Corporate: Restructuring - L&T's Quest for Hidden Values

It's all about valuations. The diversified conglomerate has plenty of value to unlock, but it is taking its time to find the key.

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Last fortnight, engineering & construction giant Larsen & Toubro (L&T) called a press conference to announce its foray into the Net jungle with a global financial portal. For this purpose, L&T has struck a joint venture (JV) with US investment bank Bluestone Capital Partners, which is providing its trading platform, Trade.com. But, as the Trade.com executives waxed eloquent, among other things, about their portal's uniqueness, L&T Managing Director & CEO A.M. Naik might have had other things on his mind.

After the presentation and the customary Q&A with journalists, as Naik lunched with the executives of the newly-formed JV company-L&T Trade.com-he was curious to know the price of the L&T stock at that time. Was Naik checking the efficiency of the portal (and of the people running it)? Perhaps, but more likely he was keen to gauge the impact created on the share price by the company's announcement the previous day that L&T's cement division-which accounts for 22 per cent of the company's revenues-would be demerged from the flagship operations.

The executives of L&T Trade.com were geared up for that question (PCs displaying the portal were at hand). Pat came the reply: ''The share has crossed the Rs 300 mark. It was close to hitting the upper circuit-filter limit, but it has now dipped slightly.'' Shrugged Naik, 58: ''So, someone has been selling.'' Nevertheless, the L&T stock ended 9 per cent higher at Rs 287 that day.

Naik's obsession with his stock price-he and a few fund managers prefer to call it an obsession with shareholder value-isn't something new. Ever since he took over in May, 1999, Naik has been shouting from the rooftops about how grossly undervalued the L&T stock is. ''After the demerger, L&T's value will double, and at the same time, the true value of the cement operations will become visible,'' declared Naik.

Few have doubts that there's still plenty of value locked away in this Rs 7,424-crore behemoth. But the process of unlocking that hidden value is beginning to resemble a never-ending soap opera, being viewed by the market's movers and punters. That investors finally switched channels some way down the line is apparent from the beating the stock price took.

As the anticipation about Naik's value initiatives reached fever pitch in June, 1999, the stock began taking off, from the Rs 300 levels into the Rs 400 range by August, to eventually touch Rs 600 early this year. And then came the rapid fall-Rs 400 by February, Rs 300 by April, and below Rs 200 by May. And, as of last fortnight, L&T's market capitalisation was virtually stagnating at the level it was when Naik took over-Rs 7,500 crore.

One reason for the bearishness was, of course, the 27 per cent drop in L&T's net profits last year. But there's another equally important reason for the hammering. More than a year after Naik made his grand declarations, the process of spinning off the cement and infotech businesses into thrust areas, and thereby, making engineering and construction the core-as has been recommended by The Boston Consulting Group (BCG)-is still under way.

BCG had submitted its recommendations way back in January, 2000, but the L&T brass dithered over whether the cement division should be spun off immediately or later. L&T's current capacity is 14 million tonnes, and it is in the process of expanding-in phases-to 19 million by 2003. Obviously, a part of the L&T board felt that an expanded cement division would fetch a higher value. In the next 6-8 months, L&T will appoint an investment bank, which in turn will have the mandate of finding a suitable partner for the business and of structuring the new entity.

But, at least the first prong of Operation Unlock Shareholder Value has been flagged off. The second-the listing of the infotech subsidiary L&T Information Technology Ltd. (LTITL)-is delayed by at least a year, thanks to its poor performance, and its inability to meet its targets. Because of a tapering off of y2k-related projects, LTITL's revenues in 1999-2000, stagnated at Rs 165 crore, and net profits plunged to Rs 13 crore from Rs 37 crore the previous year. The revised D-Day for the IPO is 2001, and Naik says that it will happen only when the subsidiary meets its target. The target for 2001, says an analyst, is revenues to the tune of Rs 250 crore.

But Naik has a good thing going in cement. Much of L&T's capacity-roughly 8 million tonnes-is 'newer' than most of the competition, having been created in the past five years. What's more, according to Ramnath Subramaniam, 28, Research Analyst of Taib Securities: ''L&T Cement's enterprise value is Rs 2,125-2,200 per tonne. To put up a new capacity today, will cost between Rs 3,500 and Rs 4,000 a tonne.''

So at 14 million tonnes-which is what L&T claims is its current capacity-the cement business should command a valuation of at least Rs 3,000 crore. L&T officials claim that by the time the demerger is complete, L&T would have a cement capacity of 15 million tonnes, which means the division should command a value of Rs 3,300 crore by then.

Will Naik be happy with such a valuation? Unlikely. In typical belligerent style, he says that any cement major interested in picking up a stake in L&T Cement should be willing to fork out 'the highest price ever paid (per tonne) for a cement acquisition'.

Currently, that honour goes to Gujarat Ambuja, which paid close to Rs 5,455 per tonne for its 7.2 per cent stake in acc. Lafarge comes in second, having paid close to Rs 3,000 per tonne to acquire Tisco's cement unit. Will Naik succeed in disturbing that order?