Tata Steel Managing Director B. Muthuraman has pointed out the economic logic behind the deal. Despite the enormous price tag for Corus, the purchase price per ton amounts to about half of what it would cost today to build those same assets from scratch. He said that the acquisition price values Corus steel-making capacity at about $710 per ton, which is far cheaper than starting from scratch. "Today, a greenfield (plant) with downstream products and construction solutions would work out to $1,200 to $1,300 per ton."
Though Tata Steel is much smaller in terms of capacity, in terms of EBITDA it is almost the same size as Corus. There are also big synergies to be availed by combining the two companies which will boost earnings.
Corus was the cheapest steel company on the basis of EV/ton
This highlights the cost competitiveness of Indian firms in this buoyant sector and many other sectors. Part of this competitiveness comes from the abundant availability of raw material and human resources. Therefore, rather then being an exporter of raw material (iron ore, for example), many Indian firms now aspire to capture as much of the value chain as possible and be closer to the consumer. Indeed, acquisitions made by most Indian firms have been to integrate forward and access consumers in the foreign markets. Yet there is simply no other steel company the size of Corus available on the market, so if a smaller player like Tata had aspirations to become a large player, this was perhaps the only one-stop move that Tata could make to do so.
The acquisition of Corus could transform Tata Steel from a domestic steel producer to an international steel company with global scale. The synergies that will be derived from Tata Steel and Corus coming together will be of tremendous strategic value to both organisations. The leveraging of low cost intermediate products from India with further processing at Corus to produce high-end finished products, along with several operation-related initiatives will improve the competitiveness of Corus in the European markets while India will benefit from high-value, sophisticated finished products developed in Corus’ R&D facilities. Further, the combined entity will foster cross fertilisation of Research & Development personnel, and domain expertise in the automotive, packaging and construction sectors, in addition to the exchange of technology, best practices
and expertise.
Tata Steel – Corus were poised to become the 5th largest steel producer
Spread of Operations could increase all over the Globe: Truly Global Vision
Key points that point to success of the merger vis a vis other simlar mergers (TCL and CNOOC from China perspective)
TCL had to write off much of its investment. The CNOOC-Unocal deal, in the different setting of the oil industry, also had a sorry ending. So, it is perhaps worth reflecting why Tata-Corus might be different. Here's why.
First, CNOOC's bid collapsed amid Washington intrigue. The Chinese proved to be babes-in-the-wood in navigating the Byzantine corridors of Washington's power, and underestimated a relentless backlash that unwound the deal. While politics and steel are not alien to each other, there is nothing in Tata-Corus like the level of political concern in the CNOOC-Unocal situation.
Second, TCL acquired Thomson's assets from a position of weakness. Margins at TCL were under pressure from cut-throat competition in mainland China. Even though TCL was one of the largest Chinese TV manufacturers (even prior to the acquisition of Thomson's assets), commodity TVs and other consumer electronics items were not producing good returns.
In contrast, Tata Steel is one of the most profitable, if not the most profitable, steel companies in the world, and is acquiring from a position of strength amid a boom in the world steel market. This will buy it valuable experimenting time and learning space.
Third, there was much difficulty in integrating Chinese and French management. Some of this surely stemmed from language considerations. To an extent, the Indians' greater command of the world's lingua franca will lubricate the inevitably-difficult integration process.
Fourth, the Tatas have built up some experience in the past few years with cross-border acquisitions. Some of this lies within Tata Steel itself, as in its acquisition in Singapore. And the rest lies in the broader ambit of the Tata group through its acquisitions of Daewoo's truck assets in South Korea, Tetley Tea in the U.K. and ritzy hotel properties on the U.S. East Coast.
TCL had some experience taking over factories in Vietnam and environs, and also a failed bid for a much smaller German company, but nothing to prepare it for the Thomson assets' integration.
Fifth, there is learning in the ambience. That is, India Inc. has built up, and is building up, its own cross-border acquisition capability. This arises not just from entrepreneurs who have been doing this for years like the Birlas and Asian Paints but also from more recent moves by India's pharmaceuticals, software, and auto component sectors, among others.
Cross-border experiences with integrating diverse management teams, communicating across borders and time zones, and integrating compensation practices, are not as new to the Tata group as they might well have been to the hapless TCL management team.
Deal Negotiation & Bidding
- Russian steel giant Severstal & Brazil’s CSN were also in race to acquire Corus
- Severstal did a quick listing in UK and appointed 5 non-executive directors on its board in order to smoothen the process. Severstal lost out to Mittal Steel earlier that year after it had agreed to merge with Arcelor
- CSN said its bid would also create a Top Five steelmaker. CSN already had a 3.8% stake in Corus. In 2002, Corus had offered to buy CSN for $3.5 billion, but withdrew the offer four months later after its shares lost about half their value
- Tata Steel had already acquired close to 22 per cent stake in Corus since winning the auction through open market transactions
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Tata Steel recommended bid of 455 pence announced on 20th October. CSN made a rival offer of 475 pence per share on 17th November,06
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Tata Steel had revised its bid to 500 pence a share on 10th December,06, which was countered by a 515 pence offer from CSN the very next day
- The UK's Takeover Panel had to intervene to resolve the bidding war in December last year which set a nine-round auction process to finalize the winner
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Tata Steel’s revised offer of 608 pence a share outbid a 603 pence offer from CSN on 31st Jan,07
- Corus shareholders approved Tata Steel offer on 7th March 2007
- The deal became effective on April 2 and Corus shares stop trading on exchanges on March 29,07
Valuation and Financing
The transaction involved the following financial details:
- Acquisition price of $13.61 per corus share in cash (68% premium over the 12 month average price)
- Equity value of Corus in $12.9 billion
- Equity Contribution of $4.1 Billion from Tata Steel and fully underwritten non-recourse debt package of $6.14 billion.
- Equity value based on 946.7 million fully diluted shares of Corus
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Transaction Value based on B/S date of 31st March 2007; with a net debt of $2.672 billion.
- Expected synergy of $350 million per year
- The Company proposes to infuse USD 4.1billion as equity to part finance the transaction. The equity will comprise of
- USD 700 million from internal generation,
- USD 500 million of ECB,
- USD 640 million from the preferential issues of equity shares to Tata Sons Ltd. in 2006-07 and 2007-08,
- USD 862 million from a rights issue of equity shares to the shareholders,
- USD 1000 million from a rights issue of convertible preference shares
- USD 500 million from a foreign issue of equity-related instrument
- USD 2.66 billion, which will be put from their Asia subsidiary will be a mezzanine debt, which will be removed as and when the requirements go down
- The remaining amount, which is close to USD 6.4 billion will be funded by the three bankers, Standard Chartered Bank, ABN AMRO Bank and Deutsche Bank to Tata Steel UK Limited, a wholly-owned indirect investment subsidiary of the Company with a non-recourse provision as far as Tata Steel is concerned
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This was to be broken down into three parts. The cash flows were be amortized on the senior debt at a yield of 200-250 bps. The high yield debt was to be benchmarked against the market rate. The third, revolving debt, which is a working capital requirement.
- SBI alone has bought over $1 billion of the Tata-Corus debt from Standard Chartered Bank. StanChart is hardly left with $750 million of the debt in its own book and would like to bring it to zero in future
Analysis/Justification of the Deal
Tata’s Viewpoint
Tata Steel believes the steel cycle is in a long-term up trend and the risk of a downturn in prices is low. In fact, managing director B Muthuraman said the global steel industry might witness sustained growth as during the 30-year period between 1945 and 1975. The International Iron and Steel Institute (IISI), a respected steel research body, corroborates this in its outlook. The growth in demand for global steel would average 4.9 per cent per year till 2010 according to the IISI. Between 2010 and 2015, demand growth is expected to moderate to 4.2 per cent per annum according to IISI forecasts. Much of this demand growth would come from China and India, where the IISI estimates growth rates to be 6.2 per cent and 7.7 per cent annually from 2010 to 2015.
Tata Steel's B Muthuraman has defended the deal arguing that the enterprise value (EV) per tonne of capacity is not very high. The EV per tonne for the Tata-Corus deal is around $710 is only modestly higher than the Mittal-Arcelor deal. Besides, setting up new steel plants would cost anywhere between $1,200 and $1,300 per tonne and would take at least five years in most developing countries. The enterprise valuation of Corus at around $13.5 billion appears too steep based on the recent financial performance of Corus. Tata Steel is paying 7 times EBITDA of Corus for 2005 and a higher 9 times EBITDA for 12 months ended 30 September 2006. In comparison, Mittal Steel acquired Arcelor at an EBITDA multiple of around 4.5. Considering the fact that Arcelor has much superior assets, wider market reach and is financially much stronger than Corus, the price paid by Tata Steel looks almost obscenely high.
Stock Market reaction
Going by the stock market reaction yesterday, the acquisition is a big blunder. The stock tanked 10.5 per cent after the deal was announced and another 1.6 per cent today. Investors are worried about the financial risks of such a costly deal.Most of the leading stock brokerages have downgraded the stock while some have come out with recommendations to sell. While a majority of analysts are willing to concede that the acquisition makes strategic sense and may pay off in the long term, the consensus view is that stock price of Tata Steel would remain depressed in the short to medium term because of the higher financial risks. The first graph below shows the stock price performance during the deal and the second one shows till date.
Investors, meanwhile, dumped Tata Steel shares with unrelenting fury in trading on the Bombay Stock Exchange, where the benchmark stock index fell about 1%. Tata Steel shares were pounded down 11%. Tata execs were philosophical about the negative reaction to the Corus acquisition. "The market is taking a short-term and harsh view," said Tata. "Hopefully, somebody will look back and say that we did the right thing."
However long term investors appreciate the fact that steel manufacturing assets are costly and this made the purchase of Corus all the more expensive. Thus many large investors have seen the strategic importance of the deal for Tata as well as the global steel industry and have started looking at it in positive light. This has resulted in the share price of Tata Steel increasing again.
Analysts & Investment banker’s Reaction
According to the investment bankers and the market, aggressive bidding by the Tatas is based on five key factors:
Access to low-cost slabs: The steel makers in India enjoy a 20 per cent cost advantage in slab making over its European peers. The ability to export surplus slabs either from Tata Steel's facilities or through acquisitions in low-cost regions over the next few years will be the key driver of this deal.
Restructuring of Corus' existing units: It is likely that over the next few years,Tata Steel will put through an extensive restructuring of its underperforming units at Port Talbot and Scunthorpe in the UK though it has ruled out any job cuts. It may also prune down high-cost slab facility at Teesside.
Potential synergies: For the first time since this deal surfaced, Tata Steel has quantified that it will benefit to the tune of $300-350 million every year. However, the benefits from the deal may be lower than this amount spelt out in the first two years and attain this level from the third year onwards.
Neat Strategic fit: Corus, being the second largest steelmaker in Europe, would provide Tata Steel access to some of the largest steel buyers. The acquisition would open new markets and product segments for Tata Steel, which would help the company to de-risk its businesses through wider geographical reach.
A presence in mature markets would also provide Tata Steel an opportunity to go further up the value chain as demand for specialised and high value-added products in these markets is high. The market reach of Corus would also help in seeking longer-term deals with buyers and to explore opportunities for pushing branded products.
Corus is also very strong in research and technology development, which would add to the competitive strength for Tata Steel in future. Both companies can learn from each other and achieve better efficiencies by adopting the best practices.
Need for Scale: Going by the IISI forecasts, global steel demand would be 1.32 billion tonnes by 2010 and 1.62 billion tonnes by 2015. Even Arcelor-Mittal, the largest global steel player by far, has a present capacity, which is just 6.8 per cent for projected demand in 2015. To maintain its current share, Arcelor-Mittal would have to add another 50 million tonnes of capacity by then. This confirms the view that there is still considerable scope for consolidation in the steel industry.
As the industry consolidates further, Tata Steel - even with its planned greenfield capacity additions - would have remained a medium-sized player after a decade. This made it absolutely vital that the company did not miss out on large acquisition opportunities. Apart from Corus, there are not many among the top-10 steel makers, which would become possible acquisition targets in the near future.
With Corus in its fold, Tata Steel can confidently target becoming one of the top-3 steel makers globally by 2015. The company would have an aggregate capacity of close to 56 million tonnes per annum, if all the planned greenfield capacities go on stream by then.
Media Reaction
Media reaction to the deal has been just the opposite of how the stock market and investors reacted. Almost all the reports were adulatory while editorials praised the coming of age of Indian industry. A prominent financial daily presented the deal almost as revenge of the natives against the old colonial masters with a picture of London covered in our national colours.
Its editorial warned the market 'not to bet against Tata', citing the previous instances when sceptics have been proved wrong by the group. Official reaction has been no different and the finance minister even offered all possible help to the Tata Group. Thus it can be said that the media was totally upbeat about this deal and saw it as a sign of India’s business ascendancy and also the consolidation in the steel industry as a very positive sign for the 21st century.
Credit Rating Agencies Reaction
Tata, after all, ended up raising its initial bid for Corus by half to fend off CSN. Even Tata's initial bid of $8 billion drew the attention of credit rating agencies such as Standard & Poor's, which placed Tata on its CreditWatch list with "negative implications" back in October.
The Deal was Cheaper @ £ 6.08 per share
The financial performance of Corus would dent the hopes of Tata Steel shareholders even further. EBITDA margins, after adjusting for one-time incomes, have steadily declined over the last 3 years. For the 9-month period ended September 2006, EBITDA margins of Corus were barely 8 per cent as compared to around 40 per cent for Tata Steel.
The price of an asset is more a factor of its future earnings potential than its past earnings record. Operating margins of Corus can be significantly improved if Tata Steel can supply slabs and billets. Tata Steel is targeting consolidated EBITDA margins of around 25 per cent as and when it starts supplying crude steel to Corus. If the company can sustain such margins on the enlarged capacities, it would be quite impressive.
But that is a long way off as Tata Steel would have sufficient crude steel capacity only when its proposed new plants become operational. Till then, the company is targeting to maximise gains through possible synergies between the two operations, which are expected to yield up to $350 million per annum within three years.
In the meanwhile, Tata Steel has to make sure that cash flows from Corus are sufficient to service the huge amount of debt, which is being availed to finance the acquisition. According to the details available so far, Tata Steel would contribute $4.1 billion as equity component while the balance $9.4 billion, including the re-financing of existing debt of Corus after adjusting for cash balance, would be financed through debt. The debt facilities are believed to be structured in such a way that they can be serviced largely from the cash flows of Corus.
Interest rates on credit facilities for such buy-outs are often higher than market rates because of the risks involved. At an expected interest rate of 7 per cent per annum, the interest outgo alone would be over $650 million per year. Along with repayment of principal, the annual fund requirement to service this debt would be around $1.5 billion - assuming a 10-year repayment horizon.
The cash flows of Corus were barely sufficient to cover this, even after considering the synergy gains. If international steel prices decline even modestly, Tata Steel would have to dip into its own cash flows or find other sources like an equity dilution to service the debt. Besides, funds may also be required for upgrading some of the Corus plants to improve efficiencies. Tata Steel would have to manage all this without jeopardising its greenfield expansion plans which may cost a staggering $20 billion over the same 10-year period.
Investors would have considered Corus a a burden for Tata Steel until such time there is a perceptible improvement in its margins. That would keep the Tata Steel stock price subdued and any decline in steel prices would have a disproportionately negative impact on the stock.
Our Analysis of Deal Value
We calculated the value of synergy’s contribution (assuming constant synergy) to the value unlocked per share for Tata Steel shareholders (Please refer the calculation below and the attached excelsheet), then we see that per share value unlocked was £ 9.18 i.e. Rs. 724.85. So, paying a premium of £ 2.46 (a 68% premium on a 12 month average price of £ 3.62) was much cheaper and hence seems to be fully justified. The appreciation which has happened in the stock price of Tata Steel which was trading at around Rs. 350 during the time of deal is around Rs. 600 which shows that the value due to synergy has got factored in the price although still more appreciation in the stock price can result if the integration news remains positive and the synergy starts getting reflected into the financials of the company.
Integration Process and Post Merger Events
The influential magazine TIME has named the Tata-Corus Merger as one of the 10 best deals in 2007 and has ranked it at number 6.
Some positive outcomes of the merger on the integration aspect are as follows:
- Joint sourcing has begun in Jan’07. This alone would result in a saving of $ 70 million. This helps the combined entity gallop towards the long-term goal of achieving self-sufficiency for Corus in raw materials. Tata steel is already 80% self-sufficient in raw materials.
- The integration is also looking at leveraging the strength of Tata companies in the UK like Brunnermond and TCS in helping the successful integration and post merger processes.
- Tata steel share price has risen to Rs 862 per share now.
Integration Processes
The integration process will have the following impact on the managements of the two entities:
- Continuation of the Senior management team of Corus
- Appointments to the boards of Tata Steel and Corus to facilitate smooth strategizing and integration:
- R.N Tata will be chairman of Tata Steel and Corus
- Mr. Jim Leng will be deputy Chairman of Tata Steel and Corus
- Mr. Philippe Varin, Mr. Schraven and Dr. Hayward to join Tata Steel Board.
- Mr. B. Muthuraman, Mr. Ishaat Hussain and Mr. Arun Gandhi to join corus board
Industry’s View on possible Integration Issues
Stnadard chartered CEO Peter sands says “there are some critical things in terms of the speed of realisation of the synergies, but also there are softer issues that whenever you bring companies together should not be underestimated”.
Considering that there aren't too many overlaps between Tata Steel and Corus, a "light-handed integration"makes more sense, wherein the Tatas bring in some changes, but don't do a complete overhaul of how Corus is run. So they can bring in the accounting systems they use, the balanced scorecard method, EVA, etc, but do not replace the top management overnight. If they do so, they are bound to encounter huge amounts of resistance.
Says N Venkiteswaran, professor, IIM-A, "If the target company is managed well, there is no need for a heavy-handed integration. It makes sense for the Tatas to allow the existing management to continue as before. Some level of planned restructuring can come in later. This way there will be no bloodletting."
Integration Measures by Tatas
Formation of a Strategic and Integration Committee to develop and execute the integration plans and further growth plans. This committee constitutes the following people:
Mr. Ratan Tata, Mr. Philippe Varin, Mr B. Muthuraman, Dr. T. Mukherjee, Mr. Koushik chatterjee, Mr. Rauke henstra ands Mr. David Lloyd.
Appropriate cross functional teams to be formed to execute the integration plans under the overall guidance of the Strategic and Integration committee.
Tata Steel has raised $ 875 million through Foreign currency Convertible Alternative Reference Securities (CARS) issue including a $ 150 million green shoe option
Post-merger targets for Tata-Corus
- Smooth implementation of the Strategic Integration Committee
- Complete the joint synergy analysis and establish timelines for delivering the synergy
- Pursue pre-planned Brownfield/Greenfield projects to expand domestic capacity
- Achieve target EBITDA levels of 25% for the combined entity
- Continue the role of Global consolidator in the global steel industry
- Maintain robust financial structure and flexibility
Conclusion
Our take on the success of the Tata Corus deal depends on the following factors:
- Cyclicity of the global steel industry
- Performance of Corus and ability of Tata steel to lower sourcing costs for Corus
- Organic expansion through Greenfield projects by Tata
- Post-merger integration and quashing of cultural issues
Considering that global demand is on the increase and India will lead the domestic demand for Tata Steel, it can be safely said that the cyclicity of the steel industry will not go against the success of the merger. The steel industry will remain on top of the cycle for quite some time to come and this will enable Tata Steel to overcome the inertia of the merger and realize the expected synergies through increased efficiency of operation for Corus as well.
It is crucial that Tata steel is unrelenting in its pursuit of expansion of capacity through organic methods like Greenfield projects. These projects will ensure that Tata-Corus will be in the top-3 steel manufacturing entities in the world by 2015. This would also ensure sufficient immunity against falling steel prices and the cyclicity of the steel industry.
However, the raging cultural issues that lie beneath the surface of this merger could undo all the good work put in by the combine. However, the Tatas having faced similar problems with the integration of Tetley and having had a good track record in the past in post-merger integration would do a good job.
So, based on the analysis Tata-Corus deal should be a success if they are able to successfully integrate Corus with Tata Steel and realize the projected synergies. Presently the market reactions and our analysis indicates a positive perception for the deal but only time will tell the actual outcome.
Appendix
- World Steel Output
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Tata Group Revenue Distribution
References
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TATA Steel
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Corus Group
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Tata-Corus taking big steps to streamline operations
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A Corus line: Did Tata do the right thing?
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Ratan Tata speaks on Tata-Corus deal: Markets are taking a short term view
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Tata Steel unveils funding plans for Corus buyout
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Tata-Corus deal was undervalued
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Tata Steel, Corus begin joint sourcing
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Tata-Corus to save $450 mn by tapping synergies
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Tata - Corus: Visionary deal or costly blunder?
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Tata wins Corus with US$ 12 billion offer
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Tata buys 21.1% Corus stake for $2.4 bn
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Tata Steel set for final battle to buy Corus
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Tata-Corus among world's ten best deals of 2007
