Gujarat Ambuja shareholders should benefit as their company stands to gain a larger chunk of ACC than before without additional investment. ACC shareholders benefit from the Holcim connection, which will make the company a stronger competitor in the medium term.

When Gujarat Ambuja [Get Quote] decided to pick up a 13.8 per cent stake in ACC in two tranches by paying three times the prevailing market price of ACC shares between December, 1999, and June, 2000, the market doubted the prudence of the move.

Why, for instance, should GACL cough up such a huge premium for a minority stake? Unless the intention was takeover.

GACL, however, refused to take the bait and kept its stake below the 15 per cent mark - the trigger point for an open offer.

But the markets remained convinced that GACL had indeed made a very smart move by gaining a toehold in a company which belonged more to the financial institutions (57 per cent) and less to any individual promoter group.

Last week, GACL made another unexpected move - in part to reverse its earlier decision. It agreed to allow Holcim of Switzerland to take majority control in the investment company -- Ambuja Cements India Ltd -- which holds GACL's stake in ACC. GACL paid an average a price of Rs 370 per share for its 13.8 per cent in ACC.

Under the deal signed last week, Holcim said it is buying out a 40 per cent stake in ACIL from two private equity investors. ACIL also owns 94 per cent of Ambuja Cement [Get Quote] (Eastern) Ltd.

Once Holcim buys out the private equity investors, it will subscribe to a fresh issue of equity and preferential shares by ACIL, and this money will be used to make an open offer for additional shares in ACC at Rs 370 to raise its stake to above 50 per cent.

Simultaneously, an open offer will also be made to the remaining 6 per cent minority shareholders in ACEL to make it a 100 per cent subsidiary of ACIL.

After the fresh equity infusion, the Gujarat Ambuja stake in ACIL will drop to 33 per cent and Holcim's will rise to 67 per cent. This will give Gujarat Ambuja an effective stake of over 16 per cent in ACC, but it has an option to exit as early as June this year by selling out to Holcim.

In any case, Holcim has a call option to buy out GACL's 33 per cent in ACIL on or after January 1, 2008. In effect, Holcim will be the ultimate owner of a majority stake in ACC - if all things pan out as planned.

Is all this good for GACL shareholders? Why should GACL cede the control that it exercised unnoticeably in the second-largest cement company in the country?

For the price of letting ACC spin out of its orbit, GACL stands to gain (notionally, as of now) a larger chunk of the company without investing anything more.

In effect, it will be owning more of a company that it could not have owned completely in the first place. Stuck in a problematic situation, GACL is making the best of a doubtful deal by ceding de-facto control of ACC to a potential competitor.

There are three threads to this argument. One, GACL couldn't have gone any further on its ACC plans. Two, it couldn't have just waited there, doing nothing.

And, finally, if the idea of its ACC investment was price stability in key markets, as it turns out to be now, it may have achieved that goal. The key question though remains: Was ACC worth giving up at all, at any cost? Let's consider these issues in some detail.

Gujarat Ambuja does not have the financial wherewithal to take full control of ACC. The total cost of buying out the private equity partners and making the mandatory open offer would have cost GACL approximately Rs 2,050 crore (Rs 20.5 billion), based on the current open-offer price of Rs 370 per share of ACC. This is nearly seven times the company's free cash flow for FY04.

"Gaining full control of Ambuja would have put the company (GACL) through substantial financial burden which has it own implications for Ambuja shareholders," says a leading investment banker.

Next, GACL could not have continued waiting in the wings forever. With the cement industry looking at bumper years ahead, ACC would surely have come under threat of a hostile takeover bid from one of the foreign players.

Perhaps, merger was an option. But as the investment banker adds, "Even though merging GACL and ACC would have been a theoretical option, the dilutive effect on shareholders would have been significant and hence undesirable."

The final thread in the argument is that GACL had no further use for the ACC stake, having achieved its objective of price stability in key markets.

"The main objective behind Ambuja acquiring a stake in ACC was to bring in price discipline in the northern markets where the two companies together have a market share of 80-90 per cent. That has happened," says Raamdeo Agrawal, joint managing director, Motilal Oswal Securities.

Indeed, GACL has not only made the best of a sticky situation, the current deal effectively lowers its cost of acquisition. "Ambuja has been able to bring down its cost of acquisition of ACC shares," concurs Motilal Oswal's Agrawal.

This means it stands to profit that much more when it decides to cash out fully - if it does. GACL acquired the ACC shares at an average price of Rs 370 per share when the prevailing market price was hovering around Rs 100-110 per share. The deal cost Ambuja Rs 928 crore (Rs 9.28 billion).

Ambuja consolidated its ACC holding in ACIL. In a parallel move, GACL transferred its 94 per cent stake in GCEL for Rs 425 crore (Rs 4.25 billion), booking a profit of Rs 240 crore (Rs 2.4 billion).

Subsequently, Ambuja sold a 40 per cent stake in ACIL to private investors for about Rs 550 crore (Rs 5.5 billion). In effect, Ambuja's cost of its shares in ACIL amounts to over Rs 650 crore after netting off the profit it booked while transferring Ambuja Eastern.

After Holcim buys the private investors out of ACIL and acquires additional equity in the company through a preferential offer, GACL would hold 33 per cent in ACIL. ACIL in turn holds 50 per cent in ACC and 100 per cent in ACEL (provided the open-offer and the buyback are successful, respectively).

Even if one assumes that Gujarat Ambuja gets Rs 47 a share (that is the price being paid currently to the private investors in ACIL) for its 28.6 crore shares (33 per cent stake) in ACIL, the company would get Rs 1,344 crore (Rs 13.44 billion) as consideration. This amounts to a return of 106.77 per cent on its investment in ACIL (GCEL and ACC).

However, Gujarat Ambuja may not want to exit ACIL at all for strategic reasons. For now, the company has saved itself the burden of raising Rs 860 crore (Rs 8.6 billion) in order to buy out the private investors in ACIL, which would have been necessary.

Moreover as Sudarshan Sampathkumar, partner, Accenture India, says, "As far as Gujarat Ambuja is concerned, in the short run, there is a direct financial advantage in terms of an increased stake in ACC. Also, if Holcim continues to make investments in India, Gujarat Ambuja will benefit as long as they stay in this partnership. However, in the long term, if Ambuja exits ACIL, it is possible that they will have to find their own place in the Indian cement industry."

For ACC shareholders, the open-offer price of Rs 370 seems reasonable going by the valuations of cement deals in the past. Analysts peg the valuation of the Holcum deal at $107 per tonne, which is about 25 per cent higher than Grasim's [Get Quote] valuation of UltraTech Cemco, L&T's former cement division.

Considering the current buoyancy in stock markets and the future prospects for cement companies, however, the valuations do not look too enticing. Holcim itself paid $277 per tonne for the acquisition of a minority interest in Cemento de El Salvador in December 2004.

Holsim will bring in international best practices and technology into ACC. "ACC would also have access to the R&D and product innovation of Holcim, which would prove beneficial in the long run as it would help ACC to improve its efficiencies and competitiveness," says Sampathkumar.

Though the stock market was not enthused by the complicated deal - both Gujarat Ambuja and ACC lost ground - analysts do not see any significant change in valuations for the two companies as of now. Many analysts have listed ACC as their top pick in the cement sector, followed by Gujarat Ambuja and Grasim.

At the current price of Rs 345, the stock trades at a price-earnings ratio of 15x FY06 earnings estimates, roughly the same level as Gujarat Ambuja. With the financial strength of a foreign player behind and the support of Gujarat Ambuja, ACC could emerge a Stable Prices

What does Holcim's entry mean for other cement players, and even Gujarat Ambuja, if and when it sells its stake in ACC? Analysts are not really worried about any sort of price war due to the entry of foreign players.

The fact is with or without foreign competition, Indian cement companies have traditionally generated low return on capital

The reason is that for many years cement supplies exceeded demand, resulting in weak prices. Also, smaller players indulged in undercutting prices to keep themselves afloat.

But that scenario is set to change as India moves into a new growth trajectory. Cement demand is likely to mimic the growth rate in the economy, at least. The outlook for the coming year also positive too.