| 7 March 2011
The financial integration of Novelis with Hindalco has given the latter the heft to push ahead with its ambitious growth plans in India
Last December was hardly a holiday season for
Debu Bhattacharya, managing director of Hindalco,
his key lieutenant CFO Sunirmal Talukdar and
their core corporate strategy and finance teams.
Even though Christmas was round the corner,
Hindalco, the Aditya Birla Group flagship, was
in the middle of reaching a crucial milestone
to financially integrate Novelis with Hindalco
and make cash fungible between the two. This
exercise in turn would give Hindalco the much
needed extra legroom and cash to accelerate
its ambitious growth plans in India.
Nobody outside the company had ever conceived this possibility in 2007 when Hindalco made its most daring move ever by acquiring Atlanta- headquartered Novelis, a company three times its size. Welcome to Project Nalanda, designed, implemented and delivered by the same Hindalco management that had promised that the acquisition would be value accretive by 2010. But besieged by an unprecedented economic meltdown, credit freeze and suicidal business contracts, nobody gave them a chance. "In 2007, if somebody said that Novelis can have a liquidity of a billion dollars, you would be laughing out of the room," Bhattacharya reminisces.
But today, Novelis is indeed assisting Hindalco to fund its `23,000 crore-plus expansion plan in India. And Project Nalanda has led to one of the largest capital repatriation by an Indian company after a foreign acquisition. It also means that within four years, half of the $3.5 billion that Hindalco
spent to buy Novelis has come back into its fold.
"We own 100 per cent of Novelis for just $1.8 billion today. This return of capital represents almost 50 per cent of the initial acquisition cost achieved within four years of the buyout,"quips Bhattacharya. But the benefits don't just stop there. This fungibility of cash actually allows Hindalco to tap the resources that were till now trapped in Novelis and could not be accessed due to the restrictive loan covenants. That money was, however, essential to bridge the project equity for Hindalco's capex.
But all this could only happen after Novelis
stood on its own two feet. So the financial realignment
was finally launched in 2010 with Novelis turning
around with close to a billion dollars in adjusted
EBIDTA (earnings before depreciation, tax and
So despite Christmas, Hindalco decided to follow its refinancing time line in what was to be a race against deadline. The book was opened on December 10 and closed a week later, with literally no time to spare. "The calls during that week started at 8.30 pm when the US markets would open. We had to close the exercise before the long holiday break kicked in,"says Talukdar.
It was no impulsive move but a continuation of a well thought out, step by step road map. "One thing I can promise you is that it hasn't just happened; it has been made to happen. And on a defined, structured path. There was no madness in it," explains Bhattacharya. And it goes back right at the time when Kumar Mangalam Birla wrote the cheque for Novelis.
The $6 billion acquisition of Novelis was done by paying $3.5 billion in cash and taking over the $2.5 billion of its debt. This debt included $1 billion of term loans and $1.4 billion of high yield bonds. But unlike similar buyouts of such size and scale, where the balance sheet of the target is 'leveraged' to raise finances for an acquisition, Hindalco did the opposite. It paid the $3.1 billion through recourse financing on Hindalco's own corporate guarantee and $450 million by liquidating some treasury stocks. No new debt was added on the Novelis books. Bhattacharya says that at that point Hindalco did not want to risk Novelis running a higher debt and face liquidity problems. "The plan was to give it time to come out of its inherited legacies, perform to potential and then put additional debt," he adds.
The first step of financial re-engineering had however begun soon after the deal in 2007. First, the 18-month bridge loan of $3.03 billion was taken out. In the middle of a severe credit crunch that was becoming a global malaise, $1.25 billion was raised via a Hindalco rights issue and another billion dollars from 12 global banks as term debt. This was subsequently routed back via its Dutch investment company AV Minerals (Netherlands) BV. The remaining amount came from the company's internal accruals. Talukdar, breaks it down further. "We decided not to put any new debt on Novelis' balance sheet because the recapitalisation would have meant higher interest costs as its bonds would then have been refinanced at 9 to 9.5 per cent. Since Hindalco had a stronger balance sheet, it got a more aggressive pricing."
That alone was not enough at that point in time. The limp back to recovery was slow and
painful for Novelis amidst severe financial meltdown across North America and Europe. The contractual price ceilings on Novelis' aluminium cans added to the woes it had to sell them at prices lower than its raw materials. It was actually losing money on every can it produced. At the end of financial year 2007 Novelis had a negative $104 million of free cash flows and an adjusted EBITDA of just $349 million.
But the strategic steps — nick named Project Sunrise— to mesh the high cost model of Novelis with that of Hindalco's low cost operations continued relentlessly including a liquidity support of $100 million. Unproductive and high cost operations in Britain and the UK were shut down or relocated to India and even the workforce was rationalised by close to 10 per cent. The immediate mandate was to make Novelis a $1-billion EBITDA company generating sufficient cash flows to initiate any financial realignment. And to do that Novelis had to transform a "value creator than a volume filler."
"Indian companies are very cost conscious and we wanted to impart that in Novelis. That's what our effort was and I will say that we are reasonably successful in that," boasts Bhattacharya.
The turn around was stark by 2010. By then Novelis'
equity value more than doubled to around $8 billion
in 2010. Its enterprise value (EV) of $12 billion
was also two times its 2007 EV. Novelis' bonds
were also trading higher on the back of this recovery
and with increasing profitability, Hindalco was
set to finally launch what it had always intended
to: Move Hindalco's acquisition debt to Novelis
books. It was time to re-lever Novelis.
In this second phase of consolidation, debt in the two companies had to be aligned so that both enjoyed sufficient liquidity. A competitive debt structure with diversified sources of capital and friendlier covenants was equally critical.
So in mid-December of 2010, on the back of over a billion dollars of adjusted EBIDTA for the last four quarters, Hindalco decided to recapitalise Novelis with $4.8 billion of debt.
"With the stable earning profile of Novelis, we were able to lever up Novelis at four times
debt/EBITDA for a higher upfront return of capital for Hindalco," said Talukdar. The company also successfully negotiated with Novelis bond holders and the bankers at a net debt to EBIDTA
covenant of three times. This relaxation removed the restriction of capital deployment and actually made cash fungible between the two companies. Novelis could then repatriate $1.7 billion to the parent. But it's not just a one-time windfall. As Novelis' financials continue to improve in future, more remittances to Hindalco will be possible. Novelis too can now dream of acquiring assets by raising more debt.
From the capital returned, Hindalco is planning to repay the $1 billion debt it had taken to pay the bridge loan and the rest will be used up for Hindalco's upcoming expansion plans in India.
It also has an extra $700 million of "seed capital" for its Aditya Alumina Refinery and Jharkhand smelter projects.
It would be wrong to see this financial integration in isolation, it's part of a bigger transformational journey of mindsets and business processes. It is also not an end but surely is a principal catalyst of a much bigger business integration. And as the sentiments have improved, Hindalco and Novelis is ready to leap frog into a new phase of growth and consolidation.
Parallel to the financial rejig, the "One Novelis" programme initiated by Novelis CEO Philip Martens has also played an equally critical role to bring together the disparate global operations of Novelis under one common ethos of the group.
"Novelis was highly decentralised. It operated as four different entities within one company. So it was important to have common processes and data bases to improve overall collaboration. Along with the people, business processes also had to be integrated," explains Santrupt Misra,director, group human resources (HR), Aditya Birla Management Corporation.
Adds Bhattacharya: "Organisationally, One Novelis, to a large extent has happened. Even cultural integration between Aditya Birla Group and Novelis has significantly progressed."
Expansion and relocation
With Novelis now aggressively expanding its production
in Brazil, Korea and other emerging markets, things
are only going to look better. The $300-million
expansion at Pinda, Brazil is the largest for
Novelis. But why attack that market? Bhattacharya
says, "The plant has a capacity of 375 kilo
tonnes per annum (ktpa) today; so we are doubling
the capacity in South America because the growth
in Brazil is phenomenal and we are almost 90 per
cent of the market. We are the market and the
market is us." The improvement has been noticeable
in the financial year 2011, but the year is not
over yet. All steps have been taken to increase
the production by 20 per cent by the financial
The relocation of the can body making plant of Novelis Rogerstone from the UK to Hirakud in Orissa has been yet another calculated move. The plan is to produce 500 ktpa of aluminium sheets out of which 130 ktpa will be up and functional in the next six months at an initial investment of `600 crore. Bhattacharya, who is visibly upbeat about the project says that the objective is to be the cheapest can body stock in the world. He has already set an internal litmus test: "In the can body plant that we are putting up in Hirakud, we have made sure that even with the highest subsidy that a Chinese manufacturer can enjoy, we will not only be competitive in India but also take on the Chinese in China."
Hindalco for long had wanted to produce can-bodies in India. It's an aspirational life style product but the market was not growing despite its tremendous potential. Importing it from West Asia at significantly higher transportation costs ensured that the can-fillers were not using it. But despite Hindalco's hardselling, companies were not convinced about Hindalco's execution of the high quality aluminium sheets. But now, with Novelis in its bag, the tables have turned. Already two companies, Rexam and Can-Pack, have approached them and many more are expected to make a beeline for India.
Bhattacharya says that the can-body consumption in the world is growing and Novelis cannot supply enough. "We will also be supplying to the international brands by taking advantage of the brand equity of Novelis. So, you can see the meshing of the two businesses. From technology, to fixed assets and brands every conceivable factor has been completely synergised."
Currently, the company is not looking to shift any more Novelis manufacturing units to the low-cost emerging markets like India. Only non performing assets will be closed down. There is still significant disparity in skill levels."We have a lot to learn and have to complete our learning before we try to replicate what they do,"Bhattacharya insists.
In fact, Hindalco over the last four years,
has never tried to hammer in its own value systems
in to Novelis. Its management was retained,
in fact, many were elevated. The entire restructuring
exercise—including shutting down of plants—was
done together with the Novelis labour unions.
"We did not dismantle their ethos. We always
believe in a consultative process," says
Misra. "Even in 2008, reducing people was
the last option."
Going forward, Hindalco will continue to be a low-cost upstream player that will play a complimentary role to Novelis'value-added downstream products. "And as Novelis' margins are completely pass through, we can get a clear idea of the revenues it will generate, thus derisking the business to a large extent," says Talukdar.
The company is betting big on the three main products groups, namely, can body, automobiles
and electronics. At present, 54 per cent of the aluminium processed by Novelis goes into cans. And Novelis, under Martens, has already overtaken rival Alcoa as the largest North American maker of metal for beverage cans. Only 7 per cent goes into cars. But with strict rules governing carbon emissions, in the next five years, demand for aluminium from the world auto sector is expected to grow by 10 per cent, while demand for beverage cans will grow at less than half that pace. Light weighting of cars along with hybrid fuel options are the new frontiers for the global auto giants. Aluminium is a lighter, more malleable metal compared to steel that is bound to help car makers find lighter and fuel efficient options.
No coincidence then that Martens happens to be an auto industry veteran being the former chief programme manager for the Panther range of cars at Ford Motor. By 43, he was also head of product creation for North America. It's also no coincidence that today most auto industry players including Ford are major Novelis customers.
Hindalco and Novelis signify a rare convergence of all strategic needs. If Hindalco is the low-cost metal convertor, then Novelis is the value-added product maker. Together, they reduce volatility
like never before.
As Bhattacharya concludes: "Hindalco is
today 50 per cent of the Aditya
Birla group. Our chairman has a target of
$65 billion of group turn over by 2015 from
the current $30 billion. And we believe that
we must deliver our share and these steps that
we have taken actually paves way to take the
group to that target." Today,there is hardly
any analyst who would dare to challenge that.