HINDALCO - NOVELIS ACQUISITION:CREATING AN ALUMINIUM GLOBAL GIANT
Rakesh Gupta Aman Srivastava
Indian Companies as a part of their growth strategy have donea series of takeovers globally. In this chain on February 10,2007, Indian aluminium giant Hindalco entered into anagreement with Novelis to acquire the company in an all-cashtransaction which valued Novelis at approximately $6.0 billion,including debt. Hindalco, through its wholly-owned subsidiaryAV Metals Inc, acquired 75.415 million common shares ofNovelis, representing 100 per cent of the issued and outstandingcommon shares. AV Metals Inc transferred the common sharesof Novelis to its wholly-owned subsidiary AV aluminium Inc.The transaction makes Hindalco the world’s largest aluminiumrolling company and one of the biggest producers of primaryaluminium in Asia, as well as being India’s leading copperproducer. The combination of Hindalco and Novelis establishesan integrated producer with low-cost alumina and aluminiumfacilities combined with high-end rolling capabilities and givesit a global footprint. Hindalco’s rationale for the acquisition isincreasing scale of operation, entry into high-end market andenhancing global presence. Novelis is the global leader (interms of volume) in rolled products with annual productioncapacity of 2.8 million tonnes and a market share of 19 percent. The acquisition will expose Hindalco to weaker balancesheet. Besides the company will move from high margin metalbusiness to low-margin downstream products business. Theacquisition will more than triple Hindalco’s revenues, but willincrease the debt and erode its profitability. The case studyattempts to analyze the financial and strategic implications ofthis acquisition for the shareholders of Hindalco. It explainsthe acquisition in detail and highlights the benefits of the dealfor both the companies. Some of the main issues the case triesto discuss and raise are: strategic rationale for this acquisition,emerging financial challenges in this acquisition, potential riskto Hindalco from this acquisition and whether the valuationfor this acquisition was correct.
‘We look upon the aluminium business as a core business that hasenormous growth potential in revenues and earnings,’ ‘Our vision isto be a premium metals major, global in size and reach .... Theacquisition of Novelis is a step in this direction’
Last decade witnessed a series of takeovers by Indian companies globally.In this chain on February 10, 2007, Asian aluminium giant Hindalco enteredinto an agreement with Novelis to acquire the company in an all-cashtransaction which valued Novelis at approximately $6.0 billion, includingdebt of $2.4 billion. Hindalco Industries Ltd., India’s biggest aluminiumproducer, agreed to acquire Novelis Inc. of Atlanta to gain sheet mills thatsupply can makers and car companies. Hindalco, through its wholly-ownedsubsidiary AV Metals Inc, acquired 75.415 million common shares of Novelis,representing 100 per cent of the issued and outstanding common shares.AV Metals Inc transferred the common shares of Novelis to its wholly-owned subsidiary AV aluminium Inc. The deal made Hindalco the world’slargest aluminium rolling company and one of the biggest producers ofprimary aluminium in Asia, as well as being India’s leading copper producer.Hindalco Industries Ltd has completed its acquisition of Novelis Inc underan agreement in which Novelis will operate as a subsidiary of Hindalco.The acquisition will more than triple Hindalco’s revenues, but will lead toincrease in debt and erode its profitability. Strategically, the acquisition ofNovelis takes Hindalco onto the global stage as the leader in downstreamaluminium rolled products. With Novelis still to emerge out of losses though,the purchase carries significant risks. While complimentary, one can seefew obvious synergies. The study estimates EPS dilution of 18 per cent inFY08. As all cash offer, the study estimates Hindalco’s gearing (ND/E)would rise to over 200 per cent, would possibly raise equity.
INDUSTRY OVERVIEW
In 2007, the world aluminium consumption stood at 37.8 million tonnes againstproduction of 38.1 million tonnes, the consumption was 10 per cent higherthan the preceding year. This growth was primarily led by China, where
consumption grew at a phenomenal 37.7 per cent in 2007, more thancompensating for demand weakness in the US. India too registered a strongdouble digit growth in 2007 in line with buoyant economic growth. The strongindustrial growth, infrastructure initiatives and electrification drive resultedin good demand for aluminium. Automobile and transportation sectors alsosupported the aluminium demand. Globally, aluminium production increasedin line with the consumption. The primary aluminium production for the yearwas 38.1 million tonnes. China again led the production growth in 2007 withan increase of 34 per cent over 2006 production. Higher aluminium pricesin the early part of the year also led to some capacity restarts which furthersupported the production. In 2008 LME aluminium prices fluctuatedsignificantly between USD 2400 and USD 3100 per tonne. During 2008,crude prices also witnessed a sharp surge and the rising crude prices resultedin higher prices for its derivatives. The soaring crude also had a cascadingeffect in terms of higher transportation costs and higher prices of alternateenergy sources like coal. All these led to a significant cost push for thealuminium industry.
Global production of primary aluminium rose from 30 million tonne (m.t.)in 2004 to 32 m.t. in 2005, a jump of 6.9 per cent. In 2006, it further increasedto 34 m.t., an increase of 6.3 per cent Year over Year (YoY). North America,Western Europe and China together accounted for approximately 56 percent production, with China alone accounting for 26 per cent of global primaryaluminium production. Asia, once again showed the largest annual increasesin consumption of primary aluminium, driven largely by increased industrialconsumption in China, which has emerged as the largest aluminiumconsuming nation, accounting for 25 per cent of global primary aluminiumconsumption in 2006. As far as global consumption is concerned, it increasedby 5.6 per cent in 2005 and touched 32 m.t.. In 2006, the correspondingfigures were 8.2 per cent and 34.7 m.t.. The Indian aluminium industrygrew by only 7 per cent YoY during FY07, in quite contrast to the 20 percent YoY growth witnessed during FY06. This was mainly on account ofsubdued demand from the power sector, which grew by 7 per cent as opposedto 23 per cent growth in FY06. However, consumption of the metal continuedto be strong in the transportation and construction sectors with growth ratesin the region of 16 per cent and 15 per cent YoY, respectively. As far asprices are concerned, they rose significantly in FY07, jumping by as muchas 31 per cent YoY. However, they were likely to soften going forward, onthe backdrop of slowing global growth. Alumina prices corrected downwardsbecause of surge in Chinese output. Rupee appreciation against the USdollar also had an impact on the realizations of domestic companies. This
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sector is going through a consolidation phase and existing producers are inthe process of enhancing their production capacity so that a demand supplygap expected in future is bridged.
The Indian aluminium sector is characterized by large integrated playerslike Hindalco and National aluminium Company (Nalco). The other producersof primary aluminium include Indian aluminium (Indal), now merged withHindalco, Bharat aluminium (Balco) and Madras Aluminium (Malco) theerstwhile PSUs, which were acquired by Sterlite Industries. Consequently,there were only three main primary metal producers in the sector. The percapita consumption of aluminium in India continue to remain abysmally lowat under 1 kg as against nearly 25 to 30 kg in the US and Europe, 15 kg inJapan, 10 kg in Taiwan and 3 kg in China. Even the World’s average percapita consumption is about 10 times of that in India. One reason of lowconsumption in the country could be that consumption pattern of aluminiumin India is vastly different from that of developed countries. The demand ofaluminium is expected to grow by about 9 per cent per annum from presentconsumption levels. The key consumer industries in India are power,transportation, consumer durables, packaging and construction. Of this,power is the biggest consumer (about 44 per cent of total) followed byinfrastructure (17 per cent) and transportation (about 10 to 12 per cent).However, internationally, the pattern of consumption is in favour oftransportation, primarily due to large-scale aluminium consumption by theaviation industry. The metal has a long working life due to its propensity forrecycling. Recycled metal requires significantly less amounts of energy formanufacturing of primary aluminium. Just to put things in perspective, therecycling of aluminium scrap requires 5 per cent of the energy required forprimary smelting, which is astoundingly lower, considering that power issuch a high cost component.
PROSPECTS OF ALUMINIUM INDUSTRY
Globally, newer packaging applications and increased usage in automobilesis expected to keep the demand growth for aluminium over 5 per cent in thelong-term. Asia will continue to be the high consumption growth area led byChina, which has been and is expected to continue to register double-digitgrowth rates in aluminium consumption in the medium-term. With keyconsuming industries forming part of the domestic core sector, the aluminiumindustry is sensitive to fluctuations in performance of the economy. Power,infrastructure and transportation account for almost 3/4th of domesticaluminium consumption. With the government focusing towards attaining
GDP growth rates above 8 per cent, the key consuming industries are likelyto lead the way, which could positively impact aluminium consumption.Domestic demand growth is estimated to average in the region of over 8per cent over the longer-term. Lowering of duties reduces the net tariffprotection for domestic aluminium producers. Aluminium imports were thensubject to a customs duty of 5 per cent and an additional surcharge of 3 percent of the customs duty. The customs duty was reduced in a series ofsteps from 15 per cent in 2003 to 5 per cent in January 2007. With reductionin import duties, domestic realization of aluminium majors, namely Hindalcoand Nalco, was likely to be under pressure, as the buffer on internationalprices was reduced. Moreover, with greater linkage to international prices,volatility in financials could increase. However, producers were movingdownstream to negate the higher volatility.
COMPANY OVERVIEW: HINDALCO
A $28 billion corporation, the Aditya Birla Group is in the league of Fortune500. It is anchored by an extraordinary force of 100,000 employees, belongingto 25 different nationalities. In India, the Group has been adjudged “TheBest Employer in India and among the top 20 in Asia” by the Hewitt-Economic Times and Wall Street Journal Study 2007. Over 50 per cent ofits revenues flow from its overseas operations. Hindalco Industries Limited,a flagship company of the Aditya Birla Group, is structured into two strategicbusinesses aluminium and copper with annual revenue of $14 billion and amarket capitalization in excess of $23 billion. In 2007, the acquisition ofNovelis Inc. a world leader in aluminium rolling and can recycling marked asignificant milestone in the history of the aluminium industry in India. WithNovelis under its fold Hindalco ranks among the global top five aluminiummajors, as an integrated producer with lowcost alumina and aluminium facilitiescombined with high-end rolling capabilities and a global footprint in 12countries outside India. Hindalco commenced its operations in 1962 with analuminium facility at Renukoot in Uttar Pradesh. Birla Copper, Hindalco’scopper division is situated in Dahej in the Bharuch district of Gujarat.Established in 1958, Hindalco commissioned its aluminium facility at Renukootin eastern U.P. in 1962 and has today grown to become the country’s largestintegrated aluminium producer and ranks among the top quartile of low costproducers in the world. The aluminium division’s product range includesalumina chemicals, primary aluminium ingots, billets, wire rods, rolled products,extrusions, foils and alloy wheels. It enjoys a domestic market share of 42per cent in primary aluminium, 63 per cent in rolled products, 20 per cent inextrusions, 44 per cent in foils and 31 per cent in wheels. Hindalco has
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launched several brands in recent years, namely Aura for alloy wheels,Freshwrapp for kitchen foil and ever last for roofing sheets. The copperplant produces copper cathodes, continuous cast copper rods and preciousmetals like gold, silver and platinum group metal mix. Sulphuric acid,phosphoric acid, di-ammonium phosphate, other phosphatic fertilisers andphospho-gypsum are also produced at this plant. Hindalco Industries Limitedhas a 51 per cent shareholding in Aditya Birla Minerals which has miningand exploration activities focused in Australia. The company has two R&Dcentres at Belgaum, Karnataka and Taloja, Maharashtra. They one dulyrecognized by the Government of India’s Department of Scientific andIndustrial Research (DSIR). Most impressively, the company has been ableto reduce the per centage of sales devoted to selling, general andadministrative costs from 4.15 per cent to 2.96 per cent. This was a driverthat led to a bottom line growth from 15.8B to 26.9B.
RECENT MILESTONES
In May 2006, the company signed an MoU with the Government of MadhyaPradesh for setting up a greenfield aluminium smelter and a captive powerplant. The company also entered into a joint venture with the Essar Power(M.P.) Ltd. to develop and operate coal mines at Mahan, Madhya Pradesh.The joint venture supplies coal to the proposed aluminium smelter andpower complex in Madhya Pradesh.
In May 2006, the company’s copper mining subsidiary Aditya BirlaMinerals Limited (formerly Birla Mineral Resources Pvt. Ltd.) came outwith an equity offering and subsequent listing on the Australian StockExchange (ASX).
In March 2006, the company acquired an aluminium rolling mill andwire rods facility, from Asset Reconstruction Company (India) Limited(ARCIL), belonging to Pennar Aluminium Company Limited.
In January 2006, the company concluded 4:1 rights issue of its shareson partly paid basis. It was the largest ever rights issue in the history ofcorporate India and first one to issue partly paid instruments.
In September 2005, the company split its shares in ratio of 10:1 in orderto enhance liquidity and to encourage participation from retail investors.
In April 2005, the company signed an MoU to establish a world class
integrated aluminium project in the state of Orissa.
In April 2005, the company entered into MOUs with the Orissa andJharkhand governments for setting up a greenfield alumina facility andaluminium facility, respectively in the states.
COMPANY OVERVIEW: NOVELIS
Novelis is the world’s largest manufacturer of aluminium rolled products. Itis the leader in Europe, Asia and South America and a close No. 2 in NorthAmerica. Novelis is a leading provider of rolling and continuous castingtechnology and is also a leader in aluminium recycling. Novelis producesaluminium flat rolled products for a variety of applications such as beverageand other packaging, automobiles, industrial, construction, printing and otherusages and serves several of the biggest names in these industries. Novelisoperates in 11 countries and has around 12,900 employees, who bring alongwith them a high level of skill and experience. Novelis has several researchand development facilities and a strong innovation culture. Novelis haspatented the much-acclaimed Fusion™ technology, which is a breakthroughapproach in multi-alloy casting. Novelis also has some bauxite, alumina,aluminium smelting and hydel power operations in South America. Apartfrom a global reach and de-risked product portfolio,
Novelis is the world leader in aluminium rolling and recycling of usedaluminium beverage cans , producing an estimated 19 per cent of the world’sflat-rolled aluminium products. The company recycles more than 35 billionused beverage cans annually. With industry-leading assets and technology,the company produces the highest-quality aluminium sheet and foil productsfor customers in high -value markets including automotive, transportation,packaging, construction and printing. Its major customers include brandssuch as Agfa-Gevaert, Alcan, Anheuser-Busch, Ball, Coca-Cola, CrownCork & Seal, Daching Holdings, Ford, General Motors, Lotte aluminium,Kodak, Pactiv, Rexam, Ryerson Tull, Tetra Pak, Thyssen Krupp, and severalothers. Novelis represents a unique combination of the new and the old.Novelis is a new company, formed in January 2005, with a new vision, anew philosophy and a new attitude. But Novelis is also a spin-off fromAlcan and, as such, draws on a rich 90-year history in the aluminium rolledproduct marketplace . Novelis has a diversified product portfolio, whichserves to the different set of industries vis-à-vis it has a very stronggeographical presences in four continents. Novelis gives Hindalcotechnological expertise in aluminium rolling and recycling. Novelis gives
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Hindalco a ready platform to serve the expected growth. During the lastyear, Hindalco and Novelis have identified and worked upon several areaswhere the two companies complement each other. The integration activitiesare proceeding smoothly and the acquisition is expected to significantlyenhance shareholder value.
ALCAN ROOTS
Novelis was always a problem entity from inception. It was set up in early2005 following ‘forced’ spin-off from its parent, the $ 23.6-billion aluminiumgiant and Canada-based Alcan. In 2003, Alcan was acquired in a hostiletake-over by French aluminium company Pechiney. However, this take overresulting in creation of Novelis. Both Alcan and Pechiney had bauxite mines,facilities to produce primary aluminium, and rolling mills to turn the rawmetal into products such as stock for Pepsi and Coke cans and automotiveparts. Later, US and European anti-trust proceedings ruled that the rolledproducts business of either Alcan or Pechiney had to be divested from themerged entity. Alcan spinned off its rolled products business to form Novelis.It became the world’s leading producer of aluminium-rolled products with a19 per cent global market share. However, in the spin-off process, Novelisended up inheriting a huge debt of over $2.9 billion on a capital base of lessthan $500 million. It marked beginning of its troubles and the situationworsened later. Though it marginally reduced debt, it incurred some lossestoo. On a net worth of $322 million, Novelis had a debt of $2.33 billion (mostof it high cost). That’s a debt-equity ratio of 7.23:1. Soon, Novelis facedanother crisis.
Novelis follows a simple business model. It buys primary aluminium,processes it into rolled products like stock for soft drink cans, automotiveparts, etc., and sells it to customers such as Coke and Ford. The management,however, took a wrong call on aluminium prices. In a bid to win more businessfrom soft drink manufacturers, it promised four customers not to increaseproduct prices even if raw material aluminium prices went up beyond apoint. A few months after Novelis signed those contracts, aluminium pricesshot up 39 per cent (between September 30, 2005 and 2006). To these fourcustomers, Novelis was forced to sell its products at prices that were lowerthan raw material costs. These four account for 20 per cent of Novelis’s$9-billion revenues. However, the management’s wrong judgement led tolosses of $350 million (in 2006). For long, Novelis’s former CFO GeoffreyP. Batt, former controller Jo-Ann Longworth and the finance team did notquantify these losses. After the complicated spin-off from Alcan — this
involved extensive operations in over 35 plants in 11 countries and fourcontinents — the finance team also struggled to file quarterly and annualresults on time. Many of the numbers it managed to file on time were wrongand were later re-stated. The board stepped in. First, it replaced its CFOand controller in December 2005. When that didn’t help much, it replacedCEO Brian W. Sturgell in August 2006. (http://www.businessworld.in/index.php/Untold-Story.html)
Novelis inherited its assets, know-how and structure from Alcan. In1902, the Canadian subsidiary of the Pittsburgh Reduction Company (laterre-named Alcoa) was first chartered as the Northern Aluminium Company,Limited. When Alcoa divested most of its interests outside the United Statesin 1928, Alcan was formed as a separate company from Alcoa to assumecontrol of most of these interests. In the following years Alcan expandedglobally, building or acquiring hydroelectric power, smelting, packaging andfabricated product facilities run by approximately 88,000 employees in 63countries. The first Alcan rolling operation began in 1916 in Toronto, Canada,with an 84-inch hot mill and three finishing mills. Over the years Alcanconstructed a number of mills, including several that are among the largestaluminium rolling operations in each of the geographic regions in whichNovelis operates:
• Oswego, United States (1963) - the hot mill began operations and isnow a major producer of can stock and industrial sheet.
• Norf, Germany (1967) - a joint venture, owned at 50 per cent, operatesthe world’s largest aluminium rolling mill in terms of capacity.
• Saguenay Works, Canada (1971) – the largest continuous caster inthe world in terms of capacity.
• Pindamonhangaba, Brazil (1977) – the only South American plantproducing beverage can body and end stock.
IMPORTANT FACTS ABOUT DEAL
Both organic and inorganic strategies have worked for companies worldwide.However, in the process of global expansion inorganic growth strategieshave always been the first preference for the companies’ global strategies.The following points underscore salient points of this acquisition by Hindalco.
• Hindalco acquired Novelis in an all-cash transaction, which valuesNovelis at enterprise value of approximately $6.0 billion, includingapproximately $2.4 billion of debt.
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• Combination of Hindalco and Novelis establishes a global integratedaluminium producer with low-cost alumina and aluminium productionfacilities combined with high end aluminium rolled product capabilities.
• Post acquisition, Hindalco will emerge as the biggest rolled aluminiumproducts maker and fifth-largest integrated aluminium manufacturerin the world.
• Novelis is the global leader in aluminium rolled products and aluminiumcan recycling, with a global market share of about 19 per cent. Hindalcohas a 60 per cent share in the currently small but potentially high -growth Indian market for rolled products.
• Hindalco’s position as one of the lowest cost producers of primaryaluminium in the world is leverageable into becoming a globally strongplayer. The Novelis acquisition gives the company immediate scaleand strong a global footprint.
• Novelis is a globally positioned organization, operating in 11 countrieswith approximately 12,500 employees. In 2005, the company reportednet turnover of $8.4 billion and net profit of $90 million.
• The company reported net turnover of $7.4 billion and net loss of$170 million in nine months during 2006, on account of low contractprices. Some of these contracts are expected to continue for nextyears also.
• Novelis is expecting the full year loss to be $263 million in 2006,however the company was expecting to be in back with $68 millionprofit in 2007. The total free cash flow is expected to be $175million in 2006.
• By January 1, 2010, all the sales contracts will get expired andprofitability may increase significantly from then onwards.
• Novelis will act as forward integration with Hindalco as the companyis expected to ship primary aluminium to Novelis for downstreamvalue addition.
• Novelis has a rolled product capacity of approximately 3 m.t. whileHindalco at the moment is not having any surplus capacity of primaryaluminium.
• Hindalco’s greenfield expansion will give it primary aluminium capacityof approximately 1 m. t., but this will take a minimum 3-4 years to allthe capacities to come into operation. Novelis profitability is adverselyrelated to aluminium prices and higher aluminium prices on LME innear future can’t be ruled out. However, it is expected the aluminiumprices shall be softening in long term and this would be positive aspectfor Novelis.
• Debt component of Novelis stood at $2.4 billion and additional
$2.8 billion would be taken by Hindalco to finance the deal. Thiswould put tremendous pressure on profitability due to high interestburden.
• Hindalco’s existing expansion will cost Rs. 25,000 crore and as aresult debt and interest burden of the company will increase further.
• CRISIL placed its outstanding long-term rating of ‘AAA/Stable’ onHindalco Industries Limited (Hindalco) on ‘Rating Watch withNegative Implications’. The short term rating of ‘P1+’ had beenreaffirmed. This would lead to higher interest rate for the company.
FUNDING STRUCTURE OF THE DEAL
The funding structure of this deal is remarkably different from the leveragedbuyout model that Tata Steel used to fund for the Corus buy. The Tataswere to buy 100 per cent of Corus’ equity for $12.1 billion. Only $4.1 billionof this is being raised by the Tatas. The remaining $8 billion will be raised(as debt) and repaid on the strength of the Corus balance sheet. Effectively,the Tatas are paying only a third of the acquisition price. This was possiblebecause Corus had relatively low debt on its balance sheet and was able toborrow more. But that is not the case with Novelis. With a debt-equity ratioof 7.23:1, it can’t borrow any more. So, the Birlas were unable to do aleverage buyout. To buy the $3.6 billion worth of Novelis’s equity, Hindalcowas borrowing almost $2.85 billion (of the balance, $300 million was beingraised as debt from group companies and $450 million was being mobilisedfrom its cash reserves). That was almost a third of the Rs 2,500 crore netprofit Hindalco may post in 2006-07 (It has reported a net profit of Rs 1,843crore for the first three quarters of this year.). The second part of the dealis the $2.4-billion debt on Novelis’s balance sheet. Hindalco will have torefinance these borrowings, though they will be repaid with Novelis’s cashflows.
RATIONALE FOR ACQUISITION
This acquisition was a good strategic move from Hindalco. Hindalco wouldbe able to ship primary aluminium from India and make value-addedproducts.’’ The combination of Hindalco and Novelis establishes an integratedproducer with low-cost alumina and aluminium facilities combined with high-end rolling capabilities and a global footprint. Hindalco’s rationale for theacquisition is increasing scale of operation, entry into high-end downstreammarket and enhancing global presence. Novelis is the global leader (in termsof volume) in rolled products with annual production capacity of 2.8 million
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tonnes and a market share of 19 per cent. It has presence in 11 countriesand provides sheets and foils to automotive and transportation, beverageand food packaging, construction and industrial, and printing markets.Acquiring Novelis provides Aditya Birla Group’s Hindalco with access tocustomers such as Generals Motors Corp. and Coca-Cola Co. Indiancompanies, fueled by accelerating domestic growth, are seeking acquisitionsoverseas to add production capacity and find markets for their products.Tata Steel Ltd spent $12 billion to buy U.K. steelmaker Corus Group Plc.Novelis had capacity to produce 3 million tonne of flat- rolled products,while Hindalco had 220,000 tonne . Hindalco plans to triple aluminium outputto 1.5 million metric tonne by 2012 to become one of the world’s five largestproducers. The company, which also has interests in telecommunications,cement, metals, textiles and financial services, is the world’s 13th-largestaluminium maker. After the deal was signed for the acquisition of Novelis,Hindalco’s management issued press releases claiming that the acquisitionwould further internationalize its operations and increase the company’sglobal presence. By acquiring Novelis, Hindalco aimed to achieve its long-held ambition of becoming the world’s leading producer of aluminium flatrolled products. Hindalco had developed long-term strategies for expandingits operations globally and this acquisition was a part of it. Novelis was theleader in producing rolled products in the Asia-Pacific, Europe, and SouthAmerica and was the second largest company in North America in aluminiumrecycling, metal solidification and in rolling technologies worldwide. Thepotential benefits from this acquisition are:
• Post acquisitions, the company get a strong global footprint.• After full integration, the joint entity becomes insulated from the
fluctuation of LME aluminium prices.• The deal gives Hindalco a strong presence in recycling of aluminium
business. As per aluminium characteristic, aluminium is infinitelyrecyclable and recycling it requires only 5 per cent of the energyneeded to produce primary aluminium.
• Novelis has a very strong technology for value added productsand its latest technology ‘Novelis Fusion’ is very unique one.
• It would have taken a minimum 8-10 years to Hindalco for buildingthese facilities, if Hindalco takes organically route.
• As per company details, the replacement value of the Novelis is$12 billion, hence considering the time required and replacement value;the deal was worth for Hindalco.
The takeover of Novelis provides Hindalco with access to the leading
downstream aluminium player in western markets. The purchase structurallyshifts Hindalco from an upstream aluminium producer to a downstreamproducer. This is reflected in Novelis’ downstream product capacity of 3.0m.t.. compared to Hindalco’s existing primary capacity of 500 KT. Evenwith Hindalco’s expansion plans to take primary production to 1.5 m.t. by2011, the Group will remain a downstream aluminium producer. Novelisshareholders are required to approve the deal which the companies expectto be completed by 2007.
VALUATION FOR ACQUISITION
The big concern is Novelis’s valuation. Analysts believd that Birlas paid toohigh a price for a company that had incurred a loss of $170 million for thenine months ended September 30, 2006. In the subsequent guidance, theNovelis management indicated a loss of $240 million — 285 million for thewhole of 2006. Even in 2005, when Novelis had made a $90-million netprofit, its share prices had never crossed $30. Thus, why Hindalco paid$44.93 a share for a loss-making company? In its guidance, the Novelismanagement had indicated a pre-tax profit of $35 million-100 million for2007. Going by the optimistic end of the guidance, the price Hindalco paidtranslated to a market capitalization/profit before tax (PBT) multiple of 36on Novelis’s 2007 forecast. Hindalco has long held an ambition to become aleading (top 10) player across its 2 key business segments, aluminium andcopper. The acquisition of Novelis should achieve part of this goal bypropelling Hindalco to the world’s leading producer of aluminium flat rolledproducts. With capacity of nearly 3.0 m.t. of flat rolled aluminium products,Novelis takes Hindalco down the value chain to become a downstreamaluminium producer, versus its current upstream focus. At a price of $44.93/share and assuming $2.4 billion of debt, Novelis did not come cheaply.Based on Novelis’ guidance and consensus forecasts for 2007, was estimatedthat Hindalco would pay 11.4 x EBITDA, 20.7x EBIT or 53.4x PE. At atotal enterprise value of $6 billion, Novelis was nearly 50 per cent largerthan Hindalco’s current market capitalization. The concern was the severityof the earnings and value dilution that would result. Assuming synergies areminimal and based on Novelis’ guidance for 2007; it was estimated thatHindalco’s EPS would be diluted by 18 per cent. At Novelis long termannual free cash flow target of $400m (using a real WACC of 9 per cent),it was estimated the acquisition would lower value by Rs. 60/share. To putit another way, Hindalco would need to improve annual free cash flow by35 per cent to $540 million for the acquisition to be net present value (NPV)neutral. Perhaps the greatest issue with the Novelis acquisition was Hindalco’s
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Management & Change, Volume 13, Number 2 (2009)
balance sheet position post acquisition. Having already committed to significantexpansion projects, Novelis will push Hindalco’s high gearing levels even further.Hindalco’s gearing (ND/E) would reach 236 per cent, with its Net Debt/EBITDAratio reaching over 5.0x. As per company assessment, an equity raising washighly probable in short to medium term. A key factor behind the losses sufferedin 2006 was price ceilings contracted to Novelis’ long-term can-makingcustomers, which impacted revenues by $350m. Novelis expected that theirexposure to these types of contracts would reduce to a maximum of 10 percent of sales in 2007. While this was comforting, the Novelis still posed challengefor turnaround. Based on Novelis guidance for 2007 and assuming this wasalso expected relevant to Hindalco’s FY08 period, Hindalco’s EPS was furtherexpected to be diluted by 18 per cent.
POST ACQUISITION SCENARIO
The acquisition exposes Hindalco to weaker balance sheet. Besides thecompany moves from high margin metal business to low—margindownstream products business. The acquisition more than triples Hindalco’srevenues, but also increases the debt and erodes its profitability. The dealalso creates value only after the Hindalco’s expansion completion, and dueto its highly leveraged position, expansion plans may get affected. Some ofthe customers of Novelis are significant to the company’s revenues, andthat could be adversely affected by changes in the business or financialcondition of these significant customers or by the loss of their business.(The company’s ten largest customers accounted for approximately 40 percent of total net sales in 2005, with Rexam Plc and its affiliates representingapproximately 12.5 per cent of company’s total net sales in that year). Novelisprofitability could be adversely affected by the inability to pass throughmetal price increases due to metal price ceilings in certain of the company’ssales contracts. Adverse changes in currency exchange rates couldnegatively affect the financial results and the competitiveness of company’saluminium rolled products relative to other materials. The Company’sagreement not to compete with Alcan in certain end-use markets may hinderNovelis ability to take advantage of new business opportunities. The end-use markets for certain of Novelis products are highly competitive andcustomers are willing to accept substitutes for the company products. Thoughthe Hindalco-Novelis acquisition had many synergies, some analysts raisedthe issue of valuation of the deal as Novelis was not a profit-making companyand had a debt of $2.4 billion. They opined that the acquisition deal wasover-valued as the valuation was done on Novelis’ financials for the year2005 and not on the financials of 2006 in which the company had reportedlosses.
High prices and buoyant demand outlook in the domestic as well asinternational markets prompted aluminium companies to undertake hugeexpansion plans. Huge quantity of aluminium will come into the market inthe coming years. All the three major companies Nalco, Hindalco andVedanta Group have drawn up plans to increase capacities. At the end ofJanuary 2007, investment in hand in the aluminium anti aluminium productssector amounted to Rs.59,81800 million and are spread across 35 projects.Most of the major projects, amounting to over 60 per cent of the aggregateinvestment in value terms, are under implementation. If all the projects aresuccessfully implemented, aluminium smelting capacity would increase from11.8 lakh tonnes to 18 lakh tonnes. Of this, about 1.6 lakh tonnes wouldcome on stream in 2007-08 and five lakh tonnes each in 2009 and 2010.Hindalco initiated massive plans to increase its capacities through capacityexpansion as well as by setting up greenfield plants. Hindalco increased itscapacity at Hirakud plant by 35,000 tonnes to one lakh tonne. When Hindalcocompletes all its project, smelting capacity would increase by about 10 lakhtonnes. Along with smelting capacities, the companies are expanding aluminacapacities and setting up captive power plants. Domestic alumina capacityis set to increase by 9.5 million tonnes when all the outstanding projects arecompleted. In 2007-08 itself about 1.23 million tonnes of capacity was tocome on stream, pushing aggregate capacity to 4.23 million tonnes. Largealumina capacities would not only feed captive aluminium smelters, but wouldalso leave surplus alumina to be exported to lucrative markets like China.
Oneness is the rationale of all ethics and all spirituality. In the lowest worm,as well as in the highest human being, the same divine nature is present.One idea stands out as the centre of all ethical systems expressed indifferent forms is doing good to others. The guiding motive of mankind shouldbe charity towards men and charity towards all animals. All ethics of humanaction and all human thought hover around on one idea of unselfishness.The whole idea of human life can be put into one word, unselfishness. First,one should bear in mind that we are all debtors to the world and the worlddoes not owe us anything. In helping the world we really help ourselves.Secondly, there is a God in this universe, which is present everywhere. Heis undying, eternally active and infinitely watchful. Thirdly, one should not
hate anyone. This world will be a mixture of good and evil. Our duty is tosympathize with the weak and to love even the wrong-doer. Fourthly, wehave to avoid being fanatic and maintain calmness as only then we willobtain cooperation of others and contribute more on socially useful projects.
Word is guided by two basic instincts pravrtti and nivrtti, with firstmore inward focused and the other more outward driven, the first could beviewed as driver of materialism, while the second as driver for spiritualism.Pravrtti is the guiding force for most human beings i.e. taking everythingfrom everywhere and heaping it around one centre, which is one’s individualself. Nivrtti drives a person away from self i.e. it destroys selfishness andbecomes cornerstone of all morality and all religion. All the great systemsof ethics preach absolute unselfishness as the goal (p.28). In other wordsanything which is selfish is immoral, and that which is unselfish is moral.
The world is a mixture of good and evil, happiness and misery andthat to increase the one must of necessity increase the other. There is notone thing in this world which one can label as good alone, and there is notone thing in the universe which you can label as bad and bad alone. Thevery same phenomenon which is appearing to be good now may appearto be bad tomorrow.
Unselfishness is more paying, only people have not the patience topractice it. It is more paying from the point of view of health also. Even thelowest forms of work are not to be despised (p.49). The ideal man is hewho, in the midst of the greatest silence and solitude, finds the intensestactivity, and in the intensest activity, finds the silence and solitude of thedesert (p.50).
Sanskara can be translated very nearly by ‘inherent tendency’. Usingthe simile of a lake for the mind, every ripple, every wave that rises in themind, when it subsides, does not die out entirely, but leaves a mark andfuture possibility of that wave coming out again. This mark, with thepossibility of the wave reappearing, is what is called sanskara. What weare every moment is determined by the sum total of these impressions onthe mind. Our character is the sum total of these marks or impressions.Character is repeated habits, and repeated habits alone can reformcharacter (p.51).
