Sterlite gets a better deal

IT has been a year-long courtship between the Indian non-ferrous major, Sterlite Industries and the US copper miner, Asarco. In May 2008, Sterlite had clinched the bid to buy the assets of Asarco, which went bankrupt in 2005, for $2.6 billion. Just a couple of months later — in July — Sterlite’s offer was set aside by Grupo Mexico, the parent company of Asarco, which was allowed to come up with a revival package.

The timing of that move was uncanny. From July 1, 2008, global prices of copper tumbled by more than 60%. This was on the back of low demand in line with the global economic slowdown. The $2.6 billion offer for Asarco, which is in possession of about 5 million tonnes of copper reserves, looked a trifle expensive. It seemed like Sterlite would have been in a bit of a bother if the deal had gone through.

Cut to March 2009. Grupo Mexico, by then, had failed to take back control of Asarco which made way for Sterlite’s re-entry. At this stage, Sterlite made a revised offer of $1.7 billion for Asarco’s assets in the light of a sharp fall in copper prices. The creditors (including government agencies), who were handed the control of Asarco, have since then accepted Sterlite’s offer.

“This acquisition is in line with our strategy of leveraging our existing skills to become a diversified global copper producer and creating long term value for shareholders,” said Anil Agarwal, chairman, Sterlite Industries. The deal is subject to the US bankruptcy court’s approval.

Sterlite will buy Asarco’s three open-pit copper mines, associated mills and a copper smelter in Arizona. Besides these a copper refinery, rod and cake plants and a precious metals plant in Texas will also come into Sterlite’s kitty. This will make Sterlite Industries a formidable metal player in the global market. Of the total copper that Sterlite produces at its plants, only 10% is met by its mine in Tasmania, Australia. The company buys the rest of the copper for its smelting plants.

Although the revised price is lot less than before, what is striking in this is the payment structure. Sterlite will pay $1.1 billion in cash and will have a deferred payment mechanism of $600 million. Starting from the second year to the eighth year (seven years in all), Sterlite will pay $20 million each year and $460 million in the ninth year. “Sterlite would make the upfront cash payment from its cash reserve of $1.8 billion. The rest will be paid from Asarco’s operations and hence will have no recourse to Sterlite,” says Tarun Jain, CFO, Sterlite Industries. “The company would assume Asarco’s operating liabilities, but not legacy liabilities for asbestos and environmental claims for ceased operations,” he adds. Though the payment outgo is linked to the movement of copper prices, the total sum promised will not change. The surprise element in the deal is that Sterlite will only pay for Asarco’s assets and not for its non-operating liabilities in the form of environmental penalty claims amounting to $7.9 billion. “It is a normal deal, it happens in the case of a distress sell,” says Rakesh Arora, associate director, Macquarie Research.

A few analysts, however, are of the view that Asarco is worth less than Sterlite’s offer price. In its report, Credit Suisse says that the price should have been less than $1 billion.

Merrill Lynch values Asarco at $750 million and believes that on a one-year horizon, the acquisition is earnings dilutive by 7%.

Clearly, there is a divide of opinion in the investor community. Arora of Macquarie Research says that the acquisition price is right. “Based on the mine’s life and copper price in the long term, the deal has an NPV (Net Present Value) of $350 million,” adds Arora.

Further, Macquarie suggests that Asarco’s EBITDA will be $200/tonne in FY10. “Our assumption is based on a production cost of $3,400/tonne, whereas the company assesses that Asarco’s copper production cost will be $2,800/tonne,” says Arora. Sterlite is looking to bring down production cost by 10%. The Merrill Lynch report says that for the deal to be value neutral, Asarco needs to earn an EBITDA of $1,650/tonne. However, Sterlite’s CFO Jain maintains that the deal would be value accretive even at the current price of copper at the LME (London Metal Exchange). “Asarco’s production cost was $3,000/tonne in January 2009 and its EBITDA was $900/tonne,” says Jain.

The silver lining is that one can expect copper prices to go up because its supply has been tight and there has been a shortfall in production in the last decade. “What is hurting now is the demand for the metal which is 25-30% down in the last six months,” says Arora. Macquarie expects the deal to be earnings dilutive in FY10, but would add around 5-6%, to its FY11 EPS estimate. The purchase will not lead to a high gearing ratio as Sterlite is a net cash company.

The deal, clearly, is about size. After the takeover Vedanta, the parent company of Sterlite Industries will become the third-largest copper producer in the world and the combined capacity of the group will be 1.2 million tonne a year. Asarco sold 237,000 tonnes of copper in 2008. Big is indeed beautiful.

PSU refiners can now convert bonds to dollars

THE Reserve Bank of India (RBI) has moved to support the rupee by starting special market operation(SMOs) enabling PSU refiners to convert their oil bonds into dollars. In the course of a SMO RBI buys the bonds and provides equivalent forex exchange to oil companies through banks.

RBI has been purchasing oil bonds from public sector refiners such as IOC, BPCL and HPCL since last week. A market source said that oil bonds worth Rs 2,500 crore have been purchased by RBI, with BPCL having sold Rs 800 crore and IOC around 1,500 crore worth of bonds.

Since the SMO is what is known as an off-market transaction, it imparts both liquidity to the oilcos and overall financial stability by providing dollars to the oil majors, who otherwise would have had to tap the forex market. Under the current circumstances, huge dollar demand by oilcos could further worsen the fall in the already struggling rupee.

The rupee has depreciated by 6.35% against the greenback in the calendar year to date, having hit a low of 52.18 to the dollar on March 3. The rupee’s fall is attributable to the unprecedented strength in the dollar relative to other currencies and continuing outflows from India.

The outlook for bonds too has worsened in the past few weeks with the government announcing extra borrowings from the market, increasing their supply. The same traders who were falling over each other to purchase quasi government bonds (like oil bonds in the hope that yields would fall) are now waiting for a chance to exit the market. This has meant that there is no appetite for oil bonds in the market, other than from RBI, LIC and provident fund trusts.

The RBI permits the oil companies to sell bonds to the extent of their import requirement. “We have so far received Rs 15,000 crore worth of bonds in the firstthree quarters of the current fiscal, while Rs 2,000 crore are receivable,” said SK Joshi, director (finance), BPCL.

“However, we can’t just offload whatever we wish to under the SMO. RBI permits us to sell bonds to cover our import requirements,” he said. SV Narasimhan, director (finance), IOC, said that the refiner had outstanding oil bonds worth Rs 30,000 crore at the beginning of March.

RESCUE MISSION
In the first leg, RBI buys the bonds and provides equivalent forex exchange in off-market deals to oil companies through banks Since SMO is an off-market transaction, it gives liquidity to the oil companies and overall financial stability by providing dollars to the firms Oil cos would otherwise have had to tap the forex market, weakening the Rupee.

Inflation dips, but prices of essentials shoot up

MARIAMMA Alexander, a homemaker, has seriously begun to doubt what she reads in the morning papers. Inflation, she is told, is down to a seven-year low of 2.4%. But when she drops by at the neighbourhood greengrocer or makes a trip to the nearest mall, she isn’t amused by what she sees.

Wheat, rice, milk, vegetables and pulses — all the items she tosses into her cart without so much as a second thought — sport bigger price tags each time she goes shopping. “Inflation is coming down only according to the papers. When you go to buy groceries, prices of almost everything have gone up.”

Inflation peaked last August at 12.5%, before easing to 2.4% at present. This can be seen in the attached table for price indices. While the index for all commodities has gone down compared with last year, that for food articles, pulses and cereals is still higher than the last year. This is because the prices of commodities like sugar and rice have risen between 8% and 10% in the past two months, according to the Mumbai Grain, Rice & Oil Seeds Merchants Association secretary Nilesh Veera.

“Prices are constantly fluctuating. Once they go up nobody will reduce them easily,” she says. Ms Alexander has her list ready to drive the point home: The price of premium variety wheat has gone up to Rs 33 per kg from Rs 27 in the past two months. Parimal rice has gone up to Rs 32 per kg from Rs 30 two months ago. Prices of wheat bread and tea have also risen in the past three to four months.

The reason for the disconnect between inflation numbers and prices at the retail level could have to do with a complex interplay of factors, ranging from the method of calculation to the number of intermediaries in the supply chain, or even political intervention in terms of maintaining minimum support prices.

Inflation numbers are compiled by the ministry of commerce and industry after taking into consideration the prices of over 200 items every week, ranging from foodgrains to fuel, and indexing it to the base price of 1993-94. The weekly inflation numbers that are released, are a year-on-year comparison.

Unlike other countries, the most commonly used measure of inflation in India is based on wholesale prices rather than consumer prices. The wholesale price index or WPI, a constituent of inflation, reflects prices at the wholesale end, whereas the consumer price index (CPI) reflects retail prices. Primary food articles constitute 22% of the WPI while it constitutes more than 50% for CPI. So, CPI led inflation for industrial workers is 10.45%
for the month of January 2009 as compared to 9.70% in December 2008.

V Shanmugam, chief economist of Multi Commodity Exchange, points out that the disconnect between inflation numbers and ground reality is mainly due to inefficiencies in the supply chain. “There are too many intermediaries in operation. Also, the government is not incentivising supply chain efficiencies.”

Prices of pulses, on their part, have remained high as the cost of imports have gone up due to a relatively weaker Indian currency. SP Goenka, secretary, Pulses Importers Association, said private importers are registering losses while state-owned companies are selling only to large traders, who in turn, are passing on the higher prices to consumers.
Lower production of sugar has led to higher prices, and the high minimum support price for rice has resulted in a 10% increase in prices. In the current slowdown, it is not just the consumer who feels the pinch. Retailers, too, are offering attractive deals, often at the cost of their margins.

R Ramasubramanian Nadar, director of Mumbai-based single store format retailer AP Mani & Sons, points out that FMCG manufacturers themselves offer good discounts on procurement, but nearly 50% of the added discounts come from the retailers’ profit margins. “Most grocers enjoy an average margin of about 10% and in times like these, we have to dip into our profit margins and play the volume game.” However, consumers feel the offers are just to clear inventories and pep up sales. “Many a time, the offers are attractive but the quality may not be guaranteed or the freebies may not serve your purpose,” says Ms Alexander.