+ All Categories
Home > Documents > Assignment Tata-Corus Merger

Assignment Tata-Corus Merger

Date post: 07-Apr-2018
Category:
Upload: gopal-gupta
View: 247 times
Download: 1 times
Share this document with a friend

of 36

Transcript
  • 8/6/2019 Assignment Tata-Corus Merger

    1/36

    Project

    TATA CORUS MERGER

    A report submitted to ISB&M, Delhi Campus as a partfulfillment of Full time Postgraduate Program in

    Business Management.

    Abhishek KumarENR NO.: 1101

    Batch: 2005-2007E-mail: [email protected]

    International School of Business & Media, Delhi7th Floor, Aggarwal Millennium Tower

    Netaji Subhash Place, Wazirpur District Centre,Pitampura, Delhi 110 034

    Index

  • 8/6/2019 Assignment Tata-Corus Merger

    2/36

    SerialNo.

    Topic PageNo.

    I Introduction: M&AII Industry Overview

    III Tata Steel

    IV Corus Perspective

    V Key Contributors towards MergerVI TATA-CORUS Merger :Positive

    Aspects

    VII TATA-CORUS Merger: The NegativeAspects

    Introduction

  • 8/6/2019 Assignment Tata-Corus Merger

    3/36

    M&As are taking place all over the world irrespective of theindustry, and therefore, it is necessary to understand thebasic concepts pertinent to this activity.

    The term merger involves coming together of two or more

    concerns resulting in continuation of one of the existingentities or forming of an entirely new entity. When one ormore concerns merge with an existing concern, it is the caseof absorption. The merger of Global Trust Bank Limited(GTB) with Oriental Bank of Commerce (OBC) is an exampleof absorption. After the merger, the identity of the GTB islost. But the OBC retains its identity. Consolidation oramalgamation involves the fusion of two or more companiesand forming of a new company. The merger of Bank ofPunjab and Centurion Bank resulting in formation ofCenturion Bank of Punjab; or merger of Indian Rayon Ltd,Indo Gulf Fertilizers Limited (IGFL) and Birla Global FinanceLimited (BGFL) to form a new entity called Aditya Birla Nuvois an example of amalgamation.

    Acquisition is an act of acquiring effective control by acompany over the assets or management of anothercompany without combining their businesses physically.Generally a company acquires effective control over thetarget company by acquiring majority shares of that

    company. However, effective control may be exercised witha less than majority shareholding, usually ranging between10 per cent and 40 per cent because the remainingshareholders, scattered and ill organized, are not likely tochallenge the control of the acquirer. When the acquisition isforced or against the will of the target management, it isgenerally called takeover. Takeover generally takes theform of tender offer wherein the offer to buy the shares bythe acquiring company will be made directly to the target

    shareholders with out the consent of the targetmanagement. Though, the terms merger, amalgamation,consolidation, acquisition and takeover have specificmeanings, they are generally used interchangeably.

    Mergers may be

  • 8/6/2019 Assignment Tata-Corus Merger

    4/36

    Horizontal,

    Vertical or,

    Conglomerate.

    Horizontal merger is a combination of two or more firms insimilar type of production, distribution or area of business.Vertical merger is a combination of two or more firmsinvolved in different stages of production or distribution.Conglomerate merger is a combination of firms engaged inunrelated lines of business activity. Further, they may befriendly or hostile. Generally, mergers are friendly whereastender offer takeovers are hostile.

    M&As aim at optimum utilization of all available resources,exploitation of unutilized and under utilized assets andresources including human resources, eliminating or limitingthe competition, achieving synergies, achieving economiesof scale, forming a strong human base, installing anintegrated research platform, removing sickness, achievingsavings in administrative costs, reducing tax burden andultimately improving the profits.

  • 8/6/2019 Assignment Tata-Corus Merger

    5/36

    Industry Overview

    Indian Steel Market: An Out-look

    All Set for High Growth.

    The steel industry is expanding worldwide. For a number ofyears it has been benefiting from the exceptionally buoyantAsian economies (mainly India and China). The economicmodernisation processes in these countries are driving thesharp rise in demand for steel.

    Above Global Average Growth.

    It is forecasted that Indian crude steel production will risefrom 38 million tonnes in 2005 to 68 million tonnes (+6%p.a.) in 2015. Extensive capacity increases are planned forthis same period. Global crude steel output should increasesomewhat less vigorously during the forecast period (byaround 5% p.a.) to 1,800 million tonnes. Despite the stellarincrease in production Indias share of global crude steeloutput is forecast to rise to just under 4% in the next tenyears. This is still comparatively tiny compared to Chinas

    share of 41%.

    Technology Making Inroads

    The biggest boost to efficiency in the steel industry hascome from the increased use of continuous casting anindicator of the modernity of the production process. Itsshare of Indian crude steel output has climbed from 38% inthe mid-1990s to 66% now. India is thus well on its way to

    joining the ranks of the leading steelmakers among theindustrial nations (share in EU-25: 96%). However, in Indiasome 6% of crude steel is still made using the outdatedopen-hearth process (EU-25: 0.3%), which suggests there isrestructuring potential.

  • 8/6/2019 Assignment Tata-Corus Merger

    6/36

    Companies Are Bursting Onto The World Market.

    The Indian steel ministry plans to raise the export sharefrom 15% at present to 24% in the next 15 years. Bigcompanies like SAIL and Tata Steel want to become globalplayers by acquiring stakes in foreign firms.

    India is one of the worlds top ten steelmakers

    Over the past ten years Indias crude steel output rosenearly 6% per year to 38 million tonnes, while global crudesteel output increased by 4% (Germany managed anincrease of just under 1% p.a.). Although India is the worldseighth largest steel producer, its 3%-plus share of global

    steel output is still very low; it is roughly the same asUkraines share of world steel production. China, the worldsbiggest steelmaker, produces nearly ten times as much asIndia.

    In 2005 Indias crude steel output of 38 million tonnes was17% higher than in 2004; only in China was the growth rate

  • 8/6/2019 Assignment Tata-Corus Merger

    7/36

    considerably higher at 25%. By contrast, production volumesfell in the US and the EU-25 by nearly 5% and roughly 4%respectively. In the first five months of 2006 Indian steelproduction continued to expand unabated, rising 19% yoy.

    The foundations for the modern Indian steel industry werelaid as long ago as 1953 with a contract for the constructionof an integrated steelworks in Rourkela (in the state ofOrissa) signed by the Indian government and the Germancompanies Fried. Krupp und Demag AG. The initial plan wasan annual capacity of 500,000 tonnes, but this wassubsequently raised to 1 million tonnes. The capacity ofRourkela Steel Plant (RSP), which belongs to the SAIL (SteelAuthority of India Ltd.) group, is now nearly 2 million tonnes.

    At a very early stage the former USSR and a Britishconsortium also showed an interest in establishing a modernsteel industry in India. This resulted in the Soviet-aidedbuilding of a steel mill with a capacity of 1 million tonnes inBhilai and the British-backed construction in Durgapur of afoundry which also has a million tonne capacity. Indias steelindustry facilities are concentrated in the east, south and thewest of the country. The integrated foundries are located in

    the east, while electric steel is produced predominantly inthe south and the west.

  • 8/6/2019 Assignment Tata-Corus Merger

    8/36

    Tata SteelA Six-Point Strategy

    A Strong Base in India

    Tata Steel has been planning its long-term strategy. TataSteels strategy, in terms of what it wanted to do over aperiod of time of 10 years, between 2002-03 and 2015, wasto grow from four million tonnes per annum, which it were at

    that time, to about 30 million tonnes plus, beyond the shoresof India, multinational, and continuing to be in a low-costposition and continuing to be EVA [?] positive. That strategyhad six elements. One of them was that it would build astrong base in India, which is why it is expanding

    Jamshedpur from five to 10 million, and it is building threegreenfield projects.

    De-Integration

    The second part of the strategy was that it adopts a de-integrated strategy where it believed that the world steelindustry, over the last 150 years or so, had adopted acertain model of making from iron to finished steel in onelocation, irrespective of where the raw materials were. TATAalways believed that this model will change, because steelhas to compete with other materials and, for the sustainablecompetitiveness of steel, it is necessary that this businessmodel will undergo a change. TATA wanted to be at theforefront of that change in business model, so it said it would

    look for private steelmaking in countries which are rich iniron ore and coal or gas. So it thought of plants in India,Bangladesh and Iran.

    Raw Material Security

  • 8/6/2019 Assignment Tata-Corus Merger

    9/36

    The third part of the strategy was raw material security. Itsimportant that TATA Steel have raw material security to becompetitive and sustainable in this world. Tata Steel hasraw material security on a 100% basis for their existing

    operations in Jamshedpur. It has a large extent of self-sufficiency for coal. Each of their three greenfield projects inIndia will carry with it raw material iron ore security. TataSteel has some strategic types and some strategic positionsin terms of coal and limestone beyond the shores of India.

    Tata steel said it should continue to look for raw materialsecurity, both in India and overseas.

    Getting More Out of Steel

    The next part of their strategy was getting more out of steel,which is by branding, by going downstream, by positioningthe products, getting into construction solutions and so on.It is with that aim they formed the joint venture withBlueScope. It is with that strategy that they started having a

    joint venture with Ryerson of the US, for going downstreaminto processed materials.

    Control over Logistics

    The next part of the strategy was control over logistics. Nolarge company no large steel company can besustainably competitive over a period of time without somecontrol on the efficiency and costs of logistics, so Tata Steeldecided to build a port in Orissa to connect Indian operationswith their overseas operations. We decided to start ashipping company with NYK of Japan, and these are all inprogress.

    Acquisition of Corus

    Tatas acquisition of Corus and their partner in Corus to forma joint entity is part of this strategy, and it is part of thisstrategy that they have been talking about for the last fewyears. Just like Mr Leng mentioned, Corus had a strategy,

  • 8/6/2019 Assignment Tata-Corus Merger

    10/36

    and the partnership with Tata Steel was part of thatstrategy. Tata had looked at it exactly in the same manner,and they believe that this entity, which will become, in termsof scale, number five in the world, has the potential to

    consolidate the steel industry even further.

    Corus Perspective

    The Need for a Strategic Partner

    The headlines of this strategy were that our exclusivepresence in Western Europe, within a global and

    consolidating industry, was unsustainable in the medium-to-long term. We identified the need to have a strategicpartner and a presence in a lower-cost country with agrowing economy and raw material availability and wherewe could use and fully exploit our technology. As to where,we had an initial focus on Brazil, on Russia and, of course, onIndia. Our subsequent travels and discussions in the pastyear were diligent and comprehensive. I wont go into thespecifics, with which we had discussions, but todays

    announcement is the result of this activity, and weredelighted and, indeed, honoured to be associated with Tata.

    India A Favored Location

    India, with its strong and growing economy, indigenous rawmaterials, rising consumer demand and infrastructureneeds, plus the countrys long relationship with the UK, wasalways a favoured location. Philippe and I travelled to Indiato meet Ratan Tata and his team in November of 2005.

    Over the next several months, we had several meetings, andour respective teams examined various business options,from JV (joint venture) to new plants and technologytransfer. It became increasingly clear that the best long-term solution could only be realised through a completemerger of our two businesses, the result of which is todays

  • 8/6/2019 Assignment Tata-Corus Merger

    11/36

    announcement, which carries the unanimousrecommendation of my Board. This will be a unique globalpartnership.

    Key Contributors towards Merger

    Need for modernisation:

    Although India has modernised its steelmaking considerablyover the past decades, nearly 6% of its crude steel isnevertheless still produced using the outdated open-hearth

    process (EU-25: just 0.3%). However, SAILs Corporate Plan2012 does contain a variety of measures to modernise itsplant and processes. These include the closure of thosecrude steel capacities that use the traditional open-hearthprocess. The biggest boost to efficiency in the Indian steelindustry has come from continuous casting, which is seen asan indicator of modernity. The continuous casting share ofcrude steel output has risen from nearly two-fifths in themid-1990s to two thirds now (EU-25: 96%), according to the

    International Iron and Steel Institute (IISI). This means thatalthough India is still a long way behind the leadingindustrial nations it is in the process of narrowing the gap.

    High share of long products because of strongconstruction demand:

    Although the production structure of the Indian steelindustry has in the past shifted towards flat products, itsplants still produce a lot of simple sectional steel as inEastern Europe. In India the ratio of sectional (long) productsto flat products is currently around 50:50, while EUmanufacturers consider a 40:60 split to be competitive.However, it should be remembered that the constructionindustry is much more important than in Europe because itis a buyer of sectional steel in India. There is also catching-

  • 8/6/2019 Assignment Tata-Corus Merger

    12/36

    up to be done in the production of stainless steel, which isprimarily required by the plant and equipment,pharmaceutical and chemical industries.

    Labor Costs & Productivity in India:

    On top of this, labor productivity in India is still very low.According to the German Steel Federation, crude steeloutput at the biggest Indian steelmaker is roughly 144tonnes per worker per year, whereas in Western Europe the

    figure is around 600 tonnes. However, labour costs in Indiaare very low at EUR 1 per hour worked compared with EUR26 per hour in Germany and EUR 18 per hour in Japan, forexample.

    India also has some catching-up to do on the steel servicecentre front. Steel service centres are positioned betweensteel mills and end-consumers. As a rule they provideservices like warehousing, further processing and assembly.

    The service centres currently cover only about 5% of totalIndian steel production and are usually operated by thesteelmakers (share in Germany: 11%). The Indian steelgroup Tata Steel estimates that steel service centres willprocess around 25% of Indian steel output in the comingyears as demand is growing for smaller batches and shorterlead times.

  • 8/6/2019 Assignment Tata-Corus Merger

    13/36

    Strong Import demand

    Even though India is now one of the worlds top tensteelmakers its domestic output is insufficient to meet thedemand in all segments. In 2005, some 4.7 million tonnes ofsteel were imported, compared with only 2.2 million tenyears earlier (an annual increase of 8%). The growth inIndian import demand in 2005 of around 2 million tonnes isroughly equivalent to the total annual output of Hungary.Low steel prices smooth the way for imports from Russia,Ukraine and Kazakhstan. The geographical proximity of

    Japan, South Korea and China makes them importantsuppliers as well. India is not expected to be self-sufficient inmany segments over the medium term. There are severalreasons for this: firstly, steel consumption is rising very fastas a consequence of the prospective dynamic economicgrowth. Secondly, there is demand for high-quality productswhich India will not be able to supply in sufficient quantitiesfor the foreseeable future. These include products withsurface finishing that helps them to be more durable andretain their value for longer. In general, the trend towardsweight-optimized components persists; this improves theprospects for Western European exporters in the Indianmarket.

  • 8/6/2019 Assignment Tata-Corus Merger

    14/36

    As a member of the WTO (since 1995) India is obliged togradually abolish import restrictions, so importing steelshould be far less problematic in future.

    On the road to Globalisation:

    Steel exports have long been of only minor importance inIndia. Ten years ago the steel export share was merely justunder 6%. Thanks to improvements in competitivenessbetween 1995 and 2005 exports rose 15% p.a. on averageand the share has more than doubled. The most important

    exporting countries are China, Indonesia and the Philippines.

    As the Indian steel industry is reliant on imported rawmaterial inputs, various cooperation agreements have beenrequired to secure long-term supplies. For example, thecooperation between SAIL and the Australian commoditiesgroup BHP Billiton was intensified. The contract is primarilyfocused on the investment in BHPs coking coal mines sincein the coming years SAIL will have to rely largely on importsto satisfy its rising demand for coke. This is why morepotential acquisitions are being screened.

  • 8/6/2019 Assignment Tata-Corus Merger

    15/36

    Keeping in the mind the forecasted growth and demand inthe domestic and global market the merger will help TATA

    Steel to exploit the opportunities in the near future.

    The following data will help us understand the forecastedsituation of the market in the near future.

    Medium-term development of the Steel market

    It is forecasted that a significant increase in output by theIndian steel industry over the medium term. The entire

    industrys contribution to gross domestic product should risein the coming years to more than 30% compared to justunder 27% at present. The growth drivers are the expandingclient industries automotive engineering (production up 16%p.a. between 2000 and 2005), mechanical engineering (up10% p.a.) and construction (up 6% p.a.).

  • 8/6/2019 Assignment Tata-Corus Merger

    16/36

    Further large increase in steel capacity inevitable

    Given the expanding economy, it is not surprising thatIndias steel industry capacities are to be increased

    significantly in the years ahead to meet the prospectivedemand. Many more basic oxygen steelmaking plants areplanned than electric steel mills. The oxygen steel route(in which iron ore and coke are the key raw material inputs)makes flat products for the automotive, iron & steel andmetalworking industries, for example. By contrast, electric

  • 8/6/2019 Assignment Tata-Corus Merger

    17/36

    steel making (in which scrap is used) provides long productsthat are primarily used in the construction and mechanicalengineering sectors. Whether the planned capacityincreases can be realised in their entirety is however

    doubtful as the firms first priority is only to secure access toiron ore deposits.

    In mid-2006 the Rotterdam-based Mittal Steel announcedthat the disadvantaged province of Orissa would become thesite for a new steel mill costing nearly EUR 7 bn with anintended annual output of 12 million tonnes. That is theequivalent of Belgiums total annual steel output.

    Support from dynamic economy

    India is the economic region that has enjoyed the worldsmost sustained boom. The Deutsche Bank Research Formel-G econometric model forecasts average real GDP growth of5.5% p.a. for India between 2006 and 2020 O followed byMalaysia (5.4%) and China (5.2%). In all, the analysiscovered 34 economies that generate some 85% of globalGDP. The growth drivers are population growth, humancapital, opening of the economy and rising investment.

    Despite the sharp increase in Indias population, per-capitaGDP in purchasing power parity terms should rise bynearly 4% per year until 2020. Since the model does nottake sufficient account of the countrys major initiatives inthe infrastructure area, average growth until 2020 mightturn out to be even closer to 6%. In fact, by the end of thedecade India could replace Japan as the worlds third biggesteconomy after the US and China.

    An important factor in the future demand for steel is thehuge amount that needs to be invested in infrastructure. Theconstruction industry accounts for a very high proportion ofsteel demand at 43%, followed by mechanical engineering(32%) and automotive engineering (5%). This breakdown isunlikely to change much in the coming years.

  • 8/6/2019 Assignment Tata-Corus Merger

    18/36

    Positive stimuli from construction industry

    The steel companies are pinning their hopes largely on theexpanding construction industry. The industry is one of thekey drivers of Indias economic growth. Up to 10 million newhomes need to be built each year until 2030. Strongpopulation growth, rising incomes and decreasing household

    sizes are forcing comprehensive measures to be taken in thehousing sector. The pent-up demand for housing isestimated at around 20 million units by the IndianConstruction Association; the Ministry for UrbanDevelopment and Poverty Alleviation claims that no lessthan 31 million dwellings are needed. The hosting of theCommonwealth Games in New Delhi in 2010 should

  • 8/6/2019 Assignment Tata-Corus Merger

    19/36

    generate additional stimulus for the construction industryand thus boost demand for steel. In addition to the sportsfacilities, accommodation for competitors and visitors isplanned. The government has announced that some 40

    hotels with a total of 15,000 beds are to be built. The Indianoffice market is benefiting from the ongoing off shoringactivities of industrial nations. Indian insourcers areconcentrated in the software development and softwareproduct segments. Their second main business area isassuming the responsibility for entire support processes, orbusiness process outsourcing (BPO). These segments stilllook set for growth.6 Furthermore, the construction sector isbenefiting from major infrastructure projects. Capitalexpenditure is to be focused on road building and the rail

    network, as well as on the construction and expansion ofports and airports.

    Strong growth in mechanical engineering

    Mechanical engineering output has increased some 10% p.a.over the past five years. Thanks to the march oftechnological progress the prospects for domestic suppliers

  • 8/6/2019 Assignment Tata-Corus Merger

    20/36

    should improve going forward, while import growth is slightlycrimped. Demand is greatest for building machinery andplastic-moulding machines as well as machine tools andtextile machinery. Since the domestic textile and apparel

    industry, for example, is focusing further up the value chain,firms have to make numerous investments in modernisingand expanding their machinery portfolios. Makers of buildingmachinery are benefiting from the large-scale infrastructureprojects planned by the Indian government, while machine-tool makers are being buoyed by the upturn in theautomobile and autoparts industries for example. Exports bythe Indian mechanical engineering industry rose recently bynearly 30% to USD 10 bn. By comparison, Germanmechanical engineering firms exported products worth close

    to USD 117 bn, including machinery to the value of aboutUSD 1 bn to India. Germany claims a particularly large shareof Indian imports of woodworking machinery and machinetools as well as pumps and compressors. The demand forforeign machinery comes from customers requiringespecially high standards of performance and precision. TheEngineering Exports Promotion Council (EEPC) forecasts thatIndian exports will be worth USD 30 bn (+32% p.a.) by 2008;nevertheless the volume is still very low by international

    standards.

    Booming Automobile Industry

  • 8/6/2019 Assignment Tata-Corus Merger

    21/36

    The automotive industry may consume a relatively smallproportion of steel output, but its growth rate is the highestof the most important clients for the steel industry. In India asmall but flourishing automobile industry has now developedthat sees its future primarily in the budget price segmentand views the domestic market and other emerging nationsas potential markets.7 Vehicle ownership (cars and trucks) inIndia at 11 per 1,000 inhabitants is even less widespreadthan in China with its very low figure of 21. The growth of

    the Indian automobile industry is being driven by healthydomestic demand. The consumption-minded, fast-growingmiddle class is a major factor. The continuing increase inincomes and low-cost financing facilities are boosting sales.However, it is not uncommon for cars to be used for 20years (Western Europe: 12 years), with vehicles that havebeen taken off urban roads often being driven for longer inrural areas.

    The populations steadily growing demand for mobility and

    sharply rising traffic volumes will continue to generatestrong demand for cars in the future. At the same timeIndias automobile sector is establishing itself as an exporterto international markets. Hyundai, for example, uses thecountry as an export base for small cars, and Fordmanufactures vehicles there for South Africa and other

  • 8/6/2019 Assignment Tata-Corus Merger

    22/36

    markets. However, competition between automakers hasintensified markedly. Whereas in 1995 there were just fivecarmakers in India the figure has now reached 10. Thebiggest are Maruti Udyog Ltd., Hyundai Motor India and Tata

    Engineering (Telco). The Tata group is even trying to gain afoothold in the European market with new models. Indiacurrently produces a total of 711,000 cars each year(Germany: 5.4 million).

    While the automakers have been posting positiveperformance, many parts suppliers have also beenflourishing. In India in the meantime a number of private,independent companies have become established, some ofwhich have already made names for themselves

    internationally (e.g. Tube Investments and BharatForge).Indian crude steel output forecasts up to 2015

    All in all, the forecasted increase in Indian crude steelproduction from 38 m tonnes in 2005 to 68 m tonnes (+6%p.a.) in 2015. The increase in Indian crude steel productionof around 30 million tones during the 10-year period ending

  • 8/6/2019 Assignment Tata-Corus Merger

    23/36

    in 2015 is roughly equivalent to the current annual crudesteel output of Italy. It should however be noted that annualsteel consumption in India currently amounts to just 35 kgper capita compared with the EU-25 average of 400 kg.

    The main reason for such high growth is the goodperformance of domestic customer industries, especially theconstruction, auto and mechanical engineering sectors.Overall, industrial production in India should undergodouble-digit growth over the coming years. Additionalstimulus will come from private consumption. The ongoingoutsourcing of IT-based business processes to India willprovide good earnings prospects for the middle class livingthere.

    The Indian government wants a modern and efficient steelindustry. The strategic objective is no longer simply tosupply the domestic market. India is also trying to positionitself more emphatically as an exporter of steel productsover the medium term. According to government plans theexport share is to be grown from 14% at present to 24% inthe medium-term. The announcement of an aggressiveexport strategy in conjunction with the planned capacity

    increases is bound to have some impact on the global steelmarket. Stiffer competition can be expected in thecommodities segment in particular. The Indian steel ministryhas set a figure of some 90 million tonnes as the supplyvolume by 2020 compared with just under 38 milliontonnes in 2005. This would mean growth of around 6% p.a.over the coming years. The expansion of the industrialsector and thus also of steel consumption is absolutelyessential to alleviate the poverty affecting broad sections ofthe population.

    By contrast, crude steel output in the EU-25 will probablyrise by just 0.5% p.a. to 196 million tonnes; nevertheless,even in ten years time it would still be almost three times ashigh as in India. Global crude steel output should increase byaround 5% p.a. between 2005 and factor in the sharp

  • 8/6/2019 Assignment Tata-Corus Merger

    24/36

    expansion of the global market is the strong demand in Indiaand China. 2015 to 1,844 million tonnes. One instrumentalfactor in the sharp expansion of the global market is thestrong demand in India and China.

    There are a few factors that are hampering the growth ofTATA steel; and if not attended to soon will cause a lot ofopportunity loses in the days to come. Let us have a look atthe problems faced by the company in the country thatcould be resolved after the merger, as it will let TATA steelhave access to international avenues for sourcing know how& capital goods.

    The growth of the Indian steel industry and its share of

    global crude steel production could be even higher if theywere not being held back by major deficiencies infundamental areas.8 Investment in infrastructure is risingappreciably but remains well below the target levels set bythe government due to financing problems.

    Energy Supply

    Power shortages hamper production at many locations.Since 2001 the Indian government has been endeavouringto ensure that power is available nationwide by 2012. Thedeficiencies have prompted many firms with heavier energydemands to opt for producing electricity with their ownindustrial generators.India will rely squarely on nuclear energy for its future powergeneration requirements. In September 2005 the 15th andlargest nuclear reactor to date went on-line. The nuclearshare of the energy mix is likely to rise to roughly 25% by2050. Overall, India is likely to be the worlds fourth largestenergy consumer by 2010 after the US, China and Japan.

    Problems procuring Raw Material Inputs

  • 8/6/2019 Assignment Tata-Corus Merger

    25/36

    Since domestic raw material sources are insufficient tosupply the Indian steel industry, a considerable amount ofraw materials has to be imported. For example, iron oredeposits are finite and there are problems in mining

    sufficient amounts of it. Indias hard coal deposits are of lowquality. For this reason hard coal imports have increased inthe last five years by a total of 40% to nearly 30 milliontonnes. Almost half of this is coking coal (the remainder ispower station coal). India is the worlds sixth biggest coalimporter. The rising output of electric steel is also leading toa sharp increase in demand for steel scrap. Some 3.5 milliontonnes of scrap have already been imported in 2006,compared with just 1 million tones in 2000. In the comingyears imports are likely to continue to increase thanks to

    capacity increases.

    Inefficient Transport System

    In India, insufficient freight capacity and a transportinfrastructure that has long been inadequate are becomingincreasingly serious impediments to economic development.Although the country has one of the worlds biggesttransport networks the rail network is twice as extensive as

    Chinas its poor quality hinders the efficient supply ofgoods. The story is roughly the same for port facilities andairports. In the coming years a total of USD 150 bn is to beinvested in transport infrastructure, which offers hugepotential for the steel industry. In the medium to long termthis capital expenditure will lay the foundations for seamlessfreight transport.

    Consolidation in Steel Industry

    In the medium term the global steel industry is likely toundergo a more extensive process of consolidation sinceindustry players are engaged in an unfettered rush for scale.In so doing steelmakers are pursuing two main objectives:by purchasing additional production capacity they aim to

  • 8/6/2019 Assignment Tata-Corus Merger

    26/36

    both improve their cost structure and increase their marketclout. The merger of the worlds two biggest steelmakersMittal Steel (Netherlands) and Arcelor (Luxembourg) willcreate an industry giant whose output is nearly four times as

    much as that of the next biggest player (Nippon Steel) andeight times as much as SAILs. In India the three biggeststeelmakers, whose combined output is almost 20 milliontonnes, have a market share of 51%. Their domesticcompetitors are numerous mediumsized and smallishcompanies. One of these, for example, is Ispat with anoutput of 2 million tonnes. More mergers can be expectedbetween companies of this size as these firms need toimprove their position with regard to the powerful suppliersof raw materials. Going forward, Indias lower wages and

    favorable energy prices will continue to promise substantialcost advantages compared to production facilities in(Western) Europe or the US. The growth prospects of theclient industries are also very good. The deployment ofmodern production systems is increasingly enabling India toimprove the quality of its steel products and thus to enhanceits export prospects.

  • 8/6/2019 Assignment Tata-Corus Merger

    27/36

    In the last two years the above mentioned figure havewitnessed a sea change Mittal steel has acquired Arcelor toincrease the gap from its second in the industry. TATA Steelwhich on 55th position has moved to 5th place after theacquisition.

  • 8/6/2019 Assignment Tata-Corus Merger

    28/36

    TATA-CORUS Merger :Positive Aspects

    Tata Group is convinced of the long-term synergies inmanufacturing, access to global customers, opening India toCorus or leveraging research and development for TataSteels greenfield projects. It hopes these will save costs upto $350 million per year. The combined entity could alsoscout for more acquisitions together effectively it iseyeing more buyouts in finished steel and iron ore.

    But tying up the funding is the immediate priority. The Corusacquisition is being routed through a special purpose vehicle(SPV) called Tata Steel, UK. (A similar structure was used forthe Tetley buy in 2000.) So far, the Tatas have indicated that

    group holding company Tata Sons will pump in $4.1 billionas equity into the SPV. The balance $8 billion will be raisedby junk bonds and senior term loans (part of it has been tiedup with banks like ABN Amro, Deutsche Bank and CSFB).

    These loans will be serviced out of Coruss profits; Tata Steelneed not repay this. This has effectively ring-fenced TataSteel shareholders.

    Of the $4.1-billion equity component, analysts say that $2.3billion-2.4 billion could be tapped from Tata Steels cashreserves. This leaves another $1.7 billion-1.8 billion that isyet to be raised. There are three routes through which thiscould be mobilised.

    First, if Tata Sons pumps in this amount as equity into theSPV, there will be a minimal impact on Tata Steels balancesheet. This will be good for Tata Steel shareholders (seeHow Tata Sons Could Further Protect Tata SteelShareholders). Tata Sons has the resources to do so. Its

    78.3 per cent holding in TCS is worth Rs 99,700 crore, and itgenerates over Rs 3,250 crore in cash profit every year.

  • 8/6/2019 Assignment Tata-Corus Merger

    29/36

    In the second scenario, Tata Steel could borrow $1.7 billion-1.8 billion; analysis done by brokerage firm CLSA shows thatthe interest on this borrowing could dilute earnings pershare (EPS) by 1.4 per cent in FY08. But such a borrowingmay be difficult as Tata Steel may need to raise more debtin 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 willhurt Tata Steels EPS even more. CLSA predicts a 13.1 percent decline in EPS in FY08 if this option is exercised (see

    EPS Unfriendly?).

    The financial strength of the Tata Group is not in doubt. Butthe funding puzzle is yet to be solved. The $4.1-billion equitycomponent is the first bit of the jigsaw. The second piece inthe puzzle is the $8 billion-debt being raised by the SPV.

    This debt has to be serviced out of Coruss profits. This is ashort-term concern. Given Coruss EBITDA margins of only 8per cent, compared to Tata Steels 30 per cent, the UK-

    based firms ability to service the additional debt of $8billion is under scrutiny.

    Analysts say that the new debt of $8 billion, which will beserviced through Coruss cash flow, will roughly bear aninterest cost of 8 per cent. In other words, the annualinterest cost would be as much as $640 million. Based on

  • 8/6/2019 Assignment Tata-Corus Merger

    30/36

    results for the 12 months ended September 2006, Corusalready has an interest outgo of $400 million, which meansthe total interest outgo could be over a billion dollars afterthe acquisition. However, after factoring in a tax break of 30

    per cent on the interest paid, (interest cost on funds used foracquisitions are an allowable expense in the UK), the netinterest outflow may be about $725 million.

    Coruss current EBITDA of $1.45 billion covers the interestoutgo more than comfortably, but a significant drop in steelprices would adversely impact it and its ability to servicedebt.

    Brokerage house First Global estimates that a $50 fall in

    global steel prices could lead to a $414-million loss from theacquisition in FY08 (see Price Impact). If there is a $75 fall,the losses could climb to $846 million. This does not seem tobe just a street view. The world steel consumption growth isexpected to slow down from 8.9 per cent in 2006 to 5.2 percent in 2007 and 4.2 per cent in 2010, an ICRA industrymonitor said.

    However, in terms of leverage, Corus currently has arelatively low net debt-equity ratio of 0.25 times. So, whileCorus has room on its balance sheet to take on more debt, itmay come under pressure on debt servicing, if steel priceshead in the wrong direction.

    1 Short term aspect

    Investors with a one-to-two year perspective may find theTata Steel stock unattractive at current price levels. Whilethe potential downside to the stock may be limited, it may

    consolidate in a narrow range, as there appears to be noshort-term triggers to drive up the stock. The formalities forcompleting the acquisition may take three to four months,before the integration committees get down working on thedeal. In our view, three elements are stacked against thisdeal in the short run:

  • 8/6/2019 Assignment Tata-Corus Merger

    31/36

    Margin picture: Short-term triggers that may help improvethe operating profit margin of the combined entity seem tobe missing. In the third quarter ended September 2006,Corus had clocked an operating margin of 9.2 per cent

    compared with 32 per cent by Tata Steel for the thirdquarter ended December 2006. In effect, Tata Steel isbuying an operation with substantially lower margins.

    This is in sharp contrast to Mittal's acquisition of Arcelor,where the latter's operating margins were higher than theformer's and the combined entity was set to enjoy a bettermargin. Despite that, on the basis of conventional metricssuch as EV/EBITDA and EV/tonne, Arcelor Mittal's valuationhas turned to be lower than Tata Corus. On top of that, Tata

    is making an all-cash offer for Corus vis--vis the cash-cum-stock swap offer made by Mittal for Arcelor.

    Corus has been working on the "Restoring Success"programme aimed at closing the competitive gap thatexisted between Corus and the European steel peers. Thegap in 2003 was about 6 per cent in the operating profitlevel when measured against the average of Europeancompetitors. And this programme is expected to deliver the

    full benefits of 680 million pounds in line with plan. With thisprogramme running out in 2006 and being replaced by `TheCorus Way', the scope for Tata Steel to bring about short-term improvements in margins may be limited.

    Even the potential synergies of the $300-350 million a yearexpected to accrue to the bottomline of the combined entityfrom the third year onwards, may be at lower levels in thefirst two years. As outlined by Mr B. Muthuraman, ManagingDirector of Tata Steel, synergies are expected in the

    procurement of material, in the marketplace, in sharedservices and better operations in India by adopting Corus'sbest practices in some areas.

    The steel cycle: While the industry expects steel prices toremain firm in the next two-three years, the impact ofChinese exports has not been factored into prices and the

  • 8/6/2019 Assignment Tata-Corus Merger

    32/36

    steel cycle. There are clear indications that steel importsinto the EU and the US have been rising significantly. At 10-12 million tonnes in the third quarter of 2006, they are twicethe level in the same period last year and China has been a

    key contributor.This has led to considerable uncertainty on the pricing front.Though regaining pricing power is one of the objectives ofthe Tata-Corus deal, prices may not necessarily remainstable in this fragmented industry. The top five players, evenafter this round of consolidation, will control only about 25per cent of global capacities. Hence, the steel cycle maystabilise only if the latest deal triggers a further round ofconsolidation among the top ten producers.

    2 Long-Run Picture

    Whenever a strategic move of this scale is made (where acompany takes over a global major with nearly four times itscapacity and revenues), it is clearly a long-term call on thestructural dynamics of the sector. And investors will have toweigh their investment options only over the long run.

    Over a long time-frame, the management of the combined

    entity has far greater room to manoeuvre, and on severalfronts. If you are a long-term investor in Tata Steel, the keydevelopments that bear a close watch are:

    Progress on low-cost slabs: Research shows that steel-makers in India and Latin America, endowed with rich ironore resources, enjoy a 20 per cent cost advantage in slabproduction over their European peers. Hence, anymeaningful gains from this deal will emerge only by 2009-

    10, when Tata Steel can start exporting low-cost slabs toCorus.

    This is unlikely to be a short-term outcome as neither TataSteel's six-million-tonne greenfield plant in Orissa nor theexpansion in Jamshedpur is likely to create the kind of

  • 8/6/2019 Assignment Tata-Corus Merger

    33/36

    capacity that can lead to surplus slab-making/semi-finishedsteel capacity on a standalone basis.

    Second, there may be further constraints to exports as TataSteel will also be servicing the requirements of NatSteel,Singapore, and Millennium Steel, Thailand, its two recentacquisitions in Asia.

    However, this dynamic may change if the Tatas can makesome acquisitions in low-cost regions such as Latin America,opening up a secure source of slab-making that can beexported to Corus's plants in the UK. Or if the iron ore policyin India undergoes a change over the next couple of years,

    Tata Steel may be able to explore alternatives in the coming

    years.

    Restructuring at Corus: The raison d'etre for this deal forTata Steel is access to the European market and significantlyhigher value-added presence. In the long run, there isconsiderable scope to restructure Corus' high-cost plants atPort Talbot, Scunthorpe and the slab-making unit at

    Teesside.

    The job cuts that Tata Steel is ruling out at present may

    become inevitable in the long run. Though it may bepremature at this stage, over time, Tata Steel may considerthe possibility of divesting or spinning off the engineeringsteels division at Rotherham with a production capacity of 1million tonnes. The ability of the Tatas to improve thecombined operating profit margins to 25 per cent (fromaround 14 per cent in 2005) over the next four to five yearswill hinge on these two aspects.

    In our view, two factors may soften the risks of dramaticrestructuring at the high-cost plants in UK. If globalconsolidation gathers momentum with, say, the merger of

    Thyssenkrupp with Nucor, or Severstal with Gerdau or any ofthe top five players, the likelihood of pricing stability mayease the performance pressures on Tata-Corus.

  • 8/6/2019 Assignment Tata-Corus Merger

    34/36

    Two, if the Tatas contemplate global listing (say, in London)on the lines of Vedanta Resources (the holding company ofSterlite Industries), it may help the group command a muchhigher price-earnings multiple and give it greater flexibility

    in managing its finances.

    Corus buy will impact Chinese steel market

    Analysts from Steel Biz Briefing (SBB) say the Corus deal willhelp Tata catapult itself into the global industry.

    They also say that the Chinese steel industry will continue togrow, and that China, not being a low-cost producer, will notflood market with cheap steel. They believe that steel priceswill be positive in 2007.

    TATA-CORUS Merger: The Negative Aspects

    An Expensive Deal

    To begin with the acquisition has not come cheap. On an

    EV/EBITDA (enterprise value/earnings before interest,depreciation and tax) basis for CY2006 estimated earnings,the multiple is 6.2 times. Thats more or less similar to theMittal-Arcelor deal. But, the big difference is that the deal isbeing paid for entirely in cash, while the Arcelor dealinvolved a share-swap along with cash. So, it is moreexpensive since it will mean a cash outflow from Tata Steelof 1.84 billion (Rs 15,000 crore or $3.3 billion).On anEV/tonne basis, Mittal paid $586 a tonne for Arcelor, while

    Tata Steel will get Corus at $537 a tonne. But thats becauseArcelor is more profitable than Corus. A glance at the shareprices of steel stocks shows that they have moved upsharply and had Tata Steel been a little more nimble, it couldperhaps have got itself a better price. The implied EV/tonnevaluation of $537 for Corus is higher than that of $374 paidfor NatSteel and $333 for Millennium Steel, which Tata Steel

  • 8/6/2019 Assignment Tata-Corus Merger

    35/36

    acquired in 2004 and 2005 respectively.

    Apart from the timing, Tata Steel would definitely have hadto pay a premium for Corus because of the much larger

    operations of Corussecond largest rolling capacity in Europeof 18 million tonneand access to better technology.

    Tata Steels cash flows at the end of March 2006 were Rs4,281 crore and it should generate around Rs 5,700 crore inFY07 and Rs 6,000 crore in FY08. However, it may need to

    dilute its equity to keep the leverageits debt-equity is at0.26 under check given that it has $4-6 billion worth ofprojects in the pipeline.

    Corus vulnerable to falling steel prices

    The borrowings in Tata Steel UK, of 3.3 billion ($6.3 billion),will be repaid through the cash flows of Corus. According toanalysts projections, the topline growth could slide to 9.53billion in 2007 and further to 9.37 billion in 2008. Corus is

    expected to turn in earnings before interest and tax (EBIT) ofaround 520 million in CY06 on net sales of around 9.6billion.In fact, analysts believe the EBIT will go up only marginallyin CY07 to between 550-570 million and could even dip to500 million in CY08.

    Thus, if steel prices slip even marginally, they could stretchCorus finances with an adverse impact on its topline andconsequently its ability to repay the debtannual interest

    outflow estimated at around 300-350 million on the newdebtbecause theres little room for cutting costs.But access to slabs can change things should Corus haveaccess to low-cost slabs, the deal begins to look better.Corus is Europes second largest steelmaker with crude steelcapacity of 18.2 million tonne in the Netherlands and theUK.

  • 8/6/2019 Assignment Tata-Corus Merger

    36/36

    But it is far less efficient than Tata Steel which, thanks inpart, to its access to iron ore and coal mines, is one of theworlds lowest cost producers with operating profits of $1.5

    billion from 5.3 million tonne. Corus has an EBITDA/tonne of$97 compared with Tata Steels $300.

    As some of Corus plants suffer from high slab costproduction (estimated at around $330-340 per tonne), thecompany needs to be supplied with slabs, at a competitiveprice. Tata Steel, whose slab cost is close to $180-190 pertonne, could be aiming to ship out slabs to Corus, and in theprocess saving around $100 per tonne, after incurringfreight costs.

    However, Tata Steel is not saying that slabs will be exportedto Corus. While Tata steel agrees that the supply of slabs toCorus is core to the strategy, it is unwilling to disclose wherethe slabs are going to come from. We have severaloptions, is all the CEO will say, adding that, the slabs willbe sent at the appropriate time from India or elsewhere.Since there is still time to gothree to four yearsbefore TataSteels slab capacity is commissioned, the answer could liein an acquisition of a company that makes slabs cheap

    located either in Russia or in Latin America, since thatswhere the low-cost slab makers are to be found.


Recommended