a mine owned by Jaypee.
"Had the economy been growing at 8 percent, I would not have sold the Gijarat unit, Manoj Gaur of Jaypee Associates told CNBC-TV18 in an interview soon after the deal was announced.
According to reports, the deal values the units at $124 per tonne, nearly half of the $230 per tonne Barings Private Equity Asia had paid in its 14 percent stake deal with Lafarge India. The private equity company had paid Rs 1,400 crore for the stake.
Further, Holcim paid $200 per tonne for buying stakes in ACC and Ambuja. But that was in 2008, when the economy was not in as bad shape.
The valuation is poor even compared with the current replacement cost of $140-145 per tonne for a 1 million tonne cement plant. Replacement cost denotes the cost required to set up a green field cement plant. Consider UltraTech's own current valuation of $131 a tonne, and you know why shares of Jaypee Associates are the worst hit today ( down 6 percent) while UltraTech is up about 1 percent.
Jaypee needs to sell more assets to pare its debt and Gaur has indicated that he would not rule out selling the Andhra Pradesh and Panipat units.
According to the agreement between UltraTech and Jaypee Cements, UltraTech will take over the debt of Rs 3,650 crore of Jaypee's Gujarat unit and transfer remaining Rs 150 crore worth of shares once the transaction is completed.
So, the transaction will help Jaypee to cut its debt to a small extent. The company has said that it would reduce debt by Rs 15,000 crore through sale of assets this year but attaining this target will be a tall task given the economic downturn.
The debt reduction from the Gujarat plant sale will happen directly from the group's flagship Jaiprakash Associate (JAL). JAL has a total debt of Rs 23,000 crore, which will now immediately be reduced by Rs 3,650 crore on conclusion of the deal.
"Post completion of this transaction, it is likely to reduce the overall debt on standalone basis by Rs 2000 crore and also reduce loans and advances by Rs 1,650 crore. This is likely to enhance earnings for the company in FY15," said Kotak in a research report.
Ultratech Cements is likely to fund the acquisition through debt, equity and internal accruals. UltraCement currently has net debts of Rs 2000 crore.
According to Kotak, this acquisition is likely to be marginally EPS negative in near term for Ultratech Cements as the deal is likely to be completed in 6-9 months and incremental debt is expected to increase interest outgo.
However, higher capacity in Gujarat is likely to increase Ultratech Cement's market share and gives company ready access to completed plant.
As this CNBC-TV18 report noted, the purchase will enable Ultratech to grow its market share in Gujarat from roughly 20 percent to 35 percent and in country's fastest growing cement region."
Overall, Ultratech's cement capacity goes up from 54 million tonnes to 59 million tones and it also gains access to 57.5 MW captive power capacity, limestone reserves sufficient for over 90 years at current capacity and a captive jetty.
"Ready, recently built capacity with potential to double the existing capacity given the land parcel and limestone reserve is a positive for UltraCement," said Morgan Stanley in a research report.
Not only will UltraTech now enjoy a higher pricing power, it will also become the leader in the cement space in the western region.
However, ICICI Securities cautioned that while the acquisition would increase UltraTech's market share by 1.5% and save three to four years of lead time for setting up plants, it would also increase its net debt to equity from 0.1x to 0.3x.
So while the deal may be beneficial for UltraTech in the near term it will increase its net debt by Rs 3650 crore, there by taking away the comfort of a relatively unleveraged balance sheet.
Many brokerages see the deal as one-off in a sector which is bogged down by economic slowdown. They do not see the deal as a harbinger of a consolidation.
Rising input and energy costs have been squeezing cement companies' margins, while demand remains a worry amid a weakening economy and high interest rates. The pressure is mounting on cement makers, especially those with high debt.
The UltraTech-Jaypee deal means nothing for the sector now.