| Billed
by one financial paper as the first step in a Global
Indian Takeover, the acquisition of Anglo-Dutch steel
major Corus by the Tata group is as much about upper-crust
India's new nationalism as it is about corporate strategy.
Tata's victory in the final head-to-head auction against
Brazil's Companhia Siderúrgica Nacional (CSN)
is undoubtedly a major event in the country's corporate
history. The Tata bid, which requires the group to pay
$13.2 billion to acquire Corus, would when completed
make the company the fifth largest steelmaker in the
world and the Tata's India's largest business group.
This is not surprising given the estimate made by data
consulting firm Dealogic, that this acquisition is nine
times higher than the largest previous acquisition of
a foreign firm by an Indian company.
It is to be expected that much thought went into the
decision made by Tata Steel to raise, in stages, the
initial bid of 455p a share by 33.6 per cent to 608
p per share, in order to clinch the deal. But there
is reason to believe that the prospect of making the
Tata brand a symbol of India's national pride played
a role. In an interview to the Financial Times Ratan
Tata reportedly said: ''We all felt that to lose would
go beyond the group and it would be an issue of great
disappointment in the country. So on the one hand, you
want to do the right thing by your shareholders and
on the other hand, you did not want to lose.''
As the euphoria over this being a ''national'' victory
wanes the question that would remain is whether the
price offered by Ratan Tata to emerge as the country's
economic hero may be too high for comfort. Besides being
close to 34 percent higher than the company's original
bid, the price paid by Tata is much higher than that
in other recent acquisitions in the steel industry.
It is even higher than the price offered by Mittal in
the highly controversial, much larger ($32 billion)
takeover of the better performing Arcelor.
B.Muthuraman, the managing director of Tata Steel, made
an attempt to justify the price paid, saying that at
$720 per tonne of installed capacity it was less than
the recent average for acquisitions in the industry,
and about a half of what it would take to set up over
an extended period of time similar capacity on a greenfield
basis. But these arguments are unlikely to convince
the sceptics. According to a London-based steel analyst
quoted by the Financial Times, 450p was ''a stand-alone
fair value for the company'', with anything beyond that
requiring returns from new synergies.
It is indeed such synergies that the Tata's are relying
on. The group is betting on the fact that it has advantages
as an integrated steel producer that has its iron ore
sources which can produce steel at low cost. Corus,
on the other hand, has the technology and the access
to markets to fabricate and market high quality steel
products. The essential strategy is to ship iron ore
and/or low-cost crude steel to the Corus' plants in
Europe, which would use their technological know-how
to turn this low-cost raw steel into finished products
that can be sold to customers close to them. Tata's
has been seeking to pursue a similar strategy through
its much smaller acquisitions of NatSteel in Singapore
and Millennium Steel in Thailand.
There are, however, a host of constraints on making
this strategy a success. The first of these is physical.
Tata would need to expand its capacity substantially
in order to be able to ensure adequate supplies of crude
steel to Corus. Corus can produce about 18 million tonnes
of steel a year. According to one estimate, Corus could
absorb about 13 million tonnes of crude steel from Tata.
But as of now Tata's steel producing capacity stands
at just 5 million tonnes. Tata already has plans to
expand capacity to 25 or 30 million tines. But that
would take time, going up to 2015. In the meantime,
the Tatas may choose to export iron ore, by acquiring
more mining capacity, but that involves a cost and would
imply that the cost savings and the returns to Tata
Steel from producing crude steel in India would not
materialize.
The second problem is ensuring that Corus can find markets
large enough to keep its capacity utilized. The demand
for steel in Europe has turned sluggish in recent years
as a result of relatively slower growth in steel-using
industries like construction, automobile production
and the white goods sector. In 2005, steel demand in
the European Union, which amounts to around 15 per cent
of global demand, reportedly fell by 1.5 per cent. While
this may reverse itself, the benefits may be neutralized
by imports from low cost regions, including China where
capacity is reportedly expanding faster than demand.
Overall, expectations are that demand growth would be
low even if not negative. Philippe Varin, Corus's chief
executive, is reported to have said that conditions
concerning steel supply could be ''more difficult'' for
Corus in 2007 on account of increasing imports into
Europe of steel from other regions, including China
in particular. Such competition can depress steel prices
in the region, affecting profits.
In a scenario of that kind, Corus would be particularly
affected since within Europe it ranks behind steel majors
such as Arcelor and ThyssenKrupp of Germany in terms
of performance. And European companies are not at the
top of the global performance league table. Part of
the reason why Corus was up for sale is that despite
a turnaround from a difficult position a few years back,
it has seen profits slip by 15 per cent during the first
nine months of 2006, due to lower steel prices. However,
stronger markets had helped the company record a significant
improvement in profitability in the quarter ending September
2006 as compared with the corresponding period of the
previous year. This improvement notwithstanding, the
challenge faced by the Tata's after the takeover is
substantial given the high price that has been paid
for the acquisition. The final bid price values Corus
at nine times earnings before interest, taxation, depreciation
and amortisation from continuing operations for the
year ending September 2006.
The acquisition is also a burden on the Tata's because
the turnover of Corus almost equals that of the Tata
group as a whole, with substantial revenues by Indian
standards from three principal lines of business: information
technology, automobiles and steel. Though cash-rich
because of profits from these areas, Tata would have
to stretch itself to finance the acquisition. While
details on how Tata Steel plans to finance the acquisition
are still unclear, expectations are that the company
would have to put up anywhere between $4 and $5 billion
as equity in a special purpose vehicle that would be
used to acquire Corus. Preliminary reports suggest that
the company plans to fund the acquisition on a 53:47
debt-equity basis, with the exposure of Tata Steel likely
to be in the region of $4.1 billion, which too will
be a mix of debt and equity. While a preferential share
issue by Tata Sons and surpluses from group companies
may go a part of the way in generating these finances,
a sum of around Rs.20,000 crore is not easy to come
by. Tata is likely to have to leverage its own equity
investment in the special purpose vehicle. Speculation
is rife that Tata Steel's debt-to-equity ratio could
rise above 100 per cent from its current level of about
15 per cent. On top of this the special purpose vehicle
will have to raise debt against Corus's future cash
flow to pay for the acquisition. But this may require
some guarantee from the side of the Tata's.
All this could mean that the Tata group itself may turn
vulnerable. In fact Australian financial consultancy
Macquarie had reportedly estimated that the deal would
be earnings per share neutral for Tata Steel at 540p
per share, after which it would begin to weigh on the
profits of the Indian steel maker. Tata's has in recent
years combined modernisation and retrenchment with access
to low cost iron ore to emerge a high margin steel producer.
But the burden of this deal and the time likely to be
taken to bring its benefits to fruition may damage the
company.
However, in a phase of India development when the government
has turned investor friendly, maybe the company can
count on support from the Indian state. When the deal
was announced Finance Minister P. Chidambaram declared
that the government ''will be ready to help Tata's,
if they have any request, to complete the Corus transaction,''
though he qualified his statement by saying that it
would only be ''general help'' in the nature of facilitating
''clearances or approvals or permissions'' within the
country. But there may be more to this support than
yet declared, which could explain the gamble that the
Tata's have taken.
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