Nalco's sobering fee

JPMorgan joins ABN AMRO as the Indian government primes its first privatization in ADR format.

The US investment bank was recently selected as a second joint global advisor for the Indian government's proposed divestment of a 59% stake in National Aluminium Company (Nalco), the world's lowest cost producer of alumina, the raw material of aluminium. On listing, the company will become the third Indian public sector unit (PSU) to be listed on the New York Stock Exchange following MTNL and VSNL, which have both converted their GDR floats into ADR programmes.

However, for Asia's investment banking community, the stand-out aspect of the transaction is the exceptionally miserly 1.96% fee the two will share for the completion of what is expected to be a roughly $250 million ADR issue. The fee is yet another example of the fierce undercutting needed to win mandates in Asia and will mark a new low for an New York listing by a government-owned entity over the past three years.

The Indian government has never traditionally paid high fees for international privatization offerings, but in previous years, they have always taken a GDR format, which typically command lower fees partly because they necessitate less onerous documentation. For example, the two most recent privatizations - VSNL's $161 million GDR of February 1999 and GAIL's $218 million GDR of November 1999 - paid respective gross fees of 1.24% and 2.25%.

But where VSNL was concerned the deal was a follow-on offering rather than a primary offering. Similarly in the ADR market, follow-on offerings for government-owned companies like Korea Telecom and China Mobile have also seen fees cut (1.5% and 1.8%), but as bankers point out both of the latter deals were extremely large and secondary offerings require less intensive due diligence.

In the past three years Asian privatizations have been dominated by China and according to figures supplied by Dealogic, fees have veered from a low of 2.5% (MTR Corp and Sinopec) to 4.75% (Chalco). More depressing still for houses with strong Indian franchises, however, are the fees that have been paid by Indian corporates seeking New York listings. Eight largely tech-related companies have listed since 2000 and paid an average fee of 5.25%, of which HDFC Bank stands at one end on 4% and Silverline Technologies and at the other on 7%.

ABN AMRO originally secured the advisory mandate for Nalco partly on the basis of its "competitive" fee. When asked to partner with a second firm from the other shortlisted banks - JPMorgan, Merrill Lynch and Morgan Stanley - it found that two of the three baulked at the combination of small deal, even smaller fee, although one also ruled itself out because it is likely to act as M&A advisor to one of the global majors interested in purchasing a strategic stake.

Nevertheless for JPMorgan the transaction is an important one. It will not only break the virtual stranglehold that Merrill Lynch and Morgan Stanley have exerted over Indian ADR offerings, but will also place the bank back at the forefront of the Indian privatization programme - a position once held by its Asian equity house Jardine Fleming. So too for ABN AMRO, a successful deal will cement its strong franchise in the domestic market.

An ADR for 20% of Nalco shares will follow a domestic offering for 10% (0.75% fee) and precede a strategic sale for 29%. The government currently owns 87% with the remaining 13% in freefloat.

A perception that the government will buck history and push the entire privatization through within a relatively rapid timeframe (target 2003) has resulted in a steep increase in Nalco's share price since the beginning of this year.

Year-to-date, the stock price is up 83.97%, closing yesterday (Monday) at Rs103.15. According to a SEBI stipulation, the strategic sale will also trigger an open offer to minorities and the price increase has also been prompted by the premium investors believe they will be bought out at, although analysts caution that the stock is now almost fairly valued. Having historically traded at a discount to the Birla-controlled Hindalco group, Nalco now stands at a premium on a p/e of 10.5 times 2002 earnings versus eight times for its main domestic competitor.

On an EV/EBITDA basis, Nalco is currently trading on a ratio of 7.04 times. According to Salomon Smith Barney analyst Abhay Laijawala, there have been four global M&A transactions in the aluminium sector since 1998 - Alcoa/Alumax 7.7 times EV/EBITDA in 1998, Alcoa/Reynolds 11.8 times 1999, Alcan/Alusuisse 8.1 times 1999 and Rio Tinto/Comalco 6.6 times 2000. More recently, however, Alcoa purchased an 8% strategic stake via Aluminium Corp of China's (Chalco) December IPO at a 4.6 times multiple.

Hindalco itself is reported to be interested in buying the strategic stake either by itself or in a consortium with a global major. Subject to price and the impact on Hindalco's balance sheet, analysts say the move makes sense as the combined entity will control 85% of the country's aluminium industry and provide a more powerful global force.

At an estimated operating cost of $1,000 per tonne, Nalco is the world's lowest cost producer of alumina and some 30% cheaper than the global average. EBITDA for 2002 is estimated at $186.069 million. Salomon's Laijawala also says in a recent research report that, "Nalco's bauxite reserves (310 million tonnes spread over 16 sq km) in the Panchpatmali hills of Orissa are not only the best in India, but are also among the world's best and are entirely gibbisitic."

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