SOLUTION A
V.S. KRISHNAN
President, RPG Enterprises

Getting a grip on Alpha Steel's debt, and reducing the interest-liability is only a small part of the much larger question that ceo Vinayak Chowdhury and his team should, in fact, be addressing. Which is: how do each of the business divisions compare with their competition? The first step in understanding the potential of a business in terms of its present and future growth is to get the elements of its final cost of operations right so that the value it adds is clearly understood. This is a critical--and vulnerable--area of action.

Critical because unless you have a clear picture of how much your company's products cost, your decisions are bound to be affected. Vulnerable because you can make mistakes without even being aware of them, such as in allocating interest on the basis of turnover instead of the capital employed. Once you have the cost-data in place through management accounting, several related questions will surface: which are the products and businesses that are profitable? What is their competitive edge? Why, and where, are the others losing out? What is the extent of cross-financing among businesses? Is the transfer-pricing fair? What are the true profits or losses that each division is making? The answers will enable Alpha to position itself in, or move out of a particular business segment. In other words, the survival--and the stability--of the company hinges on its ability to quickly adopt a profit-centre approach in each of the four business divisions that comprise the conglomerate.

It is only when Chowdhury decides which businesses he should be in that he should take up a restructuring. Three issues need to be considered as part of the first phase of restructuring:

What is the best structure from the company's point of view? Only issues of ownership and control become relevant here.

What is the structure that will gain the acceptance of the institutional lenders? Since loans have been given on the basis of a certain asset- portfolio, I am assuming that any change will require the concurrence of Alpha's lenders.

Finally, where is the tax-minimisation going to be? This is important from the point of view of shareholder-benefits, and the retention of value in the company.

The second step in restructuring is the choice of structure and its implementation. There are two options. The first is a vertical split. This is neat, but takes time to execute. Since the businesses are vertically-split, each becomes a stand-alone entity, with the same shareholding and debt patterns. Chowdhury can then decide to float, say, steel stock, and invest the proceeds in the stronger businesses. Each business will have a price-to-earnings multiple higher than that of the conglomerate. The only limitation of vertical slicing is that a focused business becomes an attractive takeover target for competitors.

The second option is a horizontal split. Essentially, this entails the creation of subsidiaries under a holding company. This process takes less time, but involves a complicated pattern of shareholding. While there are cross-company linkages that will deter a potential takeover, the advantage is that it also minimises the capital-gains tax. The typical strategy is to subsidise the businesses from which you want to garner maximum value. Don't forget, a potential investor always sees more value in a clean and focused subsidiary.

Solution B
SHAKTI SARAN
Director, Price Waterhouse Associates

Maximising shareholder value should be the real concern of Alpha's top management. Linked to it is the issue of competitiveness. The breaking up of the conglomerate into separate companies is, on balance, a sensible suggestion. Businesses, invariably, perform better as focused units in their own right than as divisions of a conglomerate. Focus gives them the freedom to deal with their destiny, and safeguard their future in a manner they deem fit. Given autonomy, they become more competitive by concentrating on their core competencies. By spinning off its various businesses into independent divisions, Alpha would improve the quality of its management and bring about a greater market-driven culture.

However, deconglomeration is not necessarily the most effective way to reduce debt. Nor is it an easy task. Alpha's top management will have to be fairly enlightened in shedding its powers and foregoing its day-to-day control of operations. It is in dealing with a mindset that has been tuned to command-and-control for decades that these efforts may come unstuck. It will also need the collective will and support of the middle management level. Deconglomeration certainly makes it less attractive for Alpha's bankers to support large-scale lending. It is in this context that Alpha is in danger of being on the wrong side of both the shareholder and the lender.

Deconglomeration could enable high-performing companies to secure finer interest rates from lenders. The financial institutions will, of course, be interested in ensuring that the company does not turn into a non-performing asset. But they are usually enamoured of size and diversity since both provide a sense of security. All of Alpha's businesses are in the core sector, where size and scale matter. Given the globalisation of the market, scale economies tend to matter in developing competitive strategy. The recent mergers in the international banking and automotive industries indicate that the number of players is shrinking in capital-intensive industries. The fewer the players, the greater the chances of survival in the global arena.

It is clear that Alpha's cost-efficient steel division has to bear the brunt of the higher interest costs of the other three divisions. Also, the power and the energy sectors, typically, have higher debt-equity ratios than other businesses. Now, the recession in the industry notwithstanding, steel can help Alpha sharpen its competitive edge. The larger issue is still the preservation of shareholder value in the short term, and its optimisation in the long run. The stockmarket, obviously, prefers pure plays. A break-up would mean that Alpha's shareholders would get pro rata shareholdings in all the spun-off companies barring, of course, the businesses which are sold. So long as the aggregate value of these stocks exceeds that of Alpha's stock, there is a case for deconglomeration.

To bring about more meaningful accounting, Alpha's treasury could introduce a more rational transfer-pricing mechanism for its strategic business units. The president of the power division has a valid point in suggesting one on market-driven terms. This does not, of course, resolve the immediate problem before Alpha: of avoiding another default on its debt-repayments. Further, merely restructuring debt, or raising more debt through a non-convertible debenture issue does not attack the core problems of cash-flows and profitability. The issue of size is, indeed, critical in the core sector. In an emerging market, survival is not an issue for the largest or the more profitable units. In short, deconglomeration wins if the benefits of greater focus and capitalising on core competencies exceed that of simply having a large balance-sheet. It is another way of saying that if the sum of the conglomerate's parts is greater than the whole, there are valid reasons for spinning off the parts.

Solution C
V.N. DHOOT
Chairman, Videocon

The reduction of interest costs is, of course, crucial to developing cost- leadership. The fact that Alpha's steel is globally competitive upto the conversion stage indicates the intrinsic strengths of the group in technology, productivity, and quality. But this is a loose end which does not translate into profitability and, hence, needs to be tied up. The profitability of the steel industry is quite low because of the demand-squeeze in the sector, both locally and globally--a situation which is unlikely to change in the medium term. An issue of particular concern is Alpha's dependence on domestic end-user industries rather than on exports. Part of the solution lies, therefore, in tapping overseas markets, where the manufacturer could command higher margins. Alpha's top management should examine this issue seriously. Also, lower interest costs, and freedom from not meeting the financial commitments of the non-steel divisions should enable Alpha to generate the resources to fund takeovers of ailing steel plants in the Commonwealth of Independent States and the Far East.

There are, however, several issues which deserve immediate attention. Focus and synergy are the more important ones. The steel division is Alpha's core business since it is globally-competitive. So, it makes sense to consolidate the steel operations. The linkages of power and aluminium with steel are strong enough to provide synergies. Chowdhury should, therefore, secure an optimal product-mix in steel which can cater to the demands of the global metals market. This does not mean that the non-steel businesses should be discarded. They would, probably, do better as independent commercial enterprises. Their managements would be more focused and, over time, grow strong enough--in terms of scale and cost of production--to generate resources on their own. Thus, the energy and power divisions would, inevitably, function better as stand-alone units than as part of a conglomerate.

A possible solution to Alpha's problems is to spin off its non-steel divisions into fully-owned subsidiaries, which can be subsequently sold off. Its interest costs can be brought under control by not over-capitalising investments and, thereby, avoiding unacceptable debt-equity ratios. It is noteworthy that Alpha's entry into capital-intensive sectors, like power, could not have been possible without the group's fund-raising capacity. Now that the divisions have attained critical mass, they should be broken up to take advantage of the benefits of focus. It is necessary to introduce a degree of transparency in a break-up; the idea is to ensure that shareholders clearly perceive the value of their investments in the new companies and, therefore, support the management's initiatives in the financial restructuring.

Garnering the support of long-term lenders is equally important for the company. This could be tricky. The financial institutions, usually, prefer a large asset size and a diverse portfolio. Their stake is limited to ensuring that their loans are adequately covered. Naturally, they are wary of any restructuring that diminishes asset size. But focus and synergy are important from the point of view of profitability, to which repayment capacity is linked. Perhaps Chowdhury should first sell the idea of the financial restructuring to the consortium of Alpha's lenders before deciding on any change-initiatives.

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