Ambuja Cements - Cash goes out, equity base expands and becomes a holding company: Why we view the deal negatively :: JPMorgan

 In our view, Ambuja’s (ACEM) stock will react negatively to the proposed
ACC-ACEM transaction. The proposed transaction essentially transfers
Holcim’s stake in ACC (~50%) to ACEM through a share swap and cash deal.
After the completion of the transaction, ACC would become a step-down
subsidiary of ACEM (50.01 holding in ACC), while Holcim’s holding in
ACEM will increase to 61.39% following the additional share issue. The
implied ACEM/ACC swap ratio for the transaction is ~6.6x. Further, ACEM’s
board gave in-principal approval for stake increase in ACC by up to 10%
(maximum of Rs30B) over the next 24 months through creeping acquisitions.

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 Why we view the deal negatively: After the transaction, the cash in ACEM
(net cash Rs37B as of Jun-13) would be taken out, with most of the cash
residing in ACC (net cash Rs29B as of Dec-12). It would be difficult for ACEM
to access this cash for future growth opportunities, with dividends as the only
option. After the transaction, ACEM would be a quasi-holding company
(similar to GRASIM before the UTCEM-GRASIM transaction) in terms of its
ACC stake, which usually warrants a holding company discount in India. The
company indicated implied valuation of ~$110/MT for ACC’s stake. While
both companies have broadly similar capacities, profitability of ACC is lower
than ACEM’s (CY12 EBITDA/MT of ACC Rs911 vs. ACEM Rs1100/T).
 Positives perceived by management from the transaction: The consolidated
entity would have a capacity of 58mt and expansion pipeline of over 12mt over
next few years. Management indicated potential synergies of Rs7.8-9B over the
next two years (beneficial to both ACC and ACEM equally) through supply
chain/ logistic optimization (Clinker and Cement swap), fixed cost reduction in
procurement, shared services of back end processes, etc. We understand
HOLCIM’s drive to create a consolidated entity with a larger balance
sheet, but view the proposed transaction as an intermediate step, before an
eventual full merger between the two entities (which also explains ACEM’s
plans to take its ACC stake to ~60%, similar to what HOLCIM would own in
ACEM). Management did not comment on this.
 Pro-forma post-transaction estimates: Based on the transaction and the
potential synergies highlighted, we expect pro-forma attributable EBITDA of
Rs39B in CY13E and attributable net cash of Rs15B. This implies CY13E
EV/EBITDA of 9.3x for ACEM and EV/EBITDA of $142/Mt.
 Implied swap ratio of ~6.6x is theoretical: In our view, given that both entities
would remain listed, the swap ratio is theoretical and hence ACEM in the near
term would fall more than the implied swap ratio with ACC would suggest.