Last month, Hinduja group announced the consolidation of their two separate listed arms by amalgamating Hinduja Foundries Limited (HFL) with Ashok Leyland Limited (ALL).

Rationale

Ashok Leyland Limited is the 2nd largest manufacturer of commercial vehicles in India, the 4th largest manufacturer of buses in the world and the 16th largest manufacturer of trucks globally. Hinduja Foundries Limited is India’s largest foundry group with the capacity to produce cylinder block and head ranging from 25 kgs to 500 kgs. The company manufactures castings for automobiles and tractors, industrial engines, construction equipment and power generation equipment. HFL is a very critical supplier of ALL. About third to 35% of HFL’s revenue comes from ALL. Main reason for the merger is backward integration for ALL.

In an era of focusing and housing different businesses in different companies to create value for the stakeholders, exactly reverse corporate action justifying value accretion for public shareholders is not easily palatable

There are accumulated losses over INR 1000 crores in HFL which will optimise income tax liabilities of the merged entity. There may be savings in indirect tax post implementation of GST.

From 1st April, 2016, both companies are shown as related parties, though before that also Hinduja group was a major shareholder in both and ALL is a shareholder of HFL since long.

Over the last 3 years, under the management of MR. Dasari, there was a significant turnaround of ALL. Recently the management of HFL also been changed. According to the management ‘EBITDA of HFL turned positive in this period’.

Shareholding Pattern of both the companies

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Hinduja Automotive Limited Holds 33.72% and 20.74% stake in ALL and HFL respectively. Further, there are 13,56,21,000 shares (held in a form of GDR) of HFL out of which 13,44,00,000 shares were issued in 2016 at INR 29.75/ share. However, it is not very clear about beneficial ownership of GDR but most of them are held by Hinduja Automotive Limited.

Main reason for the merger is backward integration for ALL.

Earlier HFL was the associate company of ALL where ALL was holding ~21% stake in HFL. In FY 2008-09, the stake came down to 18.82%. Currently, ALL holds 2.61% stake (Considering GDR) in HFL.

One of the important reason behind merger could be to save the redemption of preference shares.

ALL has subscribed to the various preference shares issued by HFL amounting to INR ~322 crores. Such preference shares are scheduled to be redeemed in 2016/2017 (after obtaining an extension for redemption couple of times).

As on 31st march, 2016, the outstanding dividend on redeemable preference shares is INR 120.56 crores. These preference shares will be cancelled as part of the scheme and ALL shall have no claims in respect of arrears of dividend on them. Hence, the merger will save the outlay of INR ~442 crores for HFL and loss to the shareholders of ALL.

It may not be surprising if in future management comes out with the scheme and rationale for demerger of foundry business

Consideration

  • Equity shareholders of HFL will get 40 equity shares of INR 1 each of ALL for every 100 equity shares of INR 10 each fully paid up of HFL.
  • 2008 series GDR of HFL will get 133 equity shares of ALL for every 1,000 GDR.
  • 2016 series GDR of HFL will get 4800 equity share of ALL for every 1 GDR.

In terms of post-merger shareholding pattern, the transaction is little bit favourable for promoters. Their holding is ALL will move from 50.4% to 51.05%.

The appointed date for the transaction is 1st October, 2016.

Financials

Table 1: Ashok Leyland Consolidated Financials (All Figures in INR Crores)

Particulars 2016 2015 2014
Revenue 20,658 15,340 11,487
EBIT 2,408 937 108
EBIT % 12% 6% -1%
PAT 1098 -214 -231
PAT % 5% -1% -2%
Networth 4,992 4,511 3,989
RoNW 22% -5% -6%
Borrowings 8,690 7,046 6,755
Capital Employed 13,682 11,557 10,744
RoCE 18% 8% -1%
Total Assets 22,963 19,524 17,534
EPS 3.76 0.48 -0.62
Total Vehicle Sales (In Numbers) 1404 1049 893

Table 2: Hindustan Forgings Consolidated Financials (All Figures in INR Crore)

Particulars Oct’ 14 to Mar’16 Apr’13 to Sep’14
Revenue 845 999
EBIT 128 152
PAT 394 262
Networth 191 188
Borrowings 408 518
Capital Employed 599 706
Total Assets 820 989

Conclusion

In an era of focusing and housing different businesses in different companies to create value for the stakeholders, exactly reverse corporate action justifying value accretion for public shareholders is not easily palatable. ALL supported HFL for last several years by subscribing to its equity and preference shares in the process save the company from going into BIFR and without any returns. Now those investments are getting cancelled in the course of the scheme.  No doubt post-merger, ALL will get tax benefits, but it will have liability to run foundry business and attached risks for no visible long-term advantage to public shareholders. After the merger, operational inefficiencies and debt of HFL will be the biggest challenges in front of ALL. The ALL has already started working closely with HFL for a turnaround. After continuous losses, as claimed by the management, HFL has turned EBITDA positive in last 2-3 months and if sustained for a long term, it may create value for all the stakeholders. It may not be surprising if in future management comes out with the scheme and rationale for demerger of foundry business.

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