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We look upon the Aluminum business as a core business that has enormous growth potential
in revenues and earnings. Our vision is to be a premium metals major, global in size and
reach with a passion for excellence. The acquisition of Novelis is a step in this directioni
On May 15, 2007, Hindalco Industries Ltd announced the completion of its acquisition of
Novelisii. The transaction made the company the worlds largest Aluminum Rolled Products
Company, one of the largest producers of primary Aluminum in Asia, and India's leading
producer of copper. Novelis would operate as a subsidiary of Hindalco. The Company entered
into an agreement with Novelis on February 10, 2007 to acquire the Company in an all-cash
transaction that valued Novelis at approximately $6.0 billion. Under the terms of the
agreement, Novelis shareholders would receive $ 44.93 in cash for each outstanding common
share. Novelis shareholders approved the transaction at a special meeting on the May 10th.
Hindalco was the flagship Company of the Aditya Birla Group, a multinational conglomerate
from India with annual revenues of $14billion and a market capitalization in excess of $23
billion.
The transaction was accomplished by way of a statutory plan of arrangement under the
Canadian law. The Company, through its wholly-owned subsidiary AV Metals Inc., acquired
75,415,536 common shares of Novelis, representing 100 percent of the issued and
outstanding common shares. Immediately after closing, AV Metals Inc. transferred the
common shares of Novelis to its wholly-owned subsidiary- AV Aluminum Inc. Upon closure
of the transaction, Novelis stock ceased trading on the New York Stock Exchange. De-listing
on the New York Stock Exchange and the Toronto Stock Exchange were expected to take
place shortly thereafter.
Analysts and investing community were apprehensive about the transaction. Some analysts
wondered whether Hindalco was overpaying for the acquisition.
Aluminum, a silvery white metal, was the most abundant metallic element in the earths crust
and the most widely used non-ferrous metal. Aluminum did not occur in the metallic form in
nature. Bauxite was the principal Aluminum ore from which Aluminum was obtained.
Approximately 25% of the worlds Aluminum production came from recycling Aluminum
scrap and rest 75% from primary production.
Its unique combination of properties like light weight, strength, flexibility, recyclability made
Aluminum ideal for a wide range of applications. Aluminum found a number of applications
in packaging (e.g. beverage cans), transport (e.g. aircraft manufacturing, alloy wheels),
electrical equipments, building and architecture (e.g. windows, roofing).
The price of primary Aluminum (ingots/billets) was market determined at LME (London
Metal Exchange) whereas the upstream products prices were determined by individual
companies depending on the product quality. Prices of alumina were market determined but
not traded at LME. That is, alumina prices were based on the prices of Aluminum.
Historically Alumina traded at 13-15 percent of the price of Aluminum.
Indias primary Aluminum industry was dominated by three companies that accounted for the
entire production. They were: National Aluminum Company Ltd (NALCO), Hindalco
Industries Ltd. and Sterlite Industries Ltd 1. Hindalco led the industry with a major share of
the production.
High Capital Requirement: The minimum economic size of an alumina refinery was around
1 million tonnes per annum and that of Aluminum smelter was 250,000 tonnes per annum.
Such size would require investment of over $1 billion each.
High Power Intensity: Aluminum smelting was energy intensive (1 tonne of Aluminum
required 14000-15000 kwh of power). An Aluminum manufacturer would require continuous
power supply. As a result, all companies had their own captive power plants. The captive
power plants added to the capital investment.
Novelis Backgroundiii
Novelis was the world leader in aluminum rolling, producing an estimated 19 percent of the
world's flat-rolled aluminum products. It was the largest producer of rolled products in
Europe and South America, and the second largest producer in both North America and Asia.
It produced Aluminum sheet and foil products for customers in high-value markets including
automotive, transportation, packaging, construction and printing. Its customers included
General Motors, Ford, Anheuser-Busch, Alcan, Kodak, Coca Cola among others. Novelis ten
largest customers accounted for 40% of net sales in 2005.
Novelis was also the world leader in the recycling of used aluminum beverage cans.
Annually, it recycled around 35 billion used beverage cans. Novelis operated in 11 countries
with approximately 12,300 employees. Exhibits 1, 2, and 3 present Novelis financial
statements.
Hindalco Backgroundiv
Hindalco Industries Limited, the Mumbai based flagship company of the Aditya Birla Group,
was structured into two strategic businesses- Aluminum and Copper. Established in 1958,
Hindalco commissioned its Aluminum facility at Renukoot in the Indian state of Uttar
Pradesh in 1962. It had grown to become the country's largest integrated producer of
Aluminum and ranked in the top quartile of low cost producers in the world. Hindalcos stock
was traded on the Bombay Stock Exchange, the National Stock Exchange of India Limited
1
The other producers of primary Aluminum included Indian Aluminum (Indal), which merged with Hindalco,
Bharat Aluminum (Balco) and Madras Aluminum (Malco), the erstwhile Public Sector Undertakings, were
acquired by Sterlite Industries
and the Luxembourg Stock Exchange. A key aspect of Hindalco's strategy was continuous
growth. The Company had taken two major initiatives in this direction in the recent past. In
1999, the company acquired a 74.6 percent controlling stake in Indian Aluminum Co. Ltd.
(INDIAL), a leader in the alumina and semi-fabricated business. The second of the initiatives
was a brown-field expansion of facilities at a cost of Rs. 18b. The expansion added 100,000
TPA to smelting capacity along with a 210,000 TPA increase in Alumina Refining Capacity
and matching augmentation of power generation capacity.
Birla Copper, Hindalco's copper division, was situated in Dahej in the Bharuch district of
Gujarat. The copper unit at Dahej was the worlds largest, single location copper smelter with
a smelting capacity at 0.5 m TPA. The plant was backed by captive power plants, oxygen
plants and by-product facilities for fertilizers and precious metals. A captive jetty with cargo-
handling capacity of over 4 m TPA facilitated easy import of copper concentrate and other
raw materials.
In addition, Hindalco held equity stakes in many companies like Idea Cellular, ABML
Australia, Aditya Birla Nuvo, Grasim, Bihar Caustic and Chemicals and NALCO4. Exhibits
4, 5, & 6 present Hindalcos financial statements
Novelis was formed as a result of the spin off from Alcan in January, 2005. In January 2005,
Novelis acquired the Aluminum rolled products business from Alcan. Novelis had a
conversion model i.e. it purchased Aluminum ingots (at LME) and converted them into rolled
products and sold these at certain margins. It enjoyed pass-through benefits. That is, it was
not affected by the volatility in LME prices as it sold its products at a spread over LME
prices. Raw material accounted for nearly 80% of its costs followed by labor and freight
(10%) and other costs.
Technological capabilities and meeting customer specification were key success factors in the
aluminum rolling industry. Technology was considerably capital intensive and setting up of a
plant took 3-4 years. Hence, Hindalco considered the acquisition of Novelis rather than
2
Hindalco has since discontinued manufacturing alloy wheels
3
Hindalco had announced capacity expansion plans of Rs 250billion apart from the Novelis acquisition.
Agarwal, Swati, Hindalco Industries, Edelweiss India Equity Research, Mar 2007; Baji, Prasad, Hindalco
Industries, Edelweiss India Equity Research, Nov 2007
4
Analysts valued these holdings at Rs 51 per share. Shah, Chirag and Ritesh Shah, Hindalco Industries, IDFC
SSKI, Nov 2007
setting up in-house facilities. With this acquisition Hindalco would get access to the world
class technology and client base of Novelis.
With operations spread across 11 countries, Novelis had a broad client base. With proximity
to its clients, the company could save considerably on freight costs and cut down lead times.
Apart from the reduction in costs, the merged entity could provide better sales support to
customers.
Since Hindalco had cheap supplies of bauxite and coal, the purchase of a downstream
producer like Novelis would provide the same benefits of other mega mergers like that of
Tata Steel and Corus Group.
On the flip side, Novelis had ended up inheriting a debt load of almost $2.9 billion on a
capital base of less than $500 m during the spin-off process. Though it marginally reduced
debt, it made some losses too. On a net worth of $322 m, Novelis had a debt of $2.33 billion
with a debt-equity ratio of 7.2.
In order to attract more business from soft drink manufacturers, Novelis promised four
customers that it would not increase product prices even if raw material prices went up
beyond a point5. Raw material prices shot up by 39 percent a few months after Novelis signed
those contracts. Novelis was forced to sell its products at lower prices than raw material costs
to these four customers. These four customers like Coca Cola and General Motors accounted
for 20 percent of Noveliss $9-billion revenues. The managements judgement led to losses of
$350 million in 2006.
Novelis already carried $2.4 billion of debt comprising of $1 billion term loans and $1.4
billion high-yield loans. The deal, of course, would increase the debt-equity ratio of Hindalco.
Also, over 50 per cent of the group's business would come from operations outside India after
the acquisition. Exhibits 7 and 8 present the financing structure of the deal, financial market
data for India and the US and firm level data for Hindalco.
5
These contracts would expire at varying times till January 2010. Analysts at UBS Investment research
estimated the present value of these losses at Rs 21600 m. See Sachdev, Sunita, Hindalco Industries, UBS, Nov
2007
Strategy This acquisition was a good strategic move for Hindalco. Hindalco would be able to
ship primary Aluminum from India and make value-added products. Kumar Mangalam Birla,
Chairman of the Aditya Birla Group, said,
"The acquisition of Novelis is a landmark transaction for Hindalco and our Group. It is in
line with our long-term strategies of expanding our global presence across our various
businesses and is consistent with our vision of taking India to the world. The combination of
Hindalco and Novelis will establish a global integrated Aluminum producer with low-cost
alumina and Aluminum production facilities combined with high-end Aluminum rolled
product capabilities. The complementary expertise of both these companies will create and
provide a strong platform for sustainable growth and ongoing success."vi
"After careful consideration, the Board has unanimously agreed that this transaction with
Hindalco delivers outstanding value to Novelis shareholders. Hindalco is a strong, dynamic
company. The combination of Novelis' 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. Hindalco's parent, the Aditya Birla Group, is one of the
largest and most respected business groups in India, with growing global activities and a
long-term business view."vii
Synergy Mr. Debu Bhattacharya, Managing Director of Hindalco and Director of Aditya
Birla Management Corporation Ltd., said,
"There are significant geographical market and product synergies. Novelis is the global
leader in Aluminum rolled products and Aluminum can recycling, with a global market share
of about 19 per cent. Hindalco has a 60 per cent share in the currently small but potentially
high-growth Indian market for rolled products. Hindalco's position as one of the lowest cost
producers of primary Aluminum in the world is leverageable into becoming a globally strong
player. The Novelis acquisition will give us immediate scale and a global footprint."viii
Novelis operated on a pure-converter model, which offered steady margins as pricing was
done either to pass-through costs or as a margin over metal. This assured steady cash
flows, and, more importantly, the company had no LME price risk. In contrast, Hindalco
operated on a model with margins directly correlated with LME prices, with higher LME
prices translating into higher margins and vice versa. Hence, under an ideal scenario (without
the price ceiling contracts), Hindalco-Novelis would be in a superior proposition offering
stable cash flows. Further, Hindalco could leverage the same in emerging markets.
Analysts from Merrill Lynch, however, speculated that the costs could outweigh the benefits
of the deal6. They pointed out that margins would be sharply squeezed during periods of
rising Aluminum prices as selling prices of finished products do not increase
6
Luthra, Vandana, and Vishal Nathany, Hindalco Industries, Merrill Lynch, Mar 2007; Luthra, Vandana
Hindalco Industries, Merrill Lynch, Sep 2007; Luthra, Vandana, and Bhaskar Basu, Hindalco Industries, Merrill
Lynch, Feb 2009
commensurately. For instance, price ceilings on beverage cans in the U.S. hurt Novelis
margins - in the first nine months of 2006 the company lost $ 170 million.
Stewart Spector, an Aluminum-industry consultant with offices in New York and Florida
echoed this view:
"In my opinion, they are overpaying. It seems to me that $6 billion is an awful big premium
to pay for a messy operation."ix
Exhibit 9 presents the consolidated free cash flow and dividend forecast for Hindalco. Exhibit
10 presents the valuation multiples of Aluminum and Copper Companies.
Demand Analysis
Domestic Indias consumption pattern of Aluminum was significantly different from the rest
of the world. In India, Electrical sector was the major consumer of Aluminum (31%)
followed by the transport sector (18%) whereas internationally, transport (26%) and
packaging (20%) sectors dominated the consumption. The consumption pattern in India was
witnessing a shift from the Electrical sector to the transport sector. The demand from the
Electrical sector had come down from 52% in 1980-81 to 31% in 2004-05 whereas the
demand from the Transport sector had increased from 11% to 18% in the same period.
Going forward, Indias consumption pattern was also expected to be in line with the worlds
consumption pattern as transport and packaging sectors were expected to become the demand
drivers for the Indian Aluminum industry.
India had been a net importer of Aluminum since 2005-06. With various projects lined up by
Indian companies analysts expected huge capacities to come up by 2010-11. India was
expected to be a net exporter from 2010-11 with the addition of new capacities. Analysts
expected a deficit of 0.05 m tonnes in 2006-07 and a surplus of 0.2 m tonnes in 2011-12.
Globalx
In a Ringsider article, analyst Adam Rowley of Macquarie Bank Ltd. estimated that the
global Aluminum consumption would increase by 7.5 percent to 34.3 million tonnes in 2006
whereas global production would increase by only 6.3 percent. He projected 2007
consumption to increase by 4.9 percent to 36 million tonnes and production to exceed
demand by 6 percent or 36 million tonnes.
The world Aluminum market had always maintained a tight demand/supply condition. A
considerable surplus was expected in 2010 and 2011 starting with a minimal deficit in 2009.
This was due to significant capacity additions worldwide, especially in Asian countries.
Analysts forecasted a surplus of 0.75 m tonnes in 2011 and expected Aluminum prices to
come down in the medium term.
Analysts expected world industrial production growth to remain above 4 per cent in the
following year. In Europe, a pick-up in investment spending and some ebbing of high
unemployment rates was expected to encourage domestic demand. The Japanese economy
was also likely to improve in 2008. The rapid pace of industrialization and urbanisation in
China, India and other emerging markets implied an increased consumption of Aluminum.
This was expected to support prices over the medium term. The Chinese demand for metals
like Aluminum had soared as these were a key input in construction, packaging and
automotive manufacturing. However, analysts were sceptical about the Chinese economy as
Foreign Direct Investment was slowing down.
The 16 countries that made up Central and Eastern Europe (CEE) included some of the
worlds fastest growing economies. Average GDP growth rate in the CEE was around 6 per
cent per annum between 2002 and 2006. This trend was widely expected to continue in the
foreseeable future. With economic growth came a greater demand for metals and other
materials required to support industrial and infrastructure development. The region had also
attracted considerable foreign investment and key manufacturing industries had grown
rapidly.
Stock markets reacted negatively to the acquisition as investors considered the acquisition to
be a drain on Hindalcos profitability due to overvaluation and high leverage of Novelis 7.
That Novelis was a loss making company also worked against Hindalco. Stock price of
Novelis, on the other hand, jumped 15 percent on the New York Stock Exchange following
the news of the acquisition. Exhibits 11 and 12 present the stock price movements of both the
companies.
Upon the announcement of the deal, brokerage houses reacted in a variety of ways: Asit
Mehta Intermediates and UBS Investment Research gave a Buy recommendation; IL&FS
Investmart gave an Accumulate recommendation; SSKI gave a Neutral recommendation;
Edelweiss Capital gave a Reduce recommendation; Citigroup and Merrill Lynch gave a
Sell recommendation.
7
Hindalcos stock traded at Rs 147 during May 2007. It actually increased marginally to Rs 148.85 upon
announcement.
Exhibit 1: Novelis Consolidated and combined statements of operations and
comprehensive Income (loss) for the year ended December 31 (in $ million)
Particulars ( In $ m except per share figures) 2006 2005 2004 2003
Exhibit 3 Continued
2006 2005 2004 2003
FINANCING ACTIVITIES
Proceeds from issuance of new debt
third parties 41 2779 575 500
related parties 0 0 1561 471
Principal repayments
third parties -353 -1822 -993 0
related parties 0 -1180 -5 0
Short-term borrowingsnet
third parties 103 -145 -774 577
related parties 0 -302 221 -29
Dividends common shareholders -15 -27 0 0
Dividends minority interests -15 -7 -4 0
Net receipts from (payments to) Alcan 5 72 -1512 -592
Debt issuance costs -11 -71 0 0
Proceeds from issuance of Common Stock in 2 0 0 0
connection with stock plans
Net cash provided by (used in) financing activities -243 -703 -931 927
Net increase (decrease) in cash and cash equivalents -34 71 3 -6
Effect of exchange rate changes on cash balances held 7 -2 1 2
in foreign currencies
Cash and cash equivalents beginning of year 100 31 27 31
Cash and cash equivalents end of year 73 100 31 27
Supplemental disclosures of cash flow information:
Interest paid 201 153 76 41
Income taxes paid 68 39 70 19
Principal payments on capital lease obligations 3 3 0 0
(included in principal repayments third parties)
APPLICATION OF FUNDS:
Gross Block 10258.51 10953.17 13443.26
Less: Accumulated Depreciation 3041.28 3806.56 4495.77
Less: Impairment of Assets 0 99.93 104.38
Net Block 7217.23 7046.68 8843.11
Lease Adjustment 0 0 0
Capital Work in Progress 711.56 1638.69 1040.28
Investments 1865.57 2955.85 3163.21
Current Assets, Loans & Advances
Inventories 1703.37 2697.04 4497.54
Sundry Debtors 751.73 840.44 1305.66
Cash and Bank 283.12 473.05 1042.34
Loans and Advances 1039.53 941.59 1032.63
Total Current Assets 3777.75 4952.12 7878.17
Less: Current Liabilities and Provisions
Current Liabilities 1295.29 1881.23 2886.12
Provisions 233.94 909.85 1024.96
Total Current Liabilities 1529.23 2791.08 3911.08
Net Current Assets 2248.52 2161.04 3967.09
Miscellaneous Expenses not written off 19.49 13.5 8.68
Deferred Tax Assets 3.67 30.4 308.43
Deferred Tax Liability 1198.93 1164.64 1536.57
Net Deferred Tax -1195.26 -1134.24 -1228.14
Net cash inflow/(outflow) from investment activities -1318.81 -1165.97 -2008.94 -1327.99
Net cash inflow/ (outflow) from financing activities 222.95 -99.78 396.12 1128.78
Net cash inflow/(outflow) due to net increase/ -192.14 -152.88 148.11 512.15
(decrease) in cash & cash equivalents
Cash flow -- opening balance 657.85 444.56 291.67 439.78
Cash flow -- closing balance 465.71 291.68 439.78 951.93
EV 6216
Debt 2860
Financed by:
Total 3356
Exhibit 8: Financial Market Data India and US
India US
10 Year T Bond Rate 7% 3.24 %
Market Risk Premium 9% 7.5 %
Hindalco
Beta 1.15
Debt/Capital 0.39
Tax rate 34%
Average cost of debt 7.4%8
Source: Luthra, Vandana, and Vishal Nathany, Hindalco Industries, Merrill Lynch, Mar 2007; Luthra, Vandana
Hindalco Industries, Merrill Lynch, Sep 2007; Luthra, Vandana, and Bhaskar Basu, Hindalco Industries, Merrill
Lynch, Feb 2009
8
This was the prevailing yield on 10 year AAA rated corporate bonds in 2006-07
Exhibit 10: Valuation multiples of Aluminum and Copper Companies
EV/EBITDA
Peers 2008E 2009E
2008E 2009E
International Aluminum Companies
Copper Companies
Source: Mehta, Chintan, Hindalco Industries Ltd, Asit C Mehta Intermediates, Dec 31, 2007
Exhibit 11: Stock Price History of Hindalco (Bombay stock Exchange)
References
1. Agarwal, Swati, Hindalco Industries, Edelweiss India Equity Research, Mar 2007
2. Baji, Prasad, Hindalco Industries, Edelweiss India Equity Research, Nov 2007
3. Brebner, Daniel et al, Hindalco Industries, UBS, Mar 2008
4. Daga, Giriraj, Hindalco Industries Ltd: Hindalco-Novelis Merger Update, Khandwalla
Securities, Feb 14, 2007
5. Energy Management Policy Guidelines for Energy Intensive Industry of India,
Chapter 3, pp 13-36 by Bureau of Energy Efficiency
6. Heather Timmons, "Indian Metals Company to Buy Canadian Rival," International
Herald Tribune, Feb 11, 2007
7. Hunt, Brook, The Long Term Outlook for Aluminum, Brook Hunt and Associates Ltd.
2007
8. India Daily, Kotak Institutional Equities, Feb 2009
9. India Daily, Kotak Institutional Equities, June 2009
10. Iyengar, Suresh P "Hindalco Deal May Not Impact Aluminum Prices," The Hindu
Business Line, February 13, 2007
11. Kuvelkar, Hitesh, Hindalco Industries, First Global Research, May 2009
12. Luthra, Vandana, and Vishal Nathany, Hindalco Industries, Merrill Lynch, Mar 2007
13. Luthra, Vandana Hindalco Industries, Merrill Lynch, Sep 2007
14. Luthra, Vandana, and Bhaskar Basu, Hindalco Industries, Merrill Lynch, Feb 2009
15. Mahtani, Pradeep and Raashi Chopra, Hindalco Industries, Citigroup Global Markets
Equity Research, March 2007
16. Mehta, Chintan, Hindalco Industries Ltd, Asit C Mehta Intermediates, Dec 31, 2007
17. Mishra, Vishal, and Sameer Dalal, Hindalco Industries, Il&FS Investsmart, May 2007
18. Sachdev, Sunita, Hindalco Industries, UBS, Nov 2007
19. Shah, Chirag, Hindalco Industries, SSKI, May 2007
20. Shah, Chirag and Ritesh Shah, Hindalco Industries, IDFC SSKI, Nov 2007
21. Surojit Chatterjee, "Birla's Hindalco Buys Aluminum Giant Novelis for US $6.4
billion," International Business Times, Feb 13, 2007
Endnotes
i
Hindalco Press Release, May 15, 2007
http://www.hindalco.com/media/press_releases/200705may/novelis_subsidiary_hindalco.htm accessed on July 1,
2009
ii
Hindalco Press Release, 16th May 2007
http://www.hindalco.com/media/press_releases/200705may/novelis_subsidiary_hindalco.htm accessed on July 1,
2009
iii
www.novelis.com http://www.novelis.com/Internet/en-US/AboutUs/ accessed on July 1, 2009
iv
www.hindalco.com http://www.hindalco.com/about_us/overview.htm accessed on July 1, 2009
v
Hindalco Press Release, 11 February 2007.
http://www.hindalco.com/media/press_releases/200702feb/hindalco_and_novelis.htm accessed on July 1, 2009
vi
Hindalco Press Release, February 11, 2007
http://www.hindalco.com/media/press_releases/200702feb/hindalco_and_novelis.htm
vii
Hindalco Press Release, February 11, 2007
http://www.hindalco.com/media/press_releases/200702feb/hindalco_and_novelis.htm
viii
Hindalco Press Release, February 11, 2007
http://www.hindalco.com/media/press_releases/200702feb/hindalco_and_novelis.htm
ix
Hindalco Press release, May 16, 2007
http://www.hindalco.com/media/press_releases/200702feb/hindalco_and_novelis.htm
x
The Ringsider Metal 2007, The London Metal Exchange