Case 4 Hindalco’s Acquisition of Novelis.pdf

Hindalco’s Acquisition of Novelis The case discusses the acquisition of US-Canadian aluminum company Novelis by India-based Hindalco Industries Limited (Hindalco), a part of Aditya Vikram Birla Group of Companies, in May 2007. The case explains the acquisition deal in detail and highlights the benefits of the deal for both the companies. It also examines the valuation of the acquisition deal and how the deal was financed. The case concludes by describing the challenges that Hindalco would face in integrating the operations of Novelis and analyzing if the deal was overvalued as opined by some industry experts.

Hindalco’s Acquisition of Novelis “The acquisition will catapult the group into the Fortune 500 league, three years ahead of the target. The combination of Hindalco and Novelis will establish a global integrated aluminium producer.” 1 - Kumar Mangalam Birla, Chairman of Hindalco, in February 2007.

“The combination of Novelis’s world -class rolling assets with Hindalco’s growing primary aluminum operations and its downstream fabricating assets in the rapidly growing Asian market is an exciting prospect.”2

-

Ed Blechschmidt, Acting Chief Executive of Novelis, in February 2007.

Introduction On May 16, 2007, India-based Hindalco Industries Limited (Hindalco), a subsidiary of the AV (Aditya Vikram) Birla Group of Companies (Aditya Birla Group), acquired the US-Canadian aluminum giant Novelis Inc. (Novelis). The acquisition was the result of an agreement arrived at between Hindalco and Novelis on February 10 , 2007. Hindalco was to buy Novelis for US$ 6 billion in cash, making it the second biggest acquisition3 by an Indian company till then. Novelis was to operate as a subsidiary of Hindalco, and was to have Kumar Mangalam Birla (Kumar Mangalam) as Chairman who was also the Chairman of Hindalco and the Aditya Birla Group. Martha Finn Brooks would continue as Chief Operating Officer and was also appointed as the President of the merged entity. Hindalco was among the leading companies in the aluminum and copper industry in the world. (Refer to Exhibit I for leading aluminum companies in the world based on EBITDA figures). In the financial year 2006 -07, Hindalco generated revenues revenues of US$ 14 billion and the company had a market capitalization of more than US$ 4.5 billion. It had a significant significa nt market mar ket share in all the segments segment s in which whic h it operated o perated and enjoyed a domestic market share of 42 percent in primary aluminum, 63 percent in rolled products, 20 percent in extrusions, 44 percent in foils, and 31 percent in wheels (Refer to Exhibit II for Hindalco‟s revenues and net income for the year 2006 and 2005).

1

Surojit Chatterjee, “Birla‟s Hindalco Buys Aluminum Giant Novelis for $6.4 billion,” http://in.ibtimes.com, February 13, 2007.

2

Heather Timmons, “Indian Metals Company to Buy Canadian Rival,” www.iht.com, February 11, 2007.

3

The biggest was Tata Steel‟s acquisition of Corus, an „all cash‟ deal which was valued at US$ 12.1 billion.

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Mergers & Acquisitions, and Strategic Alliances

Exhibit I: Leading Aluminum Companies in the World (Based on the EBITDA percent) 60

50

50

39

39 34

40 30

16

14

20 10 0

o t o t a l c n n i a a T n d o n d i i e H R V

P H B

o a l c A

a n l c A

Source: www.hindalco.com.

Exhibit IIA: Income Statement of Hindalco (In Rs. Millions) st

As on 31 March

Net sales and operating revenues

2007

2006

183,130

Other Income Profit before Tax Tax Profit After Tax

2005

2004

2003

113,965

95,235

61,908

49,755

3,701

2,439

2,700

2,400

2,330

35,046

21,057

19,042

12,457

8,994

9,841

3,341

5,707

2,606

2,520

25,643

16,555

13,233

8,389

5,821


Exhibit IIB: Balance Sheet of Hindalco (In Rs. Millions) st

As on 31 March

2006

2005

Assets

Gross Block

103,323.21

87,119.09

67,435.15

55,808.73

Capital WIP

8,329.17

13,229.81

Investments

11,342.20

10,477.55

Inventory

40,950.88

23,745.18

Receivables

12,484.01

23,745.18

Other Current Assets

48,086.70

39,689.30

Net Block

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Hindalco’s Acquisition of Novelis

st

As on 31 March

2006

2005

188,628.11

150,824.24

985.66

927.77

Reserves

94,624.01

75,417.59

Total Debt

49,034.38

37,999.97

Creditors and Acceptances

19,745.30

14,573.87

Other current liab/prov

24,238.76

21,905.04

188,628.11

150,824.24

Balance Sheet Total Liabilities

Equity Share Capital

Balance Sheet Total Source: www.myiris.com.

Novelis had a three million ton capacity for manufacturing value added aluminum rolled products4 and was a leading producer of aluminum sheet and light gauge (thin) rolled products for the construction and industrial markets. The company operated in 11 countries and supplied high quality aluminum sheet and foil products to various industries including automotive, transportation, packaging, construction, industrial products, and printing. Novelis‟customers included companies companies like Coca-Cola, Kodak, Ford, General Motors, and other leading Fortune 500 companies. Novelis sold rolled aluminum products in Asia, Europe, North America, and South America (Refer to Exhibit III for performance of Novelis in different regions).

Exhibit III: Performance of Novelis in Different Diff erent Regions (All US$ Millions)

N.America

Europe

Asia

S.America

Assets

1,487

2,392

1,021

814

Net sales

2,841

2,688

1,235

626

Regional Income

64

208

70

122

10 Plants*, 2 Recycling Facilities.

14 Plants, 1 Recycling Facility

3 Plants

2 Plants, 2 Smelters, 1 Refinery, 2 Bauxite Mine

Description of Assets

* Plants refer to aluminum rolled product facilities. Source: www.novelis.com.

Industry analysts opined that the acquisition would benefit Hindalco by strengthening the company‟s global presence, as Novelis had flat rolled aluminum manufacturing plants in different locations in the world. They considered considered the deal a good platform for 4

Aluminum rolled products are semi-finished aluminum products that constitute the raw material for manufacturing finished goods ranging from automotive bodies to household foils.

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Hindalco to access global customers. Novelis had a 19 percent global market share in foil products, 25 percent in construction and industrial products, and 43 percent in beverage cans. After the acquisition, the merged entity would emerge e merge as the world‟s largest aluminum rolling company and an d among the world‟s top five aluminum manufacturers. According to Shivanshu Mehta, Assistant Vice-President, NCDEX, “The deal will catapult Hindalco‟s flat rolled product capacity from 0.2 million ton to 3.2 million ton per annum and elevate the company to a leadership position in the business.”5 Some analysts, however, were of the view that the deal was not beneficial to Hindalco as it had paid a huge amount in cash to acquire a company which was recording losses. Novelis had incurred a loss of US$ 275 million for the year 2006. Even in the year 2005, when Novelis had reported US$ 90 million as net profit, its share price did not cross US$ 30 (Refer to Exhibit IV for Novelis and Hindalco stock charts). The analysts pointed out that the way the deal was financed would affect Hindalco‟s financial performance as the acquisition would not add value in the short and medium term.

Exhibit IV Novelis – Novelis – Stock Stock Price Chart (January 2005 – 2005 – May May 2007)

Source: www.bigcharts.com. Contd…

5

Suresh P Iyengar, “Hindalco Deal May Not Impact Aluminum Prices,” The Hindu Business Line, February 13, 2007.

364


Contd…

Hindalco – Hindalco – Stock Stock Price Chart (December 2006 – 2006 – May May 2007)

Source: www.economictimes.com. www.economictimes.com.

The deal included writing off Novelis‟ debt, which would increase Hindalco‟s debt equity ratio. According to Karvy Stock Broking, Hindalco‟s consolidated earnings for the year 2008 would come down due to the losses that Novelis had incurred. Moreover, the interest on the loan which was taken for funding the acquisition would also affect Hindalco‟s profits.

Background Note Hindalco Industries Limited The Birla Group of Companies was founded by Seth Shiv Narayan Birla in 1857 as a cotton trading company at Pilani, Rajasthan, India. The group later expanded its operations into other business segments (Refer to Exhibit V for other business of Birla Group). Hindustan Aluminum Corporation Limited (HACL) was established on December 15, 1958, to manufacture alumina, aluminum, and aluminum fabricated items. The company was formed as collaboration between Kaiser Aluminum & Chemicals Corporation (KACC), US, and the Birla Group. Under the agreement with KACC, KACC had to train the people of HACL and provide technical advice and information for 20 years along with the assistance to operate the aluminum fabrication plant.

Exhibit V: Other Businesses of Aditya Birla Group Grasim Industries Ltd.: A subsidiary of the Aditya Birla Group of Companies, it is one of the largest private sector companies and comprises Viscose Staple Fiber (VSF), Cement, Sponge Iron, Chemicals and Textiles. It was established in 1947 as a small rayon weaving company in Gwalior, Madhya Pradesh. Contd…

365


Contd…

Aditya Birla Nuvo: Formerly known as Indian Rayon & Industries Ltd., it is a diversified conglomerate of the Aditya Birla Group. Its business segments include Viscose Filament Yarn (VFY), carbon black, branded garments, fertilizers, textiles, and insulators. Aditya Birla Nuvo through its subsidiaries and joint ventures provides services such as Life insurance, T elecom, Business Process Outsourcing (BPO), IT services, Asset Management, and other financial services. Ultra Tech: UltraTech Cement Limited is a Grasim subsidiary that manufactures and markets Ordinary Portland Cement, Portland Blast Furnace Slag Cement, and Portland Pozzolana Cement. It is the country‟s largest exporter of cement and clinker. It exports to countries around the Indian Ocean, Africa, Europe, and The Middle East. The Narmada Cement Company is a subsidiary of the company. Source: www.birlagroup.com.

As a result, the HACL was set up as an integrated complex with a capacity of 20,000 MTPA (million ton per annum). It started producing aluminum metals in 1962 in Renukoot in eastern Uttar Pradesh. Renukoot had a fully integrated plant, comprising three main plants i.e. the Alumina, Smelter, and Fabrication Plants. In 1965, HACL installed an extrusion press and rolling mill for the production of aluminum sheets and rolled products with a capacity of 2,000 ton and 7,000 ton respectively, thereby increasing the total capacity of the fabrication plant to 15,000 ton per annum. The company could produce 60,000 ton of primary metal. After several modifications to the plant in the year 1968, the company‟s production capacity was enhanced to 200 ton per day. In 1967, HACL established its own power plant in Renusagar, in collaboration with Renusagar Renusa gar Power Company Limited (RPCL). All of RPCL‟s assets were merged with that of HACL. In the year 1986, the company raised its capacity from 120,000 ton to 150,000 ton of aluminum per annum. As part of a policy, the Kaiser Group divested itself of its holdings in various corporations worldwide where it had a minority interest and in the process it decided to disinvest its holdings in HACL also. In the year 1988, the Kaiser Group had sold off all its shares at a premium to the shareholders of the company and to the employees of the company. On October 09, 1989, HACL was renamed Hindalco. In 1992, RPCL, which had been a wholly-owned subsidiary of Hindalco, was merged with the company. In the mid1990s, with a view to leveraging on its core strengths, Hindalco started exploring the possibility of setting up an integrated aluminum complex in Orissa. Subsequently, it signed an MOU with Orissa Mining Corporation for the transfer of bauxite deposits. The project was named “Aditya Aluminum.” In the year 1997, HACL announced a technical collaboration agreement with the Stahlschmidt & Maiworm Gmbh 6 of Germany for the establishment of an aluminum alloy wheel plant at Silvassa Capital of Dadra and Nagar Haveli Union Territory in western India. The company went for expansion and modernization of an aluminum alloy wheel plant in the domestic market. After the establishment of the plant, Hindalco became the country‟s largest integrated aluminum company, surpassing 6

It is one of the leaders in alloy wheels industry with plants in Germany, South Africa, Poland, and the US.

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Indian Aluminum company Limited (Indal) 7. In the year 1999, Hindalco acquired 19,38,900 shares of a public sector major, the National Aluminum Company Limited (Nalco)8, through one of its investment subsidiaries. In the year 2000, Hindalco acquired a 74.6 percent equity stake in Indal, an Alcan Canada Group Company, which had a major presence in aluminum products and was a leader in specialty alumina chemicals. Indal became a subsidiary of Hindalco. Indal‟s strength in alumina and downstream 9 products products complemented complemented Hindalco‟s Hindalco‟s strong presence presence in metal. metal. Indal was was among among the world‟s lowest cost aluminum producers. In early 2005, all Indal‟s businesses, except for the Kollur foil plant 10 in the southern Indian state of Andhra Pradesh, were merged with Hindalco. Later, in April 2005, the company signed an MoU with the governments of Orissa and Jharkhand, states in eastern India, for setting up a Greenfield alumina and aluminum facility in those states this helped Hindalco to increase the alumina and aluminum capacities to much higher levels. By 2007, Hindalco was primarily involved in production of aluminum and semifabricated products. The company operated in three segments: aluminum, copper and other precious metals. Hindalco was the leading producer of aluminum in India (Refer Exhibit VI for a note on the aluminum industry in India). The products of the group included primary aluminum ingot, alloy ingot, billet, cast slab, wire rods, redraw rods, alloy rod, foils, and sheet product. The copper business comprised production and sale of copper in the form of cathodes and continuous cast rods and by-products and other precious precious metals. Hindalco‟s Hindalco‟s stock stock was publicly traded traded on the Bombay Bombay Stock Exchange, Exchange, the National Stock Exchange of India Limited, and the Luxembourg Stock Exchange.

Exhibit VI: Aluminum Industry in India The Indian aluminum sector is characterized by large players like Hindalco and National National Aluminum Aluminum Company (Nalco). (Nalco). India has the fifth largest largest bauxite reserves reserves with deposits of about 3 billion ton or 5 percent of the world deposits while its share in world aluminum capacity rests at about 3 percent. However, the per capita consumption of aluminum in India is extremely low at less than 1 kg as against nearly 25-30 kg in the US and Europe, 15 kg in Japan, 10 kg in Taiwan, and 3 kg in China. Contd…

7

Established in 1938, Indal started with India‟s first aluminum sheet rolling mill at Belur, near Kolkata, West Bengal. Indal has a nationwide spread of plants and mines, operating through all stages of aluminum value chain from bauxite mining, alumina refining, aluminum smelting with captive power to downstream sheet and foil rolling and extrusions.

8

Nalco‟s activities include exploring, producing, manufacturing, and distributing distributing aluminum and related aluminum products. The company operates in two segments – Aluminum and Chemicals. The Aluminum segment includes aluminum ingots, wire rods, billets, strips and other related products. The Chemicals segment includes calcined alumina, alumina hydrate and other related products. It also produces Bauxite and power.

9

Downstream is closer to the point of sale than to the point of production or manufacture. Companies in this case are involved in further processing the output of an upstream company to produce different products and sell them in the market as end products.

10

The Indal Kollur foil foil plant was originally a part of Annapurna Foils Limited, the largest manufacturer of aluminum foil in south India. The company was acquired by Indal in 2001 and later merged in April 2002. The plant has the technology from the world-renowned Fata Hunter of Italy. It is located in Kollur village, Hyderabad, in Andhra Pradesh.

367


Contd…

In the past decade, the primary aluminum producers were Bharat Aluminum (BALCO) and NALCO in the public sector and Indian Aluminum (INDAL), Hindalco, and Madras Aluminum (MALCO) in the private sector. However, Indal merged with Hindalco and MALCO was acquired by Sterlite industries. Consequently, there are only three main pri mary metal producers in the sector. With liberalization, the prime strategies were joint venture investments, technology acquisition/offers, international marketing tie-ups; buy-back arrangements and subcontracting, technical, managerial, and marketing expertise. As a part of reform, several policy changes have been expressed to ensure hassle free entry of private investments. Similarly, as part of moving toward privatization, the government has withdrawn its presence from as many areas as possible, through closure and sale of equity or disinvestments. As a result of the process of liberalization of trade in aluminum, India has emerged as a net exporter of aluminum, on competitive terms. Government monopoly, in terms of aluminum production and removal of price and distribution control over aluminum has been diluted in favor of the private sector. The ownership pattern in the private sector has undergone changes. Compiled from various sources.

Novelis Novelis was split from its parent company, Alcan Inc. (Alcan), the Canada-based aluminum giant and set up as its subsidiary in January 2005. The origin of the company can be traced back to 1902 when the Northern Aluminum Company, a Canadian subsidiary of the Pittsburgh Reduction Company was set up. The Pittsburgh Reduction Company was renamed as the Aluminum Company of America (ALCOA) in the year 1907. In 1925, The Northern Aluminum Company was renamed the Aluminum Company of Canada (ACOC) Limited. In 1928, when ALCOA started disinvesting its funds from outside the United States, a Canadian holding company called Aluminum Limited (AL) was formed to control the operations. This then became the parent company company of ACOC. During the 1930s and 1940s, ACOC witnessed significant business growth as smelting11 and hydroelectric units and fabricating plants were built in the UK and Canada. In 1939, during the Second World War, the demand for aluminum for the manufacture of aircraft for the military increased dramatically in Canada, the UK, and the US. In 1945, ACOC registered the trade name „ALCAN‟. In order to meet the demand for aluminum, the company concentrated on hydroelectric sites to increase annual smelter production to nearly five times the existing 500,000 tons and fabricated plants to produce sheet and other components for the aircraft. After the war, Alcan expanded its power and smelter capacity. In the year 1965, the company acquired Central Cable Corporation and, in 1966, the Metals Disintegrating Corporation. After the acquisition, the Central Cable Corporation was renamed as the Alcan Cable Corporation and the Metal Disintegrating Corporation as the Alcan Metal Powders Inc. The acquisition brought about an increase in the smelting capacity to almost one million tons, which was 11

To melt or fuse to separate the metallic constituents.

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nearly double the existing capacity. In the year 1966, AL was renamed as Alcan Aluminum Limited (AAL). In the 1970s and 1980s, AAL expanded its operations internationally by increasing the capacity of the fabricated products and smelting operations in Australia, the UK, Brazil, and India. In the early 1980s, taking advantage of the restructuring in the international aluminum industry, AAL acquired The British Aluminum Company Plc 12 and the Atlantic Richfield13 company in the US. Thereby, it increased its presence in the markets for fabricated products. In 1987, as a result of corporate restructuring, ACOC, which was the principal subsidiary became the parent company and was also called AAL. In the early 1990s, there was a global depression in the prices of metals due to which the company disinvested from its downstream businesses in Argentina, Australia, Brazil, Canada, New Zealand, the UK, the US, and Uruguay. The company also restructured its operations in Japan, China, and Southeast Asia. In 2000, AAL expanded its packaging business and acquired Alusuisse 14, thereby becoming the world‟s leading supplier of aluminum-based aluminum -based automotive products, lightweight engineered products, and Alusuisse‟s specialty packaging. In 2001, the compa ny was renamed Alcan to reflect the company‟s diversified product mix and global character. In the year 2003, Alcan acquired French aluminum company Pechiney. The merger combined the assets of both companies, which included bauxite mines, plants to produce primary aluminum, and rolling mills to produce flat rolled products. The merged entity supplied products to customers like Coke and Pepsi for cans and to the manufacturers of automotive components. In 2004, Alcan split the major activities of Pechiney to hive off its rolled aluminum products business into a new organization called Novelis. The company was primarily set up for can recycling and aluminum rolling in January 2005. The rolled aluminum was made up of a variety of alloy mixtures that were hard, thick, and of appropriate widths with various coatings designed specially for its end users. It started operations with 37 operating units in 12 countries with more than 13,500 employees. Novelis inherited a debt of US$ 2.9 billion from its parent company and suffered losses. The company bought primary aluminum from Alcan and processed it into rolled products. In mid-2005 and in 2006, the company signed price ceiling contracts with some soft drink manufacturers to supply aluminum products at a specified price. Due to these contracts, the company was forced to sell at a price lower than the raw material costs though the price of aluminum increased subsequently. This affected Novelis‟ business. The company incurred a loss of US$ 350 35 0 million in the year 2006. Other reasons for the loss were higher energy and transportation costs; adverse effects of currency exchange rates; and expenses related to the company‟s restatement and review process.

12

The aluminium producer British British Aluminium Limited Limited was originally formed formed as the British Aluminium Company Limited on May 07, 1894 and when ALCAN bought it in 1982, it was known as British Alcan Aluminium Plc.

13

Atlantic Richfield is an American oil company that was was formed by the merger of the Eastcoast based Atlantic Refining and the California-based RichField Petroleum, in 1966.

14

It is a Switzerland-based Switzerland-based aluminum company that produces rolled iron products products for trucks and coaches and rough ingots for the food and pharmaceuticals industry. After amalgamation, it was called the Alcan Aluminum Valais SA.

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In 2006, Novelis restructured its European operations and sold its aluminum rolling mill in Annecy, France. This was considered as an important step as it helped the company to focus on its core business and improve its competitiveness in the European market. Novelis marked the t he year 2006 as an innovation year with the intro duction of Novelis Fusion technology, a new process through which multiple alloy layers can be cast into a single aluminum rolling ingot simultaneously. Fusion Technology increased the formability15 of aluminum and made the metal suitable to use and to make sheet metal that helped in building cars with more curves. It increased the use of the strong and light metal in the automotive industry. Novelis was the first company to start commercial production of multi-alloy aluminum in gots. As of February 2007, Novelis operated in 11 countries with 12,900 employees. The company was organized under four operating segments – Novelis North America, Novelis Europe, Novelis Asia, and Novelis South America (Refer to Exhibit VII for Novelis Operating Segments). Novelis operated six aluminum recycling units for producing aluminum sheets and foils. It recycled used aluminum such as beverage cans; scrap from internal operations, and from customers‟ production plants. Novelis catered to automotive, transportation, packaging, construction, industrial, and printing markets by supplying aluminum sheets and foil products. Its shares were listed on the New York Stock Exchange and the the Toronto stock exchange.

Exhibit VII: Novelis Operating Segments Novelis North America: This segment manufactures aluminum sheet and light gauge products for beverage cans, containers and packaging, automotive and transportation applications, building products, and other industrial applications. Most of the recycled material is from used beverage cans and the material is casted into sheet ingots for North America‟s can sheet production plants. Novelis Europe: It provides value-added sheet and light gauge products through 14 plants. plants. The company supplies sheets for building products such as roofing, roofing, siding, panel walls, walls, and shutters shutters.. Novelis Europe is a leader leader in the the production production of lithographic lithographic sheets. It has the largest beverage can recycling plant at Latchford, UK. Novelis Asia: It operates through Novelis Korea Limited and Aluminum Company of Malaysia. Together, they operate three manufacturing units in the Asian region. The Korean company provides its products to the Asia/Pacific region for construction, industrial and beverage can markets. The Aluminum Company of Malaysia is a publicly traded company catering to the Southeast Asian markets. It operates a continuous casting, rolling, and coating operations. Novelis South America: It operates two rolling plants and primary production units in Brazil. It manufactures various aluminum rolled products, including can stock, automotive and industrial sheets, and light gauge for the beverage & food can, construction & industrial, and transportation. The company‟s rolling and recycling facility in Brazil is the largest aluminum rolling and recycling unit in South America. Source: www.novelis.com.

15

Formability is the capacity of the material to able to bend, stamped stamped or shaped into the required form.

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The Deal Hindalco acquired Novelis through its wholly owned subsidiary AV Metals 16 on February 10, 2007. AV Metals purchased 100 percent of the issued and outstanding common shares of Novelis at US$ 44.93 per share, amounting to US$ 3.6 billion. Hindalco paid a premium premium of 16.6 percent percent on the closing closing price price of Novelis‟ Novelis‟ stock. stock. Apart Apart from equity equity purchas purchase, e, Hinda Hindalco lco also also acqui acquired red Novel Novelis‟ is‟ debts debts to to the the tune tune of US$ US$ 2.4 2.4 billio billion. n. The amount of US$ 3.6 billion was financed through borrowings, debts from group companies, and internal cash reserves. Of the total amount, US$ 2.85 billion was financed by AV Metals Metals through through loans loans taken taken from three three financi financial al institut institutions ions – UBS,17 ABN Amro18, and Bank of America 19. US$ 300 million was brought in by Essel Mining 20, a closely held group company, and US$ 450 million was mobilized by Hindalco. The debt of US$ 2.4 billion was to be taken by Hindalco into its books. The company planned to repay the debt through through the cash flows of Novelis. Hindalco had had to get the approval for the deal from 66.66 percent of Novelis‟ shareholders. According to Canadian law on mergers and acquisitions, if a company secured 66.66 percent approval, then the remaining shareholders had to sell their shares at the price agreed upon. However, if the company did not receive the required approval, it had to quit the deal.

Rationale for Acquisition After the deal was signed for the acquisition of Novelis, Hindalco‟s management issued press releases claiming that the acquisition would further internationalize its operations and increase the company‟s global presence. By acquiring Novelis, Hindalco aimed to achieve its long-held long- held ambition of becoming the world‟s leading producer of aluminum flat rolled products. Hindalco had developed long-term strategies for expanding its operations globally and this acquisition was a part of it. Novelis was the leader in producing p roducing rolled products in the Asia-Pacific, Europe, and South America and was the second largest company in North America in aluminum recycling, metal solidification and in rolling technologies worldwide. Novelis had the most modern technology in the industry and efficiently produced high-quality products in several countries across the world. While combining t he assets of both t he 16

AV Metals is the the AV Birla Group‟s Canada-based Canada-based SPV which is a subsidiary of Hindalco and was created to fulfill specific or temporary objectives, primarily to isolate financial risk, usually bankruptcy but sometimes for a specific ta xation or regulatory risk.

17

UBS is a global financial services firm offering wealth management, investment banking, asset management, and business services to the clients. In Switzerland, UBS is the market leader in retail and commercial banking. The bank‟s net profit for the year 2006 was US$ 9097 million.

18

ABN Amro is one of the leading banks in Europe and has operations all over the world. It was a result of the merger of Alegemen Bank Nederland (ABN) and AmsterdamscheRotterndamsche Bank (AMRO). In April 2007, Barclays announced the deal to buy ABN Amro. The company recorded a profit of euro 4780 million.

19

It is the largest commercial commercial bank in America in terms of deposits. Prior to 1993, it was called Nations Bank and in 1998, it merged with the San Francisco-based Bank America and the name was changed to Bank of America. For the year ended 2006, it recorded US$ 74247 million as revenues and a net income of US$ 21133 million.

20

Established in 1950, it is one of India‟s largest iron ore mining companies and part of the Aditya Birla group. It is the largest producer of noble ferro alloys like molybdenum, vanadium, tungsten, and titanium with an annual mining capacity of over 5 million ton.

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companies, the merged entity could establish a global integrated aluminum producer with low-cost alumina and aluminum production facilities along with aluminum rolled product capabilities. Hindalco, which had an upstream 21 technology of mining bauxite and converting it into alumina and then smelting it into aluminum, would benefit from the downstream technology of Novelis which produced a variety of aluminum products from the raw aluminum. Kumar Mangalam said, “In aluminum, one needs to invest in downstr eam downstr eam to go up the value chain and India does not offer suitable downstream investment opportunities of a global scale.” 22 Novelis had a downstream product capacity of 3.0 million tons while Hindalco had approximately 500 kilo tons. In this context, Debu Bhattacharya, Bhattacharya, Managing Director of Hindalco, said, “If we earn $10 for every $100 of aluminum we sell, we will now be able to earn another $10 for every $100 worth of aluminum that Novelis processes into rolled products.” 23 The deal was expected to fetch economies of scale to Hindalco in the long run by reducing the costs and time spent in accessing raw materials and by catering to the global customers of Novelis. The most important link between them was aluminum, which was Hindalco‟s finished product and the ra w material for Novelis. Hindalco got its revenues from the sale of its raw metal aluminum, while Novelis added value to the raw metal aluminum to come out with rolled aluminum products. These products were used in several high technology applications like automobiles, beverages, building and construction, etc. This helped Hindalco to capture the total value chain in the aluminum business. Hindalco had another advantage as the value chain was already established; it could directly access the market at a lower freight cost. Hindalco served one end of the value chain while Novelis served the other end. By clubbing both, they could achieve greater economies of scale in the long run. According to a research finding, nearly 35 million tons of aluminum was consumed globally every year. Of that, 40 percent came from rolled products, in which Novelis was a leading player with a 19 percent share. As Hindalco did not serve this segment, the acquisition would help it gain access to this segment. In India, it was expected that the aluminum rolled products market would grow from around 220,000 ton in 2006 to 1 million ton in few years. There was a huge demand for these products in Asian regions, led by China; which contributed nearly 2.5 million ton of the total demand. Novelis had highly sophisticated technology which would have taken Hindalco at least ten years to develop. According to analysts, Novelis‟ assets had a replacement value of US$ 12 billion and Hindalco would take a long period to match these assets in the four continents at its current production of 3.3 million ton. Donlad Marleau, Primary Credit Analyst at Standard & Poor, commented, “This deal is high -level buying. Novelis is a strong acquisition because of the technology.” 24 In his opinion, it was difficult to get such technology and even harder to get customer certification.

21

Upstream is closer to the point of production or manufacture manufacture than to the point of sale. Companies in this case are involved in the procurement and production of a p articular product which which is not by itself the final product and which can be processed further for specific use.

22

Nandini Lakshman, “Metal Merger: India‟s Birla Thinks Big,” www.businessweek.com, February 11, 2007.

23

M.Anand, “Hindalco“Hindalco- Novelis Novelis The (Scary) Untold Story,” www.businessworld.com, February 26, 2007.

24

M. Anand, “Hindalco“Hindalco- Novelis Novelis The (Scary) Untold Story,” www.businessworld.com, www.businessworld.com, February 26, 2007.

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Apart from gaining technology, Hindalco would also have access to the contracts which Novelis had entered into for the supply of can body (material for beverage cans). These contracts would expire in January 2010. After 2011, Novelis can pricing issues would have been solved and the management expected that it would generate nearly 12 percent return on capital with an annual cash flow of US$ 400 million. Hindalco would have more aluminum capacity by then and earn good returns on investments as it planned to add new capacities in its plants which were closer to Novelis plants in Malaysia Malaysia and South Korea. One of Hindalco‟s most important strategies in acquiring Novelis was to have an edge over the London Metal Exchange (LME) 25 prices. Although Hindalco was a low cost producer of aluminum with good numbers on its balance sheet, it was still affected by the fluctuations in the prices of aluminum set by the LME in the previous few years. If the prices of aluminum came down in the near future, its profits were also likely to be affected (Refer to Exhibit VIII for aluminum price fluctuations).

Exhibit VIII: Alumina and Aluminum Prices (2004-07) (In US$ per ton)

Year*

Alumina

Aluminum

2004

490

1,700

2005

440

2,000

2006

640

2,900

2007

395

2,832

* In the beginning of the year.


Hindalco‟s management believed that if it acquired a company that sold value -added aluminum products then it might pass on the price fluctuations to the customers. Though Hindalco had a presence in this value added segment it did not have the required technology to have an edge. Hence, it acquired Novelis, which which had the largest share in the market. Novelis would add nearly Rs.415 billion 26 of sales to Hindalco with an addition of three million ton of aluminum products to its portfolio.

The Pitfalls Though the Hindalco-Novelis merger had many synergies, some analysts raised the issue of valuation of the deal as Novelis was not a profit-making company and had a debt of US$ 2.4 billion. They opined that the acquisition deal was over-valued as the valuation was done on Novelis‟ financials for the year 2005 and not on the financials of 2006 in which the company had reported losses (Refer to Exhibit IX for Novelis P&L statements and balance sheets). They said that Hindalco might have to collect a huge amount of resources to revive and restructure Novelis. Stewart Spector, an aluminum industry consultant, opined, “It seems to me that US$ 6 billion is an awful big premium to pay for a messy operation” 27

25

26 27

LME is the world‟s premier non-ferrous non -ferrous metal market. It offers futures and options contracts for aluminum, copper, nickel, zinc and lead. The exchange provides a forum for all trading activity. In 2006, LME achieved volumes of 87 million lots, equivalent to $8,100 billion annually. 1 US$ = Rupees 41.04 as of August 17, 2007. Surojit Chatterjee, “Birla‟s Hindalco Buys Aluminum Giant Novelis for $6.4 billion,” http://in.ibtimes. com, February 13, 2007.

373


Exhibit IX (A): Novelis Selected Financial Data (In US$ Millions)

2006

2005

2004

9,849

8,363

7,755

Other Income

(82)

(299)

(62)

Interest Charges

206

194

48

Depreciation

233

230

246

Profit Before Tax

(278)

224

231

Net Income/Loss

(275)

96

55

Net Sales

Source: Novelis Inc., Annual Report, March 2007.

Exhibit IX (B): Consolidated Balance Sheet of Novelis (In US$ Millions)

Assets

2006

2005

Current Assets

Cash and Cash equivalents

$ 73

$ 100

1,321

1,098

21

33

1,391

1,128

42

66

106

194

9

8

Total Current Assets

2,963

2,627

Property Plant and Equipment net

2,143

2,160

236

211

20

21

Investments in and advances to non consolidated affiliates

150

144

Fair value of derivative instruments – net of current portion

44

90

Deferred income tax assets

76

45

101

107

59

71

5,792

5,476

Accounts Receivable -

Third Parties

-

Related Parties

Inventories Prepaid expenses and other current assets Current position of fair value of derivative instruments Deferred income tax assets

Goodwill Intangible Assets – Assets – net net

Other long term assets -

Third parties

-

Related parties

Total Assets

Contd…

374


Contd…

LIABILITIES AND SHARE HOLDERS EQUITY Current Liabilities

Current portion of long term debt

144

3

Short term borrowings

133

27

1,542

964

44

38

508

543

61

26

Total Current liabilities

2,432

1,601

Long term debt – debt – net net of current portion

2,158

2,600

81

186

Accrued post retirement benefits

425

305

Other long term liabilities

343

192

5,439

4,884

158

159

Preferred stock

…

…

Common stock

…

…

398

425

(198)

92

(5)

(84)

195

433

5,792

5,476

Accounts Payable -Third parties - Related parties Accrued expenses and current liabilities Deferred income tax liabilities

Deferred income tax liabilities

Minority interest in equity of consolidated affiliates Share holders equity

Additional paid in capital Retained earnings (accumulated deficit) Accumulated other comprehensive losses Total share holders equity Total liability and share holders equity Source: Novelis Inc., Annual Report 2007.

After the deal, Hindalco‟s debt– equity equity ratio was expected to slide down to 2:1 from 1:2. This was expected to further affect Hindalco‟s balance sheet. Analysts were predicting a dilution in the EPS of Hindalco by 18 percent after the acquisition. Further, the deal could reduce Hindalco‟s reserves, which were being used for funding the deal. The profits would also be affected due to the interest on the debt borrowed. The analysts therefore were of the opinion that the acquisition would dilute the earnings of the company. Due to the massive expansion plans taken up by Hindalco, Novelis would further push Hindalco‟s high gearing level 28. It was also estimated that Hindalco would have to improve annual free cash flow by 35 percent to US$ 540 million for the acquisition to be considered as neutral. 28

Debt gearing level is the relationship between the long term liabilities of the business and the capital employed. The idea behind calculating the ratio is to have a balance between the shareholders‟ funds and the long term liabilities.

375


According to a report by Edelweiss Research 29 on Hindalco, the Novelis deal was valued at 4.7 times EV/EBITDA30 for the financial year 2006-07 earnings. This valuation had been done based on the debt and the earnings before accounting for all non-cash items. It also did not take into account the price ceiling contracts. The report stated that the deal seemed to be expensive for a non-integrated low margin business. It also stated that the deal would dilute the 2007-08 2007- 08 financial years‟ earnings by 12 percent, while the debt-equity ratio was expected to increase to (2.72:1 from 0.43) for the same year. The key assumptions made by Hindalco‟s management while entering into the deal was an increase in aluminum and copper prices, increase in metal production, and higher backward integration related synergies which were not factored by Edelweiss Research into their estimates. Industry experts pointed out that though Novelis had a leading global presence in rolled aluminum products, it did not have much pricing power. This was because Novelis had to face competition from strong players like Alcoa, Norsk Hydro, Alcan, and Aleris who contributed nearly 53 percent of the global market share. In such a scenario, to gain market share, Novelis had entered into can contracts till 2010 and sacrificed its profits. Novelis was running into losses due to the can contracts. A research note from Merrill Lynch speculating on the possibility of such a deal said the negatives could outweigh the positives. Merrill analyst, Vandana Luthra, pointed out that during periods of rising aluminum prices, margins were sharply squeezed, as selling prices for finished product did not increase commensurately. However, Hindalco‟s management felt that the deal would be beneficial for the company in the long term and would allow it access to global customers. Kumar Mangalam said, “The complementary expertise of both these companies will create and provide a strong platform for sustainable growth and ongoing success.” 31 He added that the acquisition would lead Hindalco into the Fortune 500 companies‟ list, three years ahead of the target. Hindalco was expected to double its turnover to US$ 20 million after the acquisition. After the acquisition was completed in May 2007, Novelis became a subsidiary subsidiary of Hindalco. In mid-2007, Hindalco was planning a massive expansion of its operations by increasing the capacity to 1.5 million tons by 2011-12. This would make Hindalco one of the world‟s fifth largest producers prod ucers of aluminum, up from its position as 13 th largest in 2007. Hindalco had formed a JV with Almex, US, to manufacture high strength aluminum alloys for application in aerospace, sporting goods, and surface transport industry.

29

India-based Edelweiss Capital Ltd offers offers investment banking, private placement of equity, convertible debt, merger and acquisition advisory, and restructuring services. The company is also involved in stock broking, distribution of financial products, and asset management services. The company also provides market research services.

30

EV includes the cost of paying debt; EBITDA refers to Earnings before Interest Tax Depreciation and Amortization. EV/EBITDA compares the value of the company free of debt, to earnings before interest and tax. It is calculated without taking into account the cost of assets or the effects of tax. EV/EBITDA is generally used to value shares, it is assumed that debt (such as bonds) that has a verifiable market value is worth its market value. Other debts may be assumed to be worth its book value (the amount shown in the accounts).

31

Surojit Chatterjee, “Birla‟s Hindalco Buys Aluminum Giant Novelis for $6.4 billion,” http://in.ibtimes.com, February 13, 2007.

376


Suggested Readings and References: 1.

http://www.alunet.net, 1999. The Birth of Giants Alcan and Alcoa, http://www.alunet.net, 1999

2.

Heather Timmons, Indian Metals Company to Buy Canadian Rival, www.iht.com, February www.iht.com, February 11, 2007.

3.

Nandini Lakshman, Metals Merger: India's Birla Thinks Big, www.businessweek.com, February www.businessweek.com, February 11, 2007.

4.

www.forbes.com, February 11, Hindalco to Buy Novelis for $6 Billion, www.forbes.com, February 2007.

5.

Hindalco Industries Ltd. and Novelis Inc. Announce an Agreement for Hindalco’s Acquisition of Novelis for Approximately $6.0 Billion, www. http://www.finanznachrichten.de/nachrichten, February http://www.finanznachrichten.de/nachrichten, February 11, 2007.

6.

www.rediff.com, February 12, Birla buys US based metal major for $6 bn, www.rediff.com, February 2007.

7.

Laura Mandro & Robert Daniel Novelis Shares Leap on $6 Billion Hindalco www.marketwatch.com, February February 12, 2007. Buyout, www.marketwatch.com,

8.

Novelis to add Rs 41,500 cr in Hindalco’s Sales, www.timesofinida.indiatimes.com. February www.timesofinida.indiatimes.com. February 12, 2007.

9.

Hindalco to Acquire US-Based Novelis in $6-B All-Cash Deal, http://www.thehindubusinessline.com, February http://www.thehindubusinessline.com, February 12, 2007.

10.

Surojit Chatterjee , Birla’s Hindalco Buys Aluminum Giant Novelis for $6.4 http://in.ibtimes.com, February 13, 2007. billion, http://in.ibtimes.com, February

11.

Suresh P. Iyengar, Hindalco may not Impact Aluminum Prices, www.businessline.com, February www.businessline.com, February 13, 2007.

12.

www.hsbcnet.com, February Flash note by HSBC on Hindalco Industries, Indus tries, www.hsbcnet.com, February 13, 2007.

13.

Role of Royalty in Hindalco Novelis Buy, Buy, www.minesandcommunitites.org, February 14, 2007.

14.

Chidanand Rajghatta, Novelis Acquisition puts Indian Stamp on Coke, www.timesofindia.indiatimes.com, February February 14, 2007. Budweiser Can, www.timesofindia.indiatimes.com,

15.

Indian Economic News- Policy Update, www.indianembassy.org, February 15, 2007.

16.

M. Anand, Hindalco – Hindalco – Novelis Novelis The Untold Story, www.businessworldindia.com, February 26, 2007.

17.

www.metalcenternews.com, March March 2007. 2007 Metal Industry News, www.metalcenternews.com,

18.

Andrew Corn, Indian Conglomerate Buys Novelis, www.seekingalpha.com, www.seekingalpha.com, April April 19, 2007.

19.

Reduce Hindalco Industries: Edelweiss, www.moneycontrol.com, May 14, 2007.

20.

Novelis Now a Hindalco Subsidiary Acquisition Process Completed, www.businesswireindia.com, May 15, 2007.

377


21.

Hindalco Industries Completes Acquisition of Novelis Inc., www.canstock.com, May 15, 2007.

22.

Martha Finn Brooks Named President of Novelis Inc., http://biz.yahoo.com, May 16, 2007.

23.

www.thehindubusinessline.com, June June Crisil Downgrades Hindalco’s NCDs, www.thehindubusinessline.com, 17, 2007.

24.

www.bigcharts.com.

25.

www.wikipedia.com.

26.

www.novelis.com.

27.

www.hindalco.com.

28.

www.alcan.com.

29.

www.aluminum.org.

30.

www.economictimes.com.

31.

www.birlagroup.com.

32.

www.myiris.com.

33.

www.novelisrecycling.com.

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Case 4 Hindalco’s Acquisition of Novelis.pdf

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