TATA- CORUS ACQUISITION.pdf

Draft MERGERS & ACQUISITIONS TATA- CORUS ACQUISITION A. Sahay A Dwarf Gobbles up a Giant – Tata Steel acquires Corus! At a steel industry event in Paris in 2003, L.N. Mittal spoke about a world where a handful of players would account for 80-100 million tonnes (mt) of capacity each and have a footprint across all major continents. At that time, Mittal Steel itself produced less than 40 mt. Not many thought it feasible then. In less than three years, the dynamics have changed, and how. Mittal Steel has since become Arcelor Mittal with a capacity of over 100 mt. The top five global steel players now have more than 20 per cent of global production (about 1.1 billion tonne). And Tata Steel, 56th in the pecking order, has just picked up Corus, ranked No. 9, after outbidding the Brazilian Steel company, CSN’s final bid of 605 pence per share with its bid of 608 pence. The deal amounted to $12.1 billion and the combined entity of Tata-Corus is now No. 5 in the world steel sector. On the morning of 31st January, 2007 – the morning after clinching the deal exuberant Ratan Tata, chairman, Tata Group, exulted: a tired but “I am glad, we are able to win the auction. I think it is a moment of great fulfillment for all of us in India because Tata Steel as an Indian steel company now has global scale. An Indian company has successfully bid for a European Steel company, much larger in tonnage size than itself. It is something that has never happened before.” The deal has triggered off a wave of reports on further consolidation. CSN, which lost out to the Tatas, is not likely to give up its aspirations. Arcelor Mittal and Posco have held talks on possible areas of co-operation, though Posco denied any merger. Nippon and Posco reportedly have a white knight agreement, by which they have agreed to come to each other’s rescue in the event of a predatory bid. Says Philippe Varin, chief executive, Corus: “This is a moving picture and is changing very quickly.” Now, consolidation is good economics in a fragmented market. But in steel, the imperatives to consolidate are a little more. The suppliers to and buyers from steel makers are wellconsolidated. In iron ore supplies, the three major players — CVRD, Rio Tinto and BHP Billiton — have three-fourths the market share and average margins of over 40 per cent. Auto makers, who buy a lot of finished steel, are also well-grouped with 6-7 global players calling the shots. That leaves the steel industry on the wrong side of the bargaining table, affecting earnings. And this has hit the industry where it hurts most — valuations. Commodity industries like mining and aluminium are trading at earnings multiples of at least 8-10, while steel trades at a multiple of around six. Says B. Muthuraman, managing director, Tata Steel: “The market has not fully believed what steel is capable of.” He should know. The Tata Steel stock has got a battering since it announced its intention to take over Corus. The consolidation equation is really simple. Greater consolidation means the industry will have less price volatility and higher bargaining power. Hot-rolled coil prices are a good example of how fragmentation has affected the industry. Take the CIS region. Between end-2004 and end-2006, 41 prices yo-yoed all the way from $580 to $370 and then again to just under $600. With fewer players, the sharp dips in the cycle will ease, increasing earning multiples and, finally, valuations. Global Steel industry – An Overview ( Exhibits 1;1.1;1.2;1.3) In 2005 World Crude Steel output at 1129.4 million metric tonne was 5.9% more than the previous year. (Source: IISI) China remained the world's largest Crude Steel producer in 2005 also (349.4 million metric tonne) followed by Japan (112.47 million metric tons) and USA (93.89 million metric tons). India occupied the 8th position (38.08 million metric tons). (Source: IISI) Global production of steel has surged around 7-8% since 2002. China’s hunger for steel has pushed global prices sharply upward. In about 4 years – from late 2001- to late 2005- prices rose dramatically. At the same time, strong price increases for Steel’s raw materials- including iron ore , coke, scrap and alloying material- contributed for a very high floor cost for steel. Two additional factors have triggered this price increase: - Temporary shortages of raw materials and steel making capacity - Deliberate reduction in production by steel makers in the developed regions of the world. The International Iron & Steel Institute (IISI) has confirmed the trend of recent years of an increase in steel use in-line with general economic growth and with the fastest growth occurring in the countries with the highest GDP growth such as India and China. Apparent world-wide Steel Demand is forecast to grow to between 1,040 and 1,053 million tonnes in 2006 from a total of 972 million tonnes in 2004. This is a growth of 4-5% over the two year period. However, according to IISI the cost of raw materials and energy would continue to represent a major challenge for the world steel industry. Since the year 2000 scrap metal prices have increased by 171%, iron ore by 164% and coke by 69%. The margins of the mining companies have outstripped the margins of the steel companies by two times. since 2001(over 40% versus 23%) The consolidation equation is really simple. Greater consolidation means the industry will have less price volatility and higher bargaining power. Hot-rolled coil prices are a good example of how fragmentation has affected the industry. Take the CIS region. Between end-2004 and end-2006, prices yo-yoed all the way from $580 to $370 and then again to just under $600. With fewer players, the sharp dips in the cycle will ease, increasing earning multiples and, finally, valuations. There are other strategic reasons for this, the main being resource geography, or as Tata Steel calls it, the de-integrated method of steel-making, where you break up the supply chain and produce parts of it where it makes most economic sense. It works in two ways. One, low-cost steel producing countries, essentially India, Brazil, Russia and, to a certain extent, China are building a lot of slab capacity because of their proximity to iron ore. They now need markets for the slabs and, hence, are looking at expanding globally, especially where they can make finished steel using their slabs close to mature markets. Tata Steel’s and CSN’s interest in Corus was a reflection of this. Russian steel makers Evraz and 1 Severstal are also scouting around for this reason. Brazilian major Gerdau, though not a large slab player, is also looking at going global. This is curiously a case of backing into a high cost situation to reduce costs. Operating in Europe is costlier than in Brazil, Russia or India but the most effective way for them to now grow is look for markets where costs are higher, simply because their low cost slabs afford that. It can even work in the other direction. European companies such as Thyssen Krupp are shifting some base to low-cost areas to source slabs. Thyssen has a tie-up with CVRD to produce slabs in Brazil. As for the top 10 steel makers, chances are that the list is going to look very different two years from now. Arcelor Mittal will be one of the strongest contenders for obvious reasons. Consolidation can also come through another source. The major trend that will address the cyclicality of steel is not management of the underlying demand (of late, steel markets have not been softening due to a drop in demand but due to oversupply). Rather it will be the control of the supply chain. Steel makers are already buying into mines and there were rumours of Mittal looking at resource majors as his next target. 2 American and East Asian majors too are gearing up. “Arcelor Mittal is present in the US through ISG, and US Steel and Nucor look particularly vulnerable with their high costs,” says an analyst. And the largely insular Japanese steel industry will soon have to step outside to manage their sourcing better. Going forward, all that can be said is that alliances will happen among all kinds of companies. The most unlikely partners will also come together. After all, who thought a year ago that Arcelor would be a merger target? The Indian Steel Industry ( Exhibits: 2; 2.1;2.2; 2.3) History The first Indian Steel plant was set up by Jamshetji N Tata in Jamshedpur in the eastern part of India in the year 1907. The plant started production in 1912. One hundred years ago Jamsetji N. Tata went to London to meet Lord George Hamilton, Secretary of State for India under Queen Victoria, to request the cooperation of the government in his building a steel plant for India. Today Tata Steel has won the bid to buy out the Anglo-Dutch steel giant Corus. The commissioning of Tata Iron & Steel Company's production unit at Jamshedpur, Jharkhand in 1911-12 heralded the beginning of modern steel industry in India. At the time of independence in 1947 India's steel production was only 1.25 Mt of crude steel. Following independence and the commencement of five year plans, the Government of India decided to set up four integrated steel plants at Rourkela, Durgapur, Bhilai and Bokaro. The Bokaro plant was commissioned in 1972. The most recent addition is a 3 Mt integrated steel plant with modern technology at Visakhapatnam. After independence, successive governments placed great emphasis on the development of a Indian steel industry. In FY 1991, the six major plants, of which five were in the public sector, produced 10 million tons. The rest of India steel production, 4.7 million tons, came from 180 small plants, almost all of which were in the private sector. India's Steel production more than doubled during the 1980s but still did not meet demand in FY 1991, when 2.7 million tons were imported. Steel Authority of India Limited (SAIL) The steel sector was to propel the economic growth. Hindustan Steel Private Limited was set up on January 19, 1954. The President of India held the shares of the company on behalf of the people of India. Hindustan Steel (HSL) was initially designed to manage only one plant that was coming up at Rourkela. For Bhilai and Durgapur Steel Plants, the preliminary work was done by the Iron and Steel Ministry. From April 1957, the supervision and control of these two steel plants were also transferred to Hindustan Steel. The registered office was originally in New Delhi. It moved to Calcutta in July 1956 and ultimately to Ranchi in December 1959. A new steel company, Bokaro Steel Limited, was incorporated in January 1964 to construct and operate the steel plant at Bokaro. The 1 MT phases of Bhilai and Rourkela Steel Plants were completed by the end of December 1961. The 1 MT phase of Durgapur Steel Plant was completed in January 1962 after commissioning of the Wheel and Axle plant. The crude steel production of HSL went up from .158 MT (1959-60) to 1.6 MT. The second phase of Bhilai Steel Plant was completed in September 1967 after commissioning of the Wire Rod Mill. The last unit of the 1.8 MT phase of Rourkela - the Tandem Mill - was commissioned in February 1968, and the 1.6 MT stage of Durgapur Steel Plant was completed in August 1969 after commissioning of the Furnace in SMS. Thus, with the completion of the 2.5 MT stage at Bhilai, 1.8 MT at Rourkela and 1.6 MT at Durgapur, the total crude steel production capacity of HSL was raised to 3.7 MT in 1968-69 and subsequently to 4MT in 1972-73. 3 Bhilai Steel Plant Bokaro Steel Plant Durgapur Steel Plant Rourkela IISCO, Burnpur Million Tonnes/Yr. (Saleable Steel) 3.153 4.5 (liquid Steel) 1.586 1.671 0.426 SWOT ANALYSIS OF THE INDUSTRY The strengths, weaknesses, opportunities and threats for the Indian steel industry have been tabulated below. The national steel policy lays down the broad roadmap to deal with all of them. Strengths 1. Availability of iron ore and coal 2. Low labour wage rates 3. Abundance of quality manpower 4. Mature production base Opportunities 1. Unexplored rural market 2. Growing domestic demand 3. Exports 4. Consolidation Weaknesses 1. Unscientific mining 2. Low productivity 3. Coking coal import dependence 4. Low R&D investments 5. High cost of debt 6. Inadequate infrastructure Threats 1. China becoming net exporter 2. Protectionism in the West 3. Dumping by competitors Indian Market Scenario • • • • • • After liberalization, there have been no shortages of iron and steel materials in the country. Apparent consumption of finished (carbon) steel increased from 14.84 Million Tonnes in 1991-92 to 39.185 million tonnes (Provissional) in 2005-06. Steel industry that was facing a recession for some time has staged a turnaround since the beginning of 2002. Efforts are being made to boost demand. China has been an important export destination for Indian steel. The steel industry is buoyant due to strong growth in demand particularly by the demand for steel in China. Production • • • Steel industry was delicensed and decontrolled in 1991 & 1992 respectively. Today, India is the 8th largest crude steel producer of steel in the world. The share of Main Producers (i.e SAIL, RINL and TSL) and secondary producers in the total production of Finished (Carbon) steel was 36% and 64% respectively during the period of April-November, 2006. Pricing & Distribution • Price regulation of iron & steel was abolished on 16.1.1992. 4 • • • • • Distribution controls on iron & steel removed except 5 priority sectors, viz. Defence, Railways, Small Scale Industries Corporations, Exporters of Engineering Goods and North Eastern Region. Allocation to priority sectors is made by Ministry of Steel. Government has no control over prices of iron & steel. Open market prices are generally on rise. Price increases of late have taken place mostly in long products than flat products. DEVELOPMENT OF INDIAN STEEL SECTOR POST LIBERALISATION (SINCE 1991) The economic reforms initiated by the Government since 1991 have added new dimensions to industrial growth in general and steel industry in particular. Licensing requirement for capacity creation has been abolished, except for certain locational restrictions. Steel industry has been removed from the list of industries reserved for the public sector. Automatic approval of foreign equity investment upto 100% is now available. Price and distribution controls have been removed from January, 1992, with a view to make the steel industry efficient and competitive. Restrictions on external trade, both in import and export have been removed. Import duty rates have been reduced drastically. Certain other policy measures such as reduction in import duty of capital goods, convertibility of rupee on trade account, permission to mobilise resources from overseas financial markets and rationalisation of existing tax structure for a period of time have also benefited the Indian Steel Industry. Future Strategy As a strategy to de-risk the earnings of steel producers from price volatility, steelmakers are now focusing more on value-added products. This is looked upon as a notable change over the last few years when semi-finished products, formed a substantial part of their portfolio. The share of value added products has been gradually increasing over the last year or so. Steelmakers are going in for a phased expansion of their capacity — a remarkable shift from their strategy of the 1990s. This staggered approach is likely to reduce the downside risk. One, it gives companies more flexibility to alter plans based on the prevailing market conditions. Two, the financing risk is reduced considerably as funds are raised proportionately without stretching the balance-sheet at one go. Domestic steelmakers have improved their geographical presence is also a strong positive. Apart from the traditional markets in South Asia, they are now exporting to the US, West Asia and Europe. Will de-integration work? Steel majors are now eyeing a new model that involves dispersal of facilities in different regions. Initiated by Tata Steel, the de-integration model is finding favour with other domestic players too. Steel companies are thus considering mining the primary metal in countries rich in raw materials and undertaking processing in growing markets. By adopting such a strategy, they are aiming at a complementary presence in various low-cost manufacturing bases and high-growth markets. Tata Steel's proposed projects in Iran and South Africa and the acquisition of NatSteel and Corus are in line with such a strategy. Having acquired a cold rolling (CR) mill in Indonesia in 2004, Jindal Stainless is now eying two more CR facilities in South-East Asia and Europe in order to absorb its expanded hot-rolled capacity in Hissar, likely to be commissioned by October. 5 Essar Steel's acquisition of Heavy Grade Pellets and Steel Corporation of Gujarat last year was with a view to gaining control over input costs and strengthening the value chain. While such a model is likely to strengthen the downstream operations and offer access to growth markets, there is a problem: It is likely to expose steel companies to geo-political and funding risks while the ability to manage logistics will also be a challenge. While the pricing environment offers a stable outlook, steel companies have to guard against the rising cost of inputs and logistics in the medium to long term. The extent and ability to control input costs is key for Indian steelmakers. As demand for iron ore (key raw material) is set to rise and the battle hots up for this scarce resource, ensuring backward linkages will prove vital in determining cost structure. Companies such as Tata Steel and SAIL, with ownership of low-cost mines, will have the edge over their counterparts in India. Key challenges Realising the importance of cutting down logistics costs, Tatas and Essars are investing in ports, roads and rail infrastructure. As freight forms a substantial part of operating costs (12-15 per cent), efficiency of steel companies in managing logistics is going to be crucial. Further, executing projects of this magnitude calls for greater discipline and strict monitoring. Cost and time over-runs have affected the viability of steel projects in the past. We believe the execution risk remains high for the projects announced by SAIL and Jindal group. Apart from the above, the ability to successfully integrate global operations and fund expansions at low cost and minimum risk will also prove challenging. The parties Involved TATA STEEL Overview: Tata Steel is India's largest private sector steel company with 2005/06 revenues of US$5.0 billion and crude steel production of 5.3 million tonnes across India and South-East Asia. It is a vertically integrated manufacturer and is one of the world's most profitable and value creating steel companies. Tata Sons, Tata Steel and other Tata companies had combined revenues in 2005/06 of approximately US$22 billion. Tata Sons'current investments are valued at approximately US$50 billion. CORUS Overview: Corus is Europe's second largest steel producer with revenues in 2005 of £9.2 billion and crude steel production of 18.2 million tonnes, primarily in the UK and the Netherlands. It is the fifth largest global steel producer with pro forma crude steel production of 23.5 million tonnes in 2005. A brief history of Corus is best recounted through a series of four vivid images. The first: tumult and euphoria over its birth. British Steel, for long a symbol of British industrial nationalism, and the Dutch Koninklijke Hoogovens merged in 1999 to create what was then the world’s third largest steel maker and Europe’s largest. At that time, it was billed as the perfect merger, if ever there was one. The second: conflict and chaos. The Dutch and British sides did not get along well. Suggested closures on the Dutch side of the business were met with resistance. Sale of the aluminium business was proposed, and then aborted. On a bigger scale, even a merger with CSN was proposed and then aborted. As the powers pulled the company in two directions, the losses 6 mounted. By March 2001, the first results after the merger saw an operating loss of £1.152 billion (for the 15 months to December) — £100 million higher than forecasts. The third image is that of Philippe Varin. He took charge of Corus as its CEO in 2003, and started with a share price of 40 pence and losses of £458 million (2002). Varin was fortuitous. Steel prices recovered and kept rising when he was at the helm. But he was also ruthless, slashing over £600 million in costs. Since 2003, share prices moved up to 390 pence (that was before Tata came calling. The 608 pence offer is now history) The final picture, from the past three years, is of a company that lived under the shadow of an acquisition. L.N. Mittal flirted with Corus before he found Arcelor. Then there was a steady stream of reports that said Russian steel makers such as Evraz and SeverStal were considering a bid for it. Among the four images, Corus’s new owner Ratan Tata would be most interested in the third. In many ways, Varin is the architect of the Corus that Tata has paid $12.1 billion for. Corus may have a long and rich Anglo-Dutch heritage, but in the past three years of the modern Corus’s seven-year history, it was Varin who prepared the company for its eventual destiny. Soon after taking charge, Varin launched the ‘Restoring Success’ programme, targeting cost savings of about £680 million over a three-and-a-half year period. By 2005-end, Corus had effected savings worth £555 million, and the gap between its earnings before interest, taxes, depreciation and amortisation (EBITDA) margin of 10 per cent and that of its competitors had dropped to 4.5 per cent. (Its margin was about 6 percentage points lower than its competitors in the EU in 2003.) Apart from cost savings, rising steel prices also helped. A large chunk of the savings (35 per cent) came from ‘manufacturing excellence’, purchase savings and supply chain optimisation. Between 2003 and 2005, the number of suppliers was cut from 16,000 to 9,000, employee productivity was raised by 5 per cent, and the ratio of on-time deliveries rose to 85 per cent from 74 per cent. By 2006-end, Corus would have effected the targeted £680 million in savings. Meanwhile, the sale of its aluminium business for £570 million to Aleris, a US-based aluminium company, effective August 2006 helped it reduce its debt burden considerably. But most of all, it is Varin’s clean-up of Corus’ manufacturing operations that will interest Tata. When Varin took charge, Corus was running five not-so-efficient production facilities in the UK (Port Talbot in Wales, Teesside, Scunthorpe, Stocksbridge, Rotherham). Varin and his team eventually pruned it to three facilities. He consolidated the flat products business in Port Talbot. Earlier, Teesside supplied slabs to Port Talbot, while Port Talbot was itself making some slabs. Now, Port Talbot handles the entire production process for flat products. And Teesside, instead of being shut down, has been put to smart use. Corus has entered into a long-term offtake agreement for 10 years with a consortium of four steel makers, including Dongkuk from South Korea and Duferco from Sweden. These companies have access to 80 per cent of the slabs produced there on a cost basis. Corus had two plants making engineering steel — Stocksbridge and Rotherham — that essentially were a small part of its long products capacity. It shut down the Stocksbridge plant, except for remelting very high-end aerospace steel, and shifted the engineering steel capacity to Rotherham. These changes are yet to be reflected in numbers as most of it took place last year. 2007 will present the correct picture. Still, Corus’s current EBITDA margin, at 8 per cent, is much lower than Tata Steel’s current margin of 30 per cent (but it is important to note that the company has come a long way on this front. 7 And as Kaushik Chatterjee, vice-president (finance), Tata Steel, points out, between 2001 and 2002, most of the steel industry was facing losses, as steel prices were as low as $200-250 per tonne. That had done most of the damage. But ‘Restoring Success’ has been the current Corus management’s calling card. Says a London-based analyst: “The management has done a lot of things right, including working well in the cultural integration bit.” After all, it was under chairman Jim Leng and CEO Varin that Corus was finally able to sell off its downstream aluminium business to Aleris. All of this makes Varin a potential Tata ally. In fact, it is widely reported that Varin would have resigned if CSN had won the bid. But under Tata, he has given a two-year commitment and now has a place on the Tata Steel board. Clearly, Varin has steered Corus to its new destiny. British Steel was formed in 1967 by the Labour prime minister Harold Wilson’s government, which saw Britain’s 14 principal steel producers brought together. Then, much of Britain’s industry was being nationalised. Yet by the 1980s, Corus was well into losses. In 1988, the Conservative Thatcher government passed the British Steel Act to privatise Corus. Then came the merger with Hoogovens, which, founded in 1918, had its own unique heritage. Now, Corus has an Indian owner. Brazilian Steel Industry Since the 1940s, steel has been of vital importance to the Brazilian economy. During the 1970s, huge government investments were made to provide Brazil with a steel industry able to support the country's industrialization boom. After a decade of little to no investment in the sector in the 1980s, the government selected the steel sector as the first for privatization commencing in 1991, resulting in a more efficient group of companies operating today. In 2004, Brazil was the eighth largest crude steel producer in the world, with a production output of 32.9 million tons and a 3.1% share of global crude steel production. Brazil accounted for approximately half of total steel production in Latin America in 2004, approximately twice the size of Mexico's and approximately one-third the size of U.S. steel production. Companhia Siderúrgica Nacional (CSN) CSN is the second largest fully-integrated steel producer in Brazil and one of the largest in Latin America in terms of crude steel production. Its production process is based on the integrated steelworks concept. Following is a brief summary of the steel making process at its Presidente Vargas Steelworks, located in the city of Volta Redonda, Rio de Janeiro State Its manufacturing facilities produce a broad line of steel products, including slabs, hot- and coldrolled, galvanized and tin mill products for the distribution, packaging, automotive, home appliance and construction industries. Companhia Siderúrgica Nacional is a Brazilian corporation incorporated in 1941. The Presidente Vargas Steelworks, located at Volta Redonda, in Rio de Janeiro State, started production in 1946, initially producing coke, pig iron castings and long products Company business The company’s business activities are organized into fits segments: mining, steel making, infrastructure and cement. Mining The mining segment consists of the Casa de Pedra and Bocaina Mines, through which CSN produces high-quality iron ore used primarily as a raw material for the company’s Presidente Vargas Steelworks. 8 Steel The steel making segment is focused on metallurgy; the initial stage of steel production, rolling; whereby slabs are transformed into steel sheets, coating, and packaging and distribution. Infrastructure The infrastructure segment is concerned with energy, ports and railways Cement cement segment is concerned with cement production and sale. Production capacity .CSN annual crude steel capacity and rolled product capacity is 5.6 million and 5.1 million tons, respectively. Production of crude steel and rolled steel products was increased in 2004. Its share in total Brazil market is as shown below In 2004, it accounted for approximately 49% of the galvanized steel products sold in Brazil. It is also one of the world's leading producers of tin mill products for packaging containers. In 2004, it accounted for approximately 98% of the tin mill products sold in Brazil. Domestic share of its various products is shown below. Company facilities The company’s facilities include a cold-rolling and galvanizing facility in the US, a steel mill in Portugal in which it holds a 50% interest, two galvanizing plants in Brazil, GalvaSud and CSN Paraná, and Presidente Vargas Steelworks located in Volta Redonda. Three major expansions were undertaken at the Presidente Vargas Steelworks during the 1970s and 1980s. The first, completed in 1974, increased installed annual production capacity to 1.6 million tons of crude steel. The second, completed in 1977, raised capacity to 2.4 million tons of crude steel. The third, completed in 1989, increased capacity to 4.5 million tons of crude steel. IT was privatized through a series of auctions held in 1993 and early 1994, through which the Brazilian government sold its 91% interest in its company. In 1993, IT adopted a capital improvement program, which was revised and extended in 1995. The goals of the capital 9 improvement program HAS been to increase its annual production of crude steel, to improve the productivity of its production units and the quality of its products and to enhance its environmental protection and cleanup programs. Since February 1996, all production has been based on the continuous casting process, rather than ingot casting, an alternative method that results in higher energy use and metal loss. From 1996 through 2002, IT HAS spent the equivalent of US$2.4 billion under the capital improvement program and for operational capacity maintenance, culminating with the revamping in 2001 of Blast Furnace #3 and Hot Strip Mill #2 at the Presidente Vargas Steelworks that has increased its annual production capacity to 5.6 million tons of crude steel and 5.1 million tons of rolled products, from approximately 5.0 million tons in each case at the beginning of 2001. CSN also has holdings in two rail networks that transport its raw materials and products, Companhia Ferroviária do Nordeste and MRS Logística. Company business strategy Its mission is to increase value for its shareholders, maintaining its position as one of the world's lowest-cost steel producers while maintaining a high EBITDA margin. With this in mind, IT intend to strengthen its position as a global player, optimizing its infrastructure assets (its mines, ports and railways) and their competitive cost advantages. To achieve this goal, IT has adopted strategies in each of its fits business segments Steel • Implement a carefully crafted globalization strategy. This may include the acquisition or construction of steel operations, steel-related businesses or distribution or service centers outside Brazil, as it has the association with other companies engaged in such ventures. • Emphasize a wide range of value-added products, mostly galvanized, pre-painted and tin-coated. • Introduce new technologies and systems to enhance its understanding of customers, competitors and industry trends. • Provide customer solutions supported by quality products and services. Mining • Expand its mining assets – its Casa de Pedra (iron ore) and Arcos (limestone and dolomite) mines – and search for investment opportunities, primarily in mining operations related to the steel business. Pursuing this strategy, in January 2004 IT announced the approval of investments, currently expected to be up to US$820 million to be made through 2007, for: • The expansion of the annual production of the Casa de Pedra iron ore mine from 15.5 million tons in 2004 to approximately 40 million tons. • The expansion of the coal terminal adjacent to its Sepetiba Port facilities to enable annual exports of up to 30 million tons of iron ore. • The construction of a six million-ton pellet plant. Cement • Achieve greater usage of by-products. In June 2004, IT announced the approval of the construction of a facility to produce 1.2 million tons of cement, using the slag generated by its blast furnaces, at a cost of up to US$43 million. Major Products in steel It produces carbon steel, which is the world's most widely produced type of steel, representing the vast bulk of global steel consumption. From carbon steel, IT sell a variety of steel products, both domestically and abroad, to manufacturers in several industries. Its Presidente Vargas Steelworks produces flat steel products—slabs, hot-rolled, cold-rolled, galvanized and tin mill products. Slabs 10 Slabs are semi-finished products used for processing hot-rolled, cold-rolled or coated coils and sheet products. IT is able to produce continuously cast slabs with a standard thickness of 250 millimeters, widths ranging from 830 to 1,550 millimeters and lengths ranging from 5,250 to 10,660 millimeters. IT also can produce medium and low carbon slabs, as it has micro-alloyed, ultra-lowcarbon and interstitial free slabs. Hot-rolled Products Hot-rolled products are comprised of heavygauge hot-rolled coils and sheets and light-gauge hotrolled coils and sheets. A heavy gauge hot-rolled product, as defined by Brazilian standards, is a flatrolled steel coil or sheet with a minimum thickness of five millimeters. IT is able to provide coils of heavy gauge hot-rolled sheet having a maximum thickness of 12.7 millimeters and cut sheet having a maximum thickness of 6.3 millimeters. Heavy gauge sheet steel is used to manufacture automobile parts, pipes, mechanical construction and other products. Light gauge hot-rolled coils and sheets produced by us HAS a minimum thickness of 1.2 millimeters and are used for ITlded pipe and tubing, automobile parts, gas containers, compressor bodies and coldformed light shapes, channels and profiles for the construction industry. Cold-rolled Products Cold-rolled products are comprised of coldrolled coils and sheets. A cold-rolled product, as defined by Brazilian standards, is a flat cold-rolled steel coil or sheet with thickness ranging from 0.30 millimeters to 3.00 millimeters. Compared to hotrolled products, cold-rolled products has more uniform thickness and better surface quality and are used in applications such as automotive bodies, home appliances and construction. In addition, cold-rolled products serve as a base steel for its galvanized and tin mill products. IT supply cold-rolled coils in thickness from 0.30 millimeters to 2.65 millimeters. Galvanized Products Galvanized products are comprised of flat-rolled steel coated on one or both sides with zinc or a zincbased alloy applied by either a hot-dip or an electrolytic process. IT use the hot-dip process, which is approximately 20% less expensive than the electrolytic process. Galvanizing is one of the most effective and low-cost processes used to protect steel against corrosion caused by exposure to water and the atmosphere. Galvanized products are highly versatile and can be used to manufacture a broad range of products, . IT produce galvanized sheets and coils in continuous hot-dip processing lines, with thickness ranging from 0.30 millimeters to 2.70 millimeters. IT produce Galvanew®, galvanized steel that is subject to a special annealing process following the hot-dip coating process. This annealing process causes iron to diffuse from the base steel into the zinc coating. The resulting iron-zinc alloy coating allows better ITlding and paint performance. The combination of these qualities makes its Galvanew® product particularly ITll-suited for manufacturing automobile and home appliance parts including high gloss exposed parts. At CSN Paraná, IT produce galvalume, a coldrolled material coated with a zinc-aluminum alloy. Its share of various products is shown below Steel Sales by Geographic Region In 2004, it sold steel products to customers in Brazil and 61 other countries. Its domestic steel sales, as a percentage of total sales volume and operating revenues from steel sales, ITre 65% and 70%, respectively, in 2002, 59% and 61%, respectively, in 2003 and 71% and 73%, respectively, in 2004. 11 The three principal export markets for its products are North America, Europe and Asia, representing 44%, 32% and 11%, respectively, of its export sales volume in 2004. In addition to sales to end customers, in North America It sell slabs to its subsidiary, CSN LLC, to be processed into hot rolled cold-rolled and galvanized products and then sold to end customers. Also, in Europe It sell hot rolled coil as raw material for Lusosider Projectos Siderúrgicos S.A., or Lusosider, its subsidiary located in Portugal. It is attempting to orient its export sales to more profitable markets in order to maximize revenues and shareholder returns. In 2004, the increase in steel consumption and record prices in North America led a shift in exports to this market. Its strategy is to maintain Europe and North America as its main export markets, taking advantage of commercial channels of its subsidiaries; CSN LLC in the United States and Lusosider in Portugal. The following table contains certain information relating to sales of steel products by destination Future Investments plans In January 2004, It announced the approval of investments, currently expected to be up to US$820 million to be made through 2007, for: • The expansion of the annual production of the Casa de Pedra iron ore mine from 15.5 million tons in 2004 to approximately 40 million tons. 12 • The expansion of the coal terminal adjacent to its Sepetiba Port facilities to enable annual exports of up to 30 million tons of iron ore. • The construction of a six million-ton pellet plant. In June 2004, It announced the approval of the construction of a facility to make cement, using the slag produced by its blast furnaces, at a cost of up to US$43 million. In April 2005, It purchased from Brascan Brasil Ltda. 100% of ERSA, which IT anticipate will provide 100% of its tin needs by 2009, after planned investments. In addition to the currently planned investments and maintenance capital expenditures, It continue to consider possible acquisitions, joint ventures and brownfield or greenfield projects to increase its steel producing capabilities. Competitveness CSN has good no of competitors as shown below The principal raw materials for steel production in an integrated steel works are iron ore, coal, coke, fluxes like limestone and dolomite and manganese ore. The iron ore consumed at the Presidente Vargas Steelworks is extracted, crushed, screened and transported by railway from its Casa de Pedra mine located in Congonhas, Minas Gerais State, 328 km from the Presidente Vargas Steelworks. The high quality ores mined and sized at Casa de Pedra, with iron content of approximately 60%, and their low extraction costs are major contributors to its low steel production costs It has the following competitive advantages over its Brazilian competitors: • Its focus on selling high margin products, such as tin plate, pre-painted, galvalume and galvanized products, in its product mix. • Its ownership of iron ore reserves, compared to its domestic competitors that purchase their iron ore requirements mainly from CVRD. • Its thoroughly developed logistics infrastructure, from its iron ore mine to its steel mill to, finally, its ports. • Its self-sufficiency in energy, through its interests in hydroelectric plants of Itá and Igarapava, and its own thermoelectric plant inside the Volta Redonda mill. • GalvaSud, which provides material for exposed auto parts, using hot-dip galvanized steel and laser-ITlded blanks, a trend in this industry. This, together with its hot-dip galvanizing process know-how, should allow us to increase its sales to the automotive segment. • CSN Paraná, gives us additional capacity to produce high-quality galvanized, galvalume and pre-painted steel products for the construction and home appliance industries. It competes on a global basis with the world's leading steel manufacturers. It has positioned itsselves in the world market with a product mix characterized by high margin, high demand steel products such as tin mill and galvanized. IT has relatively low-cost labor available and own highgrade iron ore reserves that more than meet its production needs. These global market 13 advantages are partially offset by costs of transporting steel throughout the world, usually by ship. Shipping costs, while helping to protect its domestic market, put pressure on its export price. To maintain its competitive viability in the world steel Its sales and profits growth over past few years is shown below. Operating revenues(US m$) 3903 2920 2383 2078 2169 2000 2001 2002 2003 2004 1600 1400 1200 1000 800 Adj. EBITDA in millions of US $ 600 400 200 0 2000 Factors leading for the sale: 2001 2002 2003 2004 Reasons for corus: Total debt of corus was 1.6 billion GBP for which it needed a backing. After undertaking the turnaround it made more sense for it to go scouting for being acquired by a buyer. Corus needed supply of raw materials at lower cost. Its operations were not very profitable. Though corus had revenues of $ 18.06 billion its profit was just $626 million, whereas TATA Steel’s profit was $824 million for a revenue of just $4.84 billion. 14 Reasons for TATA steel to bid: To enable de integration of the steel plant, by locating raw materials near the mines and the finishing factories near the market for obtaining operational efficiencies. It would also provide access to the advanced R & D and technology of Corus and market higher end products in Europe. Further cost of acquisition is far lower than setting up an equivalent green field plant which would take a longer gestation period around 15 years. ANALYSIS: TATA-CORUS: STRATEGIC FIT Is the Corus acquisition by Tata Steel a defining moment for the company as made out to be? Or is it a disaster in the making for Tata Steel? After five months of twists and turns, Tata Steel has won the race to acquire Corus Group. The bidding war between Tata Steel and Brazilian company CSN was riveting and ended in a rapidfire auction. Initial reactions to the deal were highly diverse and retail investors were completely puzzled by the market reaction. Going by the stock market reaction, the acquisition seemed a big blunder. The stock tanked 10.5 per cent after the deal was announced and another 1.6 per cent later. Investors were worried about the financial risks of such a costly deal. Media reaction to the deal has been just the opposite. 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 colors. Its editorial warned the market 'not to bet against Tata', citing the previous instances when skeptics were proved wrong by the group. Official reaction has been no different and the finance minister even offered all possible help to the Tata Group. Is the acquisition too costly for Tata Steel? Is price the only criterion while evaluating an acquisition? Should managers focus on keeping shareholders happy after every quarter or should they focus on the long-term, big picture? These are tough questions and, unfortunately, answers would be clear only after many years - at least in this case. When could the steel cycle turn? The last few years were some of the best ever for the global steel industry as robust demand from emerging economies like China pushed up prices. Profits of steel manufacturers across the globe swelled and their market capitalizations have multiplied many times. Global (in million tonnes) Country China Japan US Russia South Korea Germany Steel 2005 355.8 112.5 94.9 66.1 47.8 44.5 output 2006 418.8 116.2 98.5 70.6 48.4 47.2 % change 17.7 3.3 3.8 6.8 1.3 6.1 15 India Ukraine Italy Brazil World production 40.9 38.6 29.4 31.6 1,028.8 44.0 40.8 31.6 30.9 1,120.7 7.6 5.7 7.5 (2.2) 8.9 How long will the good times last? 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 massive post-war infrastructure build-up in Western countries led to the sustained steel demand growth in that period. The coming decades would see similar infrastructure spending in emerging economies and steel demand would continue to grow, according to this view. 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. Now let us consider steel prices. Expectations of sustained demand growth have already led to massive capacity additions, mostly in emerging markets. Chinese steel capacity has expanded significantly over the last decade while a large number of mega steel plants are being planned in India. Capacity additions by Russian and Brazilian steelmakers would also be significant in future as they have access to raw material. Would the capacity additions outrun the demand growth and lead to subdued steel prices? Under normal circumstances, that could have been a very strong possibility. But many industry leaders believe that the global steel industry would see a structural shift in the coming years. Some of the inefficient steel mills in mature markets would face closure while others would shift production to high value-added products using unfinished and semi-finished steel supplied by steel mills in locations like India, Russia and Brazil with access to raw material. This would limit aggregate supply growth and keep prices stable in future. Major global steel makers are also not unduly worried about the possibility of large-scale exports from China, which would depress international steel prices. Chinese capacity is expected to continue to grow in the coming years, but so would the demand. Besides, Chinese steel plants are not expected to emerge very efficient as they depend on imported raw materials, which limit their pricing power. Many steel analysts expect significant consolidation in the Chinese steel industry as margins erode further in future. The Chinese government has already started squeezing the smaller units by withdrawing their raw material import permits. The 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, 16 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. Global Steel Ranking Company Capacity tonnes) Arcelor - Mittal 110.0 Nippon Steel 32.0 Posco 30.5 JEF Steel 30.0 Tata Steel - Corus 27.7 Bao Steel China 23.0 US Steel 19.0 Nucor 18.5 Riva 17.5 Thyssen Krupp 16.5 (in million 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. Tata Steel – Corus Present Capacity Corus Group (in UK and The Netherlands) 19 Tata Steel - Jamshedpur 5 NatSteel - Singapore 2 Millennium Steel - Thailand 1.7 Aggregate present capacity 27.7 Tata Steel – Corus : Projected capacity Corus Group Netherlands) (in UK and The 19 Tata Steel - Jamshedpur 10 Tata Steel - Jharkhand 12 Tata Steel - Orissa 6 Tata Steel - Chattisgarh 5 17 NatSteel - Singapore 2 Millennium Steel - Thailand 1.7 Aggregate projected capacity 55.7 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. 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. But at what cost ? Now that Tata Steel has achieved its strategic objective of becoming one of the major players in the global steel industry and steel demand growth is likely to be robust over the next decade, has the company paid too much for Corus? Even those analysts and industry observers who agree on the positive outlook for steel demand growth and the need to achieve scale believe so. 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. 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. But, are the manufacturing assets of Corus good enough to command this price? It is a wellknown fact that the UK plants of Corus are among the least efficient in Europe and would struggle to break even at a modest decline in steel prices from current levels. Recent 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. 18 Corus Financials Year Revenues EBITDA EBITDA Margin (%) Operating Profits Operating Profit Margin (%) Net Profit Net Profit Margin (%) Figures in $ Billion 2004 18.32 1.91 10.44 1.30 7.09 0.87 4.73 2005 19.91 1.86 9.34 1.17 5.89 0.72 3.63 Jan-Sep 2006 14.10 1.12 7.96 0.75 5.29 0.25 1.77 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 current cash flows of Corus are 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 jeopardizing its greenfield expansion plans which may cost a staggering $20 billion over the same 10-year period. No wonder investors are deeply worried! To its credit, the Tata Steel management has acknowledged that it would not be an easy task to manage the next five years when Corus would have to hold on to its margins without the help of cheaper inputs supplied by Tata Steel. If the group can survive this initial period without much damage, life may become much easier for the Tata Steel management. 19 Investors would consider Corus as 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. However, long-term investors would appreciate that right now steel manufacturing assets are costly and Corus was a prized target which made it even more costly. With the strategic importance of such a large deal in mind, Tata Steel management has taken the plunge. If it can pull it off, even after a decade, the Corus acquisition would become the deal, which would transform Tata Steel. Ratan Tata, the chairman of the world’s 56th-ranked steel producer Tata Steel, had enthused that this is a “strategically compelling combination.” Corus chief executive Phillipe Varin and chairman Jim Lange were equally enthusiastic, saying the deal represented the “right partner at the right time, at the right price and on the right terms.” This is a prime instance of the popular ‘mergers and acquisitions’ strategy, which is employed worldwide nowadays to fuel expansion, inorganically if not effortlessly. Deals like the Tata one are planned carefully, where corporate finance advisors help identify ‘target’ companies for acquisition, study them in depth through ‘due diligence’ processes, value the deal, and finally, structure it. Top management consultancies earn huge commissions from such deals. This does not necessarily take away from either the legitimacy or efficacy of such deals. It isn’t a surreptitious takeover game or corporate colonisation, but a strategic corollary of the globalisation and liberalisation impetus where big is often better. Ratan Tata has said: “I think our sight is set on a strategic fit.” Even if Corus was a five milliontonne company, Tata says they would have gone ahead. Further, Ratan Tata has explained the deal is “entirely consistent with our strategy of growth through international expansion.” A skepticism that the pragmatic businessman manages to see what others can’t, their vision supposedly clouded by the codes of logic! It’s easy to imagine that the big businessman has a secret agenda, a subtle vision, and an assured ability to write and read a corporate subtext in deals. Given the Tata group’s known commitment to business ethics and professional values, the Corus deal seems transparent and strategic. It uses global practices like mergers and acquisitions to embed its position. It might well mark the arrival of Indian MNC’s that will compete, and often, beat foreign companies in their own backyard. R. Seshasayee, president, CII says: “The internationalization of the Indian corporate sector has reached a new high with this landmark deal.” The Tatas, though the world’s 56th largest steel producer, have now gobbled up Corus, which was the ninth largest producer, to occupy the fifth position in the world steel rankings. Only recently, LN Mittal had acquired Arcelor in a controversial deal, becoming the leader of the pack, with the No. 1 producer being three times larger than the No. 2, Nippon Steel. So, is it possible that Tata Steel, India’s most famous steelmaker was responding to Mittal’s methods? Some have singled out the not inconsequential corporate ego factor. But it’s a little unlikely that a man as composed as Ratan Tata would plump billions of pounds — and a warchest of nearly £10 billion — only to outdo the Mittal-Arcelor behemoth. In fact, hours after inking the agreement, he said: “I don’t think our sights are set to surpass or equal Lakshmi Niwas Mittal.” While the Tata-Corus combine would produce 24 million tones per annum (MTPA), MittalArcelor produces 110 MTPA. Even by 2011-12 Tata expects to produce 40 MTPA. Clearly, this isn’t a head-to-head competitive scenario, at least in the global sweepstakes. Ratan Tata has 20 asserted that they would concentrate on strategic opportunities, not captive, to mere tonnage numbers but to achieve inorganic growth. Yet, given that Mittal has entered India’s steel terrain, it’s unlikely that the Tatas can ignore this happenstance. Earlier, there have been reports that the Tatas have been consolidating their holdings to ward off any hostile takeover attempt. Will this deal enable the Tatas to counter the Mittal-Arcelor behemoth as it travels on Indian territory any better? The implications for India are important to register. Tata-Corus attempting to build power as they try to woo customers, and as importantly, leverage their power to drive negotiations as they deal with an increasingly consolidated bunch of suppliers in the iron ore industry. In the Tata-Corus deal, Tata Steel will use this to inorganically grow, gaining market access to some big steel buyers in Europe, who are on Corus’ customer list. It can also benefit from the UKDutch steel major’s ability to work higher up in the value chain. It’s said that Tata Steel could send its steel to Corus to produce more refined products with which it can then access the Western markets. If the Tatas are bringing low-cost production to the table, Corus is offering the technology and processes to manufacture more refined products. Many feel that the Tatas have managed to get a good deal. Some say they have offered too low a price. Standard Life, the largest shareholder with a 7.9 percent stake in Corus has accused its management of accepting a much too low £4.3 billion offer. A Standard Life spokesman commented: “The 455 pence per share offer by Tata for Corus is lower than we would have expected.” The objections are primarily because the steel major’s trading performance has been good providing healthy cash flows. As the deal became corporate India’s conversation piece, what wasn’t discussed often enough was: what’s Corus getting out of the acquisition? Seemingly, the current CEO had been hunting for a partner. When he took over, Corus was in the red; under him it’s making money but its performance has faded compared to its halcyon days in the late 1970s. Production and employment are a margin of what they used to be, making the CEO realize that in a changing world it’s got to hitch the ride with a corporate powerhouse if it’s to survive. Ratan Tata, with whom he’s said to share chemistry, has provided an opportunity where Corus will retain its identity and core market, and gain a war-chest of close to £10 billion. Corus hopes to gain in security from being part of a larger business group. Also, with the focus shifting to Asian markets, and Tata enjoying its own sources of iron ore and coal, this would give Corus a firmer footing in sourcing raw materials in a volatile market. In a changing steel industry, Ratan Tata has alluded to the long, proud histories of both the companies. He’s said: “Together we will be even better equipped to remain at the leading edge of the fast-changing steel industry.” The deal has displayed the crucial position of stakeholders in blocking acquisitions; employee pension trusts have favoured Tata as a benevolent employer helping it win the sweepstakes. Indian regulatory authorities need to vet each deal and ensure that vital stakeholder interests are safeguarded. It’s important to realize that even divestment of public entities in India are acquisitions that need to be interrogated using the barometer of public interest. Even though liberalization has made concerns about monopoly and anti-trust unfashionable, the sacred space in which the private citizen lives can’t be suffocated without puncturing the essence of democracy. It’s necessary to have a vigilante regulator who is alert to the interest of the small player and ordinary customer, and is also dynamic and forward-looking. As corporations coagulate to enjoy ever-increasing power, their social responsibility and impact will become a central issue. Anti-trust legislation and stakeholder approval are just some of the determinants of equity and justice that mergers and acquisitions could potentially jeopardise. 21 In this context, the Tatas with their commitment to society, and genuine corporate citizenship, have over time demonstrated an enlightened understanding of their growing position. The holding company Tata Sons funds a variety of public trusts and endowments. Leaders like JRD and Ratan Tata have known that their privileged business position can only be tenable by virtue of responsible and restrained corporate behaviour. Their reputation played a key role in winning them the confidence of the pension trusts in the Corus deal, and this case trademarks trust as a corporate asset that can be acquired only in a determined and dedicated manner beyond the number game. That’s the leadership game in business, both institutionally and individually. It defines the visionary business leader from the ravenous corporate raider. Globally, the Tatas may well enshrine this business value beyond the calculus of corporate finance. Valuation : Taking the replacement cost approach of $1100-1300 per mmt the valuations have been justified as the amount paid comes to only around $710 per mmt. Further this also provides speed to market as gestation period of setting up a green field plant would take around 15 years.Though it can be argued that the plant is old and may need some capital expenditure, this argument cannot be totally wished away. Keeping in view if the steel upcycle extends the valuations could scale much high comparatively on the time line. Using the Income approach, a hypothetical analysis based on projections of future steel prices by BCG and presuming the steel cycle to be intact still reveals that it would take TATAs around 11 years for the payback @ 7% DCF .( REF Exhibit- 3) Brokerage house First Global further estimates that a $50 fall in global steel prices could lead to a $414-million loss from the acquisition in FY08 (see ‘Price Impact’). If there is a $75 fall, the losses could climb to $846 million. This does not seem to be just a street view. “The world steel consumption growth is expected to slow down from 8.9 per cent in 2006 to 5.2 per cent in 2007 and 4.2 per cent in 2010,” an ICRA industry monitor said. However, in terms of leverage, Corus currently has a relatively low net debt-equity ratio of 0.25 times. So, while Corus has room on its balance sheet to take on more debt, it may come under pressure on debt servicing, if steel prices head in the wrong direction. In addition to the $ 12.1billion for equity shareholders,TATA has also entered into an arrangement with the pension funds with a commitment to pay the deficit contribution of GBP 126 million upfront along with increasing the contribution from 10 to 12% and assured support till 2009 which adds to the cost of acquisition. 22 The stock markets has reacted negatively to the deal. Tata Steel has lost a billion dollars in market capitalisation since it first announced its intention to buy Corus in October last year. (The BSE Sensex rose 18 per cent during the same period.) The market perception is that the Tata Group paid too much for this acquisition. Several brokerage houses have pointed out that the deal implies a high enterprise value/ earnings before interest, taxes, depreciation and amortisation (EV/EBITDA) multiple of 9 for Corus versus 4.6 for Tata Steel. (L.N. Mittal paid 5.8 times EBITDA for Arcelor.) Ratan Tata disagrees: “We believe that, looking back in time, the price today will prove to be one that was worthwhile because the price of steel companies is likely to be even higher in the coming year.” Despite the thumbs-down from the markets, the Tata Group is convinced of the long-term synergies in manufacturing, access to global customers, opening India to Corus or leveraging research and development for Tata Steel’s greenfield projects. They believe that the impact on the bottom line is not the result of just one factor like steel prices. They are betting that several synergies would bring about $350 million in savings in three years. Says Tata Steel’s Chatterjee, “The product mix of Corus is different and its output cannot be put in the usual product and price relationship matrix.” He also disagrees with a section of analysts on their forecasts of demand slack. The combined entity is also expected to scout for more acquisitions together effectively — it is eyeing more buyouts in finished steel and iron ore. Perhaps, it is more important to look at the broader business model that the Tatas have envisaged for the combined entity. Simply put, this deal will increase Tata Steel’s capacity exponentially; give it a wider customer base and an enhanced product portfolio. Significant cost savings are also expected by exporting cheaper inputs (slabs) from India that will be processed in Corus’s plants in the UK. Many believe export of low-cost slabs from India will be the key to improving Corus’s profitability. But currently, Tata Steel does not have spare slab capacity — its Jamshedpur plant of almost 5 million tonnes (mt) is operating at full tilt. It now has to get its greenfield expansions in Orissa, Chhattisgarh and Jharkhand up and running in double quick time. But analysts expect these to be commissioned not before 2010. Supplying slabs to Corus’s facilities in the UK is definitely on Muthuraman’s mind. “Completing our greenfield and brownfield expansions on time is as important as the new integration process. So is getting ownership of iron ore... we are working on those locations (Africa, Canada and Brazil)’’, he says. In short, Tata Steel will have to work with clockwork precision to ensure that its upstream activities outside of Corus are up in time to boost Corus’s profitability. After all, its target is pushing up the combined entity’s EBITDA to 25 per cent in three years. Funding woes: But tying up the funding is the immediate priority. The financial strength of the Tata Group is not in doubt. But the funding puzzle is yet to be solved. The $4.1-billion equity component is the first bit of the jigsaw. The second piece in the puzzle is the $8 billion-debt being raised by the SPV. The Corus acquisition is being routed through a special purpose vehicle (SPV) called Tata Steel, UK. (A similar structure was used for the Tetley buy in 2000, Ref Exhibit – 4) So far, the Tatas have indicated that group holding company Tata Sons will pump in $4.1 billion as equity into the SPV. The balance $8 billion will be raised by junk bonds and senior term loans (part of it has been tied up with banks like ABN Amro, Deutsche Bank and CSFB). These loans are expected to be serviced out of Corus’s profits; Tata Steel need not repay this. This has effectively ring-fenced Tata Steel shareholders. 23 However this appears to be a cause for concern. Given Corus’s EBITDA margins of only 8 per cent, compared to Tata Steel’s 30 per cent, the UK-based firm’s ability to service the additional debt of $8 billion is under scrutiny. Analysts say that the new debt of $8 billion, which will be serviced through Corus’s cash flow, will roughly bear an interest cost of 8 per cent. In other words, the annual interest cost would be as much as $640 million. Based on results for the 12 months ended September 2006, Corus already has an interest outgo of $400 million, which means the total interest outgo could be over a billion dollars after the acquisition. However, after factoring in a tax break of 30 per cent on the interest paid, (interest cost on funds used for acquisitions are an allowable expense in the UK), the net interest outflow may be about $725 million. Corus’s current EBITDA of $1.45 billion covers the interest outgo more than comfortably, but a significant drop in steel prices would adversely impact it and its ability to service the debt. Equity: The need for TATAs to not only create but also protect shareholder value makes the raising of equity a more complex issue. Of the $4.1-billion equity component, analysts say that $2.3 -2.4 billion could be tapped from Tata Steel’s cash reserves. This leaves another $1.7 -1.8 billion that is yet to be raised. There are three routes through which this could be mobilised. First, if Tata Sons pumps in this amount as equity into the SPV, there will be a minimal impact on Tata Steel’s balance sheet. This will be good for Tata Steel shareholders. Tata Sons has the resources to do so. Its 78.3 per cent holding in TCS is worth Rs 99,700 crore, and it generates over Rs 3,250 crore in cash profit every year. In the second scenario, Tata Steel could borrow $1.7 billion-1.8 billion. Analysis done by brokerage firm CLSA shows that the interest on this borrowing could dilute earnings per share (EPS) by 1.4 per cent in FY08. But such a borrowing may be difficult as Tata Steel may need to raise more debt in the next 18-24 months for its greenfield projects in Orissa, Chhattisgarh and Jharkhand. The third option is that Tata Steel could dilute equity, possibly through a preferential issue to Tata Sons. This will hurt Tata Steel’s EPS even more. CLSA predicts a 13.1 per cent decline in EPS in FY08 if this option is exercised (see ‘EPS Unfriendly? Ref Exhibit- 5’). Also the option of share swap as in the case of Mittal Arcelor doesn’t seem to have been explored and it appears to be an all cash deal. TATAs have, however, tried to reduce the amount of external financing needed by offering loan notes maturing in 2013 in lieu of immediate cash payment which however remains to be seen as to how many of the shareholders would subscribe to that option. Post Merger Issues There is no doubt that Tata has pulled off a coup — Corus makes nearly four times more steel than Tata Steel. Together, the combine becomes the fifth largest producer in the world and the second in Europe. But to make the most of the deal, Tata has to manage several variables including steel prices, raw material supplies and interest costs on the $8-billion debt that is being raised to fund the deal. Soon he may also have to deal with the sensitive issue of possible job cuts in Corus’s manufacturing plants. There are also the usual set of integration challenges that come with such large buyouts. The deal may be done, but the hard work is just beginning. Backstage, the Tata team is working round-the-clock. If Koushik Chatterjee, vice-president (finance), Tata Steel, is shuttling between London and Mumbai to sew up the financing of the 24 deal, managing director B. Muthuraman is zeroing in on the company’s next acquisition — iron ore assets overseas — to lower Corus’s costs. More on that later. There is little doubt that the Tatas wanted Corus badly. Sources say that the group was willing to go as high as 630 pence per share in the nine-round bidding auction. Arun Gandhi, the M&A whiz of the group, wouldn’t confirm that figure but indicated that the Tatas were prepared to bid higher than the 608 pence that sealed the deal. When the bidding began, he was stationed at the office of the group’s lawyer on Primrose Street, London, EC 2A 2HS, all night — with a motorcycle stationed kerbside, revved up and ready to go, in case networks failed and the e-mail bids could not be sent. In the run up to the auction, Tata had maintained a low profile despite CSN’s aggressive stance. “They underestimated our firepower,” says Gandhi, who admits that even bankers to the transaction — ABN Amro and Deutsche Bank — were in the dark as to how far Ratan Tata was willing to go. At present, Muthuraman is also busy kicking off the integration process between Tata Steel and Corus by setting up task forces in different areas — iron-making, research and development, and marketing. “We’ve done this before in Natsteel and Millennium...but it is challenging nonetheless,” he says. Few will disagree. The Tata Steel managing director is likely to look for more acquisitions as he aims to increase the company’s total capacity to 100 mt by 2015. To reach that destination, a lot will depend on whether the group can make Corus fly. And it may be more challenging for Mr Tata than flying the F16. For the Tatas, the Corus acquisition is only half the battle won. While the financial and strategic reasons may sound rational, much rides on the post-merger integration, an issue fraught with cultural undertones and ego clashes. Robert Bruner, dean of the Darden School of Business, University of Virginia, says, "When integration gets bogged down, bad things happen—all stemming from the 'me 'issues." Adds Phil Rosenzweig, a professor at the International Institute of Management Development, "The integration issues in the case of Tata-Corus get even more complex because it is a very large, cross-border deal." An estimate suggests that 70% of all failed M&As have come apart due to cultural issues. The high-profile merger of Compaq and Digital Equipment Corp failed because Compaq's highvolume, fast-to-market focus didn't merge with Digital's long sales cycles. Peter Killing, professor of strategy at IMD says, "This gets even more complex because Corus itself is the result of a cross-border merger. They already have a mix of Dutch and English culture and now add an Indian element to it as well." 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." The Tatas need to identify the key people at Corus and ways to keep them as headhunters try to snatch good managers in such vulnerable situations. "If there is a rival company in close proximity, it will take advantage of this situation by snapping up customers as well as management "says Jay Bourgeois, professor at Darden. But the Tatas 25 already seem to be doing the right things. "The fact that they have put two Corus people on the Tata board shows that the Tatas don't view the acquired company as a loser, "says Venkiteswaran. It is important because employees loathe uncertainty about their fate in the company. Phanish Puranam, professor, London Business School, says, "Productivity drops, competition takes away business and soon the value of the deal is gone even before integration starts." There has to be clear and honest communication, especially to Corus employees and customers. Darden's Bourgeois says that Tetley, the Tata's previous UK buy, ran into cultural and racial obstacles because of concerns that British employees would resent having managers from a former British colony. "The trick here is for the Tatas to learn from their Tetley acquisition and maybe use some of the managers who handled that integration, “says IMD's Killing. After all, as Darden School's Bruner puts it, "A bad integration effort can trigger a downward spiral that is very hard to correct and can ultimately result in bankruptcy." Conclusion: Going by the skepticism and fortune telling going on in the industry by different analysts, it appears that TATAs have preferred to ride on the wave of consolidation undergoing in the industry not only to broaden their horizons but also ensure sustainability and survival in the long run. Happen what may in future, this acquisition is surely a landmark which would provide an excellent study in times to come. 26 Scouting Report – Target Prospect Start Date: 8th June, 2006 Company Name: Corus Group plc. Company Address: Corus 30 Millbank London SW1P 4WY UK T: +44 (0) 20 7717 4444 F: +44 (0) 20 7717 4455 Industry: Steel What does the company do? Corus is an international company, providing steel and aluminium products and services to customers worldwide. Corus is Europe's second largest steel producer with revenues in 2005 of £9.2 billion and crude steel production of 18.2 million tonnes, primarily in the UK and the Netherlands. It is the fifth largest global steel producer with pro forma crude steel production of 23.5 million tonnes in 2005. The company is comprises four Divisions, Strip Products, Long Products, Distribution & Building Systems and Aluminium, and has a global network of sales offices and service centres. Company History: Corus Group (formerly British Steel), one of the world's largest steel companies. The company was formed when the UK privatized its major steelworks in 1988. It then changed its name to Corus Group after acquiring most of Dutch rival Koninklijke Hoogovens. Corus was formed on 6th October 1999 through the merger of British Steel and the Dutch company Koninklijke Hoogovens. Corus had two plants making engineering steel — Stocksbridge and Rotherham — that essentially were a small part of its long products capacity. It shut down the Stocksbridge plant, except for remelting very high-end aerospace steel, and shifted the engineering steel capacity to Rotherham. These changes are yet to be reflected in numbers as most of it took place last year. 2007 will present the correct picture. Corus’s current EBITDA margin is 8 per cent. Products: Corus makes coated and uncoated strip products, sections and plates, wire rod, Bar & billets, Narrow Strips, Plates, Packaging Steel, Plated Steel Strips, Rail Products, Tube Products, Engineering steels, and semi-finished carbon steel products. Customers: Customers include the manufacturing industries automotive, construction, engineering, and household-product Subsidiaries: Corus Engineering Steel Thomas Steel Strip Corpn. 27 Decision Makers – Primary points of entry: Jim Leng, Chairman Philip Varin, CEO Points of Entry: David Lloyd, Chief Financial Officer Emma Tovey, Director, Investor Relations Tel: +44 (0) 207717 4557 Tel: +44 (0) 207717 4504 Credit Suisse (lead financial adviser to Corus) James Leigh-Pemberton Jeremy Fletcher Zachary Brech Tel: +44 (0) 207888 8888 Tel: +44 (0) 207888 8888 Tel: +44 (0) 207888 8888 JPMorgan Cazenove (joint financial adviser and corporate broker to Corus) Edmund Byers Tel: +44 (0) 207588 2828 Barry Weir Tel: +44 (0) 207588 2828 Matthew Lawrence Tel: +44 (0) 207588 2828 HSBC (Rule 3 adviser to Corus) Adrian Coates Charles Packshaw Raj Kohli Jan Sanders Brunswick (PR adviser to Corus) Kevin Byram Laura Cummings Ash Spiegelberg Competitors Key Numbers Revenues (bn euro) EBIDTA (bn euro) Arcelor-Mittal 62.2 11.5 Tel: + 44 (0) 207992 2326 Tel: +44 (0) 207992 2162 Tel: +44 (0) 207992 2328 Tel: +44 (0) 207992 2115 Tel: +44 (0) 207404 5959 Thyssenkrupp Steel 10.747 2.053 United States Steel 10.650 2.083 28 Exhibit-1 Exhibit 1.1 29 Exhibit –1. 2 Exhibit –1.3 Global Steel Output (As on Dec.06) Country China Japan United States Russia South Korea Germany India World Steel Production 418.8 116.2 98.5 70.6 48.4 47.2 44 1239.5 % Growth 18.5 3.3 3.8 6.8 1.3 6.1 7.6 8.8 Exhibit – 2 Table 1: Production, Imports, Exports and Consumption of Steel in India (in million tonnes) Exports Consumption Production Imports 2019-20 110 6 26 90 2004-05 38 2 4 36 CAGR 7.3% 7.1% 13.3% 6.9% 30 Exhibit –2.1 Import of Finished (Carbon) Steel in India Year 2001-2002 2002-2003 2003-2004 2004-2005 2005-2006 (Source: JPC) Qty. (In Tonnes) 1.271 1.510 1.540 2.109 3.765 Million Exhibit –2.2 Exports of Iron & Steel from India (Qty. in Million Tonnes) Finished (Carbon) Steel 2002-2003 4.506 2003-2004 4.835 2004-2005 4.381 2005-2006 4.350 (Source : Joint Plant Committee) Pig Iron 0.629 0.518 0.393 0.300 31 Exhibit –2.3 PRODUCTION OF FINISHED CARBON STEEL in INDIA (In million tonnes) Year Main Producers Secondary Producers Grand Total % of share Secondary Producers 1991-92 7.96 6.37 14.33 14.5% 1992-93 8.41 6.79 15.20 44.7% 1993-94 8.77 6.43 15.20 42.3% 1994-95 9.57 8.25 17.82 46.3% 1995-96 10.59 10.81 21.40 50.6% 1996-97 10.54 12.18 22.72 53.6% 1997-98 10.44 12.93 23.37 55.32% 1998-99 9.86 13.24 23.82 57.32% 1999-2000 11.20 15.51 26.71 58.07% 2000-2001 12.51 17.19 29.7 57.88% 2001-2002 13.05 17.58 30.63 57.4 % 2002-03 14.39 19.28 33.67 57.27 % 2003-04 15.19 21.00 36.19 58.03 % 2004-05 15.61 24.44 40.05 61.02 % 2005-06 16.236 26.400 42.636 61.92 % 9.692 16.800 26.492 63.42 % 2006-07 Oct' 06) (Apr- of 32 Valuation Replacement Cost approach Cost of new plant based on tonnage capacity: $12001300/ton Value of corus 2125 0 Actual paid Income approach YEAR Revenues next 5 years @ 5% p.a. Iron ore sourcing from australia Less: operating costs@90% Less: interest cost (.35+.65) Taxes@30% Cash profits Needs 5 years to set up $ 21.25 billion $ 12.1 billion 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 18.99 19.94 20.94 21.99 23.09 24.24 25.45 26.73 28.06 29.47 30.94 32.49 34.11 35.82 37.61 17.10 17.95 18.85 19.44 20.43 21.47 22.56 23.70 24.91 26.17 27.50 28.89 30.35 31.89 33.50 1.90 1.99 2.09 2.55 2.66 2.77 2.90 3.02 3.16 3.30 3.44 3.60 3.76 3.93 4.11 1.00 0.27 0.63 1.00 0.30 0.70 1.00 0.33 0.77 1.00 0.46 1.08 1.00 0.50 1.16 1.00 0.53 1.24 1.00 0.57 1.33 1.00 0.61 1.42 1.00 0.65 1.51 1.00 0.69 1.61 1.00 0.73 1.71 1.00 0.78 1.82 1.00 0.83 1.93 1.00 0.88 2.05 1.00 0.93 2.18 pv @8% in billion US$ 10 yrs 7.20 15yrs 10.75 pv @ 7% in billion US$ 7.59 11.60 41 Exhibit – 4 Impact on Tata steel’s FY ‘’08 P & L with $1.7 b pref issue to TATA sons Addnl debt on B/s Net D/E at FY’07 end(%) Net D/E at FY’08 end(%) Price for equity issue(Rs) Equity dilution (%) Interest/loss of other Income Tata Steel’s share in SPV profits Synergy gains Net increase in PAT Increase in EPS(%) Net debt/equity post dilution(%) FY’ 08 ROE without considering Corus acquisition(%) FY’ 08 ROE with Corus acqn(%) 5,802.5 0.4 0.4 500 25.1 (814) 618.2 450.0 374.3 (13.1) 0.39 22.10 17.30 (Fig –Rs. In crores) Source: CLSA Exhibit – 5 41