Tata Steel: Challenges ahead in Corus acquisition
For Tata Steel, the proposed takeover of Anglo-Dutch steelmaker Corus does make strategic sense, as it would be the next logical step in the value chain after its acquisitions in the Asian region.
More importantly, the move is in line with its de-integration model that involves making primary metal in markets close to raw materials and establishing finishing (value-adding) facilities in the end-user markets.
The deal, if it goes through, will catapult Tata Steel into the league of top 10 global steelmakers – a massive leap in terms of size, considering that Corus is at least three times larger than Tata Steel when it comes to revenues and production capacities.
Besides, the deal between a large player with a significant presence in value-added steel and a strong distribution network (Corus) and an outfit that is the lowest-cost producer of steel (Tata Steel) suggests synergies.
However, the larger issues now pertinent to the deal are related to valuation and funding.
Tata Steel has pegged the value of the deal at about $10 billion (Rs 45,000 crore). This roughly works out to about seven times the EBITDA (earnings before interest, taxes, depreciation and amortisation).
There is a possibility of counter-bids being launched by Brazilian and Russian steel majors who have been eyeing Corus for quite a while.
Such an eventuality implies upward revision of the offer by the Tatas if they remain in the race, as seen in the Arcelor-Mittal episode. The valuation could then go up to $12-15 billion.
This brings into focus the larger and most significant aspect of funding the deal. Although there is no clarity on the exact funding structure that the Tatas are going to adopt, it is largely expected to be on the lines of Tata Tea-Tetley merger executed in 2000.
The funding is likely to come from multiple channels, viz., Tata Steel’s internal accruals, preferential allotment to Tata Sons (holding company of Tata Steel), encashment of Tata Sons’ cross-holdings in group companies and borrowings.
Tata Steel currently has Rs 10,000 crore in reserves and a debt-equity ratio of 0.3:1.
Of the proposed $10 billion, the Tatas plan to raise $6-6.5 billion (Rs 27,000-30,000 crore) through debt by floating a special purpose vehicle jointly held by Tata Sons and Tata Steel.
This would increase the debt-equity ratio to 2.5:1, much higher than the current industry average of 1:1. Tata Sons has already begun milking its cash cow, TCS, by offloading 0.75 per cent of its stake, and expects to increase this to three per cent by March 2007.
Tata Sons currently holds close to 80 per cent in TCS, which is valued at about Rs 85,000 crore.
Back home, the steel major has already lined up aggressive plans for greenfield projects with an outlay of Rs 35,000 crore for tripling capacity to 15 million tonnes over the next five years.
This, along with an expected cash outflow of about Rs 45,000 crore for taking over Corus, is likely to exert some pressure on the balance sheet, the impact of which would be pronounced if the steel cycle takes a downturn.
Although the Tatas have proven abilities in managing large acquisitions in the past, the acquisition of Corus, if it goes through, is likely to be much more challenging.
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