Steeling a deal: a calculated risk
Long-term implications are positive, say analysts. But there are concerns on the dilution of earnings in the short-term
AKASH JOSHI
What does the Corus deal mean for Tata Steel? Being catapulted from having the 56th position among world steel manufacturers to become the fifth largest – this is what Tata Steel gets in this deal. This quantum jump will have a definite impact on Tata Steel investors in India.
“The long-term implications are positive for Tata Steel,” says Sachin Neema, head research, with India Infoline. Similar views were expressed by most. But in the short-term, there are concerns on the dilution of earnings.
At an offer price of 455 pence, the deal amounts to around $7.9 billion. Realistically speaking, analysts expect it to close at around 500 pence or around $10 billion.
By all accounts, the Tata Steel management has arranged for this eventuality. For this, around $3.39 billion is expected to be pooled in by Tata Steel. The rest will be by way of a loan from Standard Chartered and setting up a Special Purpose Vehicle with a consortium of bankers bringing in roughly $6.5 billion.
“Tata Steel is in a good position to make use of this opportunity,” says Hitesh Agarwal, analyst with Angel Broking. The reasoning is that the current debt to equity ratio of 0.3:1 on FY06 numbers allows Tata Steel room to borrow and leverage its equity.
In addition, Tata Steel is in a position to raise around $1.5 billion from its reserves and investments. It could also raise the rest of the $2 billion dollars or Rs 9,200 crore through debt. The company has already received approval from shareholders to raise debt worth Rs 20,000 crore.
In case it raises Rs 9,200 crore through debt issuances, the debt to equity ratio will still be around 1:1 times. “This means that there will not be any substantial dent to the gearing of the company,” says Agarwal. Purely from an operational perspective, Agarwal estimates a net profit of around Rs 4,200 crore for FY07, and expects it to scale down around Rs 3,600 crore at the most. In this scenario, the EPS works out to around Rs 65 per share. The current FY06 Tata Steel EPS stands at Rs 63.35.
Operationally, Tata Steel will get access to European markets and Corus will also have cost advantages. A Merrill Lynch report states that synergies could directly bring in a $70 per ton advantage to Corus if it imports slabs from Tata Steel.
However, these benefits will start reflecting over a period. “It takes around three years for benefits of steel acquisitions to generate results into the balance sheet,” holds Agarwal. The positive factor is that the Tata Steel management has estimated an EBITDA margin of around 25% in FY12. Steel industry experts believe that it takes around $700 a tonne to set up a greenfield steel project, the current price range for the Corus deal works out to $ 500 a tonne, considering a higher price.
The downside for this deal remains the softening of steel prices that are currently ruling strong. Once steel prices take a beating, profitability calculations will go for a toss.
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