Aarati Krishnan

Marketing operations will now be captured only in the consolidated numbers.

HENKEL SPIC has proposed a swathe of restructuring measures, which will rejig its operations and wipe its books clean of accumulated expenses, which have been artificially depressing the profits from year to year. But the restructuring measures will also have the effect of vesting the most attractive part of the company's business in a fully-owned subsidiary. Henkel SPIC, as a standalone company, will remain a manufacturing organisation and may experience a decline in revenues and profits in the immediate term. Shareholders may hold the stock at the current price of Rs 23, and track the company's consolidated financials once the restructuring takes effect.

How the restructuring works

There are three distinct aspects to the restructuring measures being proposed now. One, Henkel SPIC India will be merged with Calcutta Chemicals Company (renamed Henkel India), a 92 per cent subsidiary, at a swap ratio of 1:1. Second, the accumulated losses (including deferred revenue expenses) of Rs 304 crore, which Henkel SPIC now carries on its balance-sheet, will be wiped clean through write-offs. This will use up the share premium account and revaluation reserves created by revaluing goodwill and fixed assets.

Third, the merged entity, Henkel India, will be transformed into a pure manufacturing organisation, while the entire marketing function will be vested with Detergents India Ltd (to be called Henkel Marketing India), a 96 per cent subsidiary. The listed company — Henkel India — will sell its output to Henkel Marketing India at an agreed transfer price. Since the marketing company will be a 96 per cent subsidiary of the listed company, its financials will reflect in the consolidated financials of the listed company. The merger is expected to be implemented with retrospective effect from July 2004; after it is put through shareholder and Court approvals.

A plus for valuation

The restructuring moves will result in considerable upheavals for the shareholders in the present Henkel SPIC India. Henkel India — whose shares they will hold after the merger — will retain almost the same equity base and feature the same promoter stake as earlier. The equity base of the merged company — Henkel India — will be at Rs 116.5 crore, barely changed from the present Rs 116.4 crore for Henkel SPIC. The merger also does not materially change the 51 per cent stake held by the German parent in the listed entity. On the positive side, the reported profits of the combined entity will receive a boost from the absence of deferred revenue expenditure, and the synergies expected from the merger.

The write-off, which is merely a book adjustment, will not materially alter either the actual financial position or the growth prospects for the company. But it does have the potential to perk up valuations for the stock. For one, it may deliver a boost to the reported profits of Henkel India, as yearly charges on deferred expenses have significantly suppressed the company's profits in the past.

In 2003, write-offs of miscellaneous expenses took away Rs 43.5 crore from the profits of Rs 49.8 crore that Henkel SPIC India had reported before taxes. The addition of revenues and profits from Calcutta Chemicals' operations and cost savings from the merger may also help scale up revenues as well as profits, after the merger. Second, the write-offs of accumulated losses may help speed up the company's return to the dividend list, a positive for valuation.

Value in consolidated numbers

The organisational restructuring that the company proposes may have a negative bearing on the prospects for Henkel SPIC (or Henkel India, as it will be called after the merger) as a stand-alone company. But this may not have a bearing on the stock price, as both the manufacturing and marketing operations will continue to be captured in the company's consolidated financials.

With the transfer of the marketing function to the subsidiary — Henkel Marketing India — Henkel India's revenues could dip, as its output is valued at a cost-plus "transfer price" instead of at full sale value.

Profit margins are likely to shrink as margins on production are typically thinner than those on marketing. But this could be more than compensated by the absence of selling expenses, which will now be borne by the subsidiary. The company's consolidated financials may have greater relevance for shareholders than the standalone picture, once the restructuring takes effect.

Risks

Shareholders in the Henkel India stock will, however, have to keep close track of the fortunes of the marketing subsidiary, which will now house the selling and distribution function.

Any moves to hive off the subsidiary or reduce Henkel India's holding in the subsidiary, will significantly reduce the former's attractiveness and should be treated as a signal to exit the stock.

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