Sandur Consolidating business by merging subsidiary

Sandur Manganese and Iron Ores Limited (SMIORE) is a well-established company, incorporated in 1954, engaged in the business of exploration, prospecting and mining of manganese ore, iron ore and also, manufacture of ferroalloys. It is currently operating in Ballari district of Karnataka. The equity shares of the company are presently listed on BSE and in process of listing on NSE.

Star Metallics and Power Private Limited (SMPPL) is a subsidiary of SMIORE who is currently holding 80.57% stake in the company. SMPPL has a ferroalloy plant with two furnaces and a 32 MW thermal power plant which is used as a captive unit for its ferroalloy operations and is operating at Hosapete Taluk of Ballari district. Under a Facility Lease Agreement, SMPPL has leased out both the ferroalloy plant and thermal power plant to the Transferee Company for a tenure of three years which is due to expire on January 31, 2019.

Transaction

• SMIORE amalgamating its subsidiary company SMPPL with itself with an appointed date of April 1, 2018.
• Equity shares held by SMIORE (i.e. 80.57% of total paid-up capital) in SMPPL will stand cancelled, and for balance shareholders, 1 (one) equity share of Rs 10 each of SMIORE for every 72 (Seventy-Two) shares of SMPPL.
• Rationale being SMIORE seeks to have captive use of manganese ore in the existing ferroalloy plant of the SMPPL and set up a 1 MTPA Integrated Steel Plant in the vicinity of the ferroalloy plant which will enable captive consumption of its iron ore also.
• In addition, on setting up the proposed integrated steel plant, SMIORE will become eligible in terms of Rule 6(3) of the Mineral (Auction) Rules 2015, to participate in the auction of ‘mines specified for end-use’ by the Government of Karnataka.
• Other reason being to reduce power cost generated from SMPPL power plant, SMIORE is working on PIG Iron Project with an ultimate plan of getting into steel manufacturing. This project will help in reducing power cost by 50% – 80% by supplying waste heat and flu gas generated from this plant and SMPPL is not in the position to invest on such a large scale and hence this can help the SMIORE in greater integration and greater financial strength and flexibility for the SMIORE.

Accounting Treatment

• The amalgamation shall be accounted in the books of account of the SMIORE according to “Pooling of Interest Method” of accounting as per Ind AS 103.
• All the assets and liabilities of the SMPPL shall be recorded at their carrying amounts as at the Appointed Date in the books of the SMIORE.
• Inter-company balances and investments, if any, shall be cancelled and shall be adjusted against the General reserves/balance in Profit and Loss Account;
• The identity of the reserves of the SMPPL shall be preserved and they shall appear in the financial statements of the SMIORE in the same form and manner, in which they appeared in its books.
• The difference between the amount recorded as share capital issued by the SIMORE and the amount of paid-up share capital of the SMPPL shall be adjusted against the General Reserves/balance in Profit and Loss Account

Shareholding

Table 1: Shareholding Pattern Pre & Post Merger

Financials

SMIORE presently generating revenue from two segments namely mining (around 72%) and from ferroalloys & power (around 28%) and is working on steel project plant which is still to generate any revenue.

Whereas SMPPL is leasing its entire facilities to SMIORE, the parent company, consequently it is earning only a fixed income in the form of lease rentals. Prior to that, it was also producing Silico manages for SMIORE on job work basis.

Table 2: Financials of SMIORE and SMPPL (All Figs in INR Crores)

Valuation

SMIORE being listed company is valued at Rs 1,067 crore using market price method and whereas SMPPL is valued at Rs 160 crore using Net Asset Value (NAV) Method. Interestingly, the cost of SMIORE investment in SMPPL for 80% shares is Rs 150.48 crore.

In November 2016, SMPPL has converted loan of Rs 1.30 crore from promoter entity into equity shares and increased promoter’s equity stake in SMPPL to 18.73% to 19.39% (equivalent decrease in SMIORE’s stake). The conversion took place at the same value as assigned for the current deal.

For Valuation for SMPPL, for valuing Land & Building and Plant & Machinery, the fair market value of them as on 30.08.2016 is considered and discounted for distresses. Further, the net non-current assets are considered as on 31.03.2017 whereas the net current assets are considered as on 31.03.2016.

The purpose for the divergence between various dates and a significant time lag between data used for valuation& valuation date is not clear. The impact of same on regulatory approvals and direct tax liability also needs to be examined.

Other factors

• SMPPL is a loss-making company having an accumulated loss of Rs 26.25 crore as on March 2017 could be available for set-of post-merger by SMIORE.
• Both companies are virtually debt free so combined net worth can be leveraged for various expansion projects.
• Merger can result in saving in lease rental charges and power cost and will also result in administrative and operational synergy.

Conclusion

SMIORE is consolidating its business by merging its subsidiary SMPPL which has provided its ferroalloy plant and power plant on lease to the company. Commercial reason to get benefits of consolidation and as a result able to execute projects relating to steel manufacturing is no doubt seems justifiable. However, it seems promoters in their individual capacity are not able to take care of operations of the subsidiary in profitable and sustainable manner.

In fact, profit of the SMPPL is due to leasing of all its facilities to the holding company. So, for promoters, as they subscribed to the equity shares of SMPPL around the same price as the holding company, they will be getting liquidity for their investments in SMPPL and losing~20% only in value even after losses.

Further, the lease agreement between the SMIORE and SMPPL is going to expire in January next year. The only income of SMPPL is the lease payment received from the SMIORE. The merger of both entities can be a step to minimise the regulatory compliances and maximise the corporate governance.