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1. Financial Statement Analysis and Valuation ProjectAnalysis of Corus

Acquisition by Tata Steel Submitted on: 18-Oct-2010 Akash Deep Batra

(2008004) Amit Bhalotia (2008007) Naufal A. Kukkady (2008039) Naveen

Kumar (2008040) Shantanu Gudihal (2008050)

2. Analysis of Corus Acquisition by Tata Steel DeclarationThis is to declare

that the report represents original work of the team undersigned and does

notcontain any material that has been taken from any source, except as

acknowledged.Signed-Akash Deep Batra (2008004)Amit Bhalotia

(2008007)Naufal A. Kukkady (2008039)Naveen Kumar

(2008040)Shantanu Gudihal (2008050)Dated: 18th October 20101|Page

3. Analysis of Corus Acquisition by Tata Steel Table of Contents1.

Executive

Summary .......................................................................................................

....................... 32.

Introduction ....................................................................................................

....................................... 43. Background to the

Acquisition .....................................................................................................

........ 4 3.1. Tata Steel – A

Background ...................................................................................................

........ 4 3.2. Corus Plc Ltd– A

Background ...................................................................................................

... 4 3.3. Tata-Corus

“Synergy” .......................................................................................................

............ 5 3.4. Final Price - The Bidding

War ...................................................................................................... 64.

Deal

Financing .......................................................................................................

............................... 75. Corus

Reformulation ................................................................................................

............................. 86. Corus Valuation & Sensitivity

Analysis ............................................................................................... 97.

Tata Steel

Reformulation ................................................................................................

.................... 108. Tata Steel

Valuation .......................................................................................................

..................... 119. Ratio

Analysis .........................................................................................................

............................ 1210.

Conclusion .....................................................................................................

................................. 1311.

References ....................................................................................................

................................... 1412.

Exhibits ..........................................................................................................

................................. 142|Page

4. Analysis of Corus Acquisition by Tata Steel1. Executive Summary Tata

acquired Corus on the 2nd of April 2007 for a price of $12.1 billion making

the Indian company the world‟s fifth largest steel producer. This acquisition

process has started long back in the year 2005. This process started in the

year 2000 and with Tata it came to an end. In 2005, when the deal was

started the price per share was 455 pence. But during the time of

acquisition held in 2007, the price per share was 608 pence, which is

33.6% higher than the first offer. The high cost of acquisition posed several

risks for Tata Steel Demand will reduce in case of global recession.

High cost of acquisition may result in significant financial constraints which

may adversely affect Tata Steel‟s capital expenditure. Corus has

experienced losses. To obtain any synergy plus benefits of acquisition,

Tata Steel had to turn around the company drastically to make it profitable.

Considering the risks mentioned, we have tried to analyse how Tata Steel

has done post acquisition and if the acquisition of Corus has actually

added value to the firm or reduced the overall value. However, the annual

report in Tata Steel mentions clearly that they expect to capture around

$450 million worth of synergy between Tata Steel and Corus operations.

Analysts mention that Tata has a great history of making deals work and

hence the Corus acquisition will be successful. However, we have taken a

neutral stance on the Corus acquisition by Tata Steel and have done a

thorough financial statement analysis to justify if Tata Steel has overpaid

for the acquisition or not. To achieve our objective, we did reformulation of

Tata Steel and Corus balance sheet and income statement to calculate the

intrinsic value of Tata Steel and Corus pre and post acquisition. We have

also done some key ratio analysis to find out how the deal has affected

operations of the firm and the return on capital employed for the

shareholders before and after the acquisition.3|Page

5. Analysis of Corus Acquisition by Tata Steel2. Introduction Tata Steel

(part of the Tata Group) acquired the Anglo-Dutch steel firm Corus after a

four month bidding war with Brazil‟s CSN (Companhia Siderurgica

Nacional) for US $13.75 billion (Rs. 52,000 crores) - this was the biggest

acquisition by an Indian firm. Tata‟s acquisition of Corus made it the fifth

largest global steel producer with an annual capacity to produce 25 million

tons of steel. The acquisition was intended to give Tata Steel access to

European markets and to achieve potential synergies in the areas of

manufacturing, procurement, R&D, logistics, and back office operations.

Analysts claimed that the acquisition price at 608 pence per share was

substantially higher than an earlier offer of 455 pence per share.

Additionally, analysts felt that it would take several years for potential

production and operational synergies to materialize that would yield

significant cost savings. Following the acquisition, Tata Steel‟s stock

suffered a significant decline in price causing Standard & Poor‟s to place it

on a credit watch list with negative implications. By analysing the financial

statements of both Tata Steel (before and after the acquisition) and Corus

(before the acquisition), the question that we are trying to answer is what

was Corus‟s intrinsic value at the time of acquisition and therefore

conclude whether Tata Steel overpaid (or underpaid) for this acquisition. In

the process we also intend to analyse the impact on the intrinsic value of

Tata Steel due to Corus‟s acquisition.3. Background to the Acquisition 3.1.

Tata Steel – A Background Tata Steel Limited, the flagship company of

Tata Group, is the largest manufacturer of steel in India with 25.6 million

tonnes of steel capacity. The company produce HR and CR coils and

sheets, galvanized sheets, tubes, wire rods, construction rebars, rings and

bearings. 3.2. Corus Plc Ltd– A Background Corus (as of 2007) was

Europe‟s second largest steel producer with annual revenues of Rs.

82,674 crores (£9.7 billion) and crude steel production of 18.3 million

tonnes in 2006. Corus had a presence in nearly 50 countries, including its

global network of4|Page

6. Analysis of Corus Acquisition by Tata Steel offices and service centers.

Corus was formed on October 6, 1999 following the merger of Koninklijke

Hoogovens and British Steel. Corus‟ main steelmaking operations were

located in the UK and the Netherlands with other plants located in

Germany, France, Norway and Belgium. As of 30 December 2006, Corus

was the ninth largest steel producer in the world and produced 18.3 mt of

crude steel in 2006 (equivalent to 18.8 mt of liquid steel). Corus had four

main operating divisions - Strip Products, Long Products, Distribution &

Building Systems and Aluminum. Corus had sales offices, stockholders,

service centers and joint venture or associate arrangements in a number of

markets for distribution and further processing of steel products. These

were supported by various agency agreements. There was an extensive

network in the EU while outside the EU Corus has sales offices in around

30 countries, supported by a worldwide trading Corus delivered innovative

solutions, differentiated products, reliable service and sound technical

advice to its customers around the world. Principal end markets for Corus‟

steel products are the construction, automotive, packaging, mechanical

and electrical engineering, metal goods, and oil and gas industries.

Construction was the largest market sector for Corus, with a strong position

in commercial and industrial construction. Corus was a leading supplier to

the automotive sector and was the third largest supplier to this sector in

Europe. Europe, principally the EU, was the most important market for

Corus, accounting for 80% of total turnover in 2006. 3.3. Tata-Corus

“Synergy” The leveraging of low cost intermediate products from India with

further processing at Corus to produce high-end finished products, along

with several operation-related initiatives will improve the competitiveness of

Corus in the European markets while India will benefit from high-value,

sophisticated finished products developed in Corus‟ R&D facilities. Further,

the combined entity will foster cross fertilization of Research &

Development personnel, and domain expertise in the automotive,

packaging and5|Page

7. Analysis of Corus Acquisition by Tata Steel construction sectors, in

addition to the exchange of technology, best practices and expertise. The

combination of Tata Steel (world‟s lowest cost producer of steel) and

Corus will move towards the next level of strategic transformation through

access to low cost steel production and high growth markets globally. 3.4.

Final Price - The Bidding War On 20th October 2006, the Boards of Tata

Steel, Tata Steel UK and Corus reached an agreement on the terms of a

recommended acquisition of the entire issued and to be issued share

capital of Corus, at a price of 455p in cash for each Corus share.

Subsequently, a competitive situation emerged when CSN subsequently

approached Corus with a proposal to make a cash offer. While Tata Steel

revised its offer to 500p per share, CSN made a binding offer at 515p per

share in December 2006. The Board of Corus recommended CNS‟s offer

to the shareholders. As the process got extended, the Panel on Takeovers

and Mergers in the UK set a deadline of 30th January, 2007 as the final

date by which Tata Steel and CSN could revise their offers for Corus

Group plc. The Panel subsequently announced in January 2007 that in

order to provide an orderly resolution to this competitive situation, an

auction process would be held on 30th January, 2007 to establish final bids

from both Tata Steel and CSN. This auction process began in the evening

of 30th January and ended in the early hours of 31st January, 2007 when

the Panel announced that Tata Steel has won the auction to acquire Corus

at a price of 608p per share. The Board of Corus subsequently

recommended the Tata Steel offer to its shareholders who voted to

approve Tata Steel‟s Scheme of Arrangement, at an Extra-Ordinary

General Meeting held on 7th March, 2007. Corus‟ shares were

subsequently suspended from trading on each of the London, New York

and Amsterdam Stock Exchanges and the Scheme became effective on

2nd April, 2007.6|Page

8. Analysis of Corus Acquisition by Tata Steel4. Deal Financing Total

enterprise value of Corus is USD 13,751 million. Tata Steel would

contribute USD 4,100 million as equity to its wholly owned Deal Structure

subsidiary Tata Steel Asia Holding Tata Steel Limted (India) (Singapore)

Limited, which would in turn 100% invest the same in Tata Steel UK, which

has Tata Steel Asia Holdings Pte. Limited acquired Corus plc. U.K.

Singapore Internal Generation: USD 1,267 million Tulip UK Holdings UK

External Commercial Borrowings: 100% USD 500 million Tata Steel UK

Limited Proceed from Right Issue: USD UK 1,888 million 100% Foreign

Equity Offering: USD 445 Corus Group Plc UK million The company has

arranged USD 6,143 million non-recourse debt financing by a consortium

of bank directly at Tata Steel UK. This refinancing provides significant

benefits and flexibility over the term of financing to the group. The

refinancing facility comprises a five- year USD 3,236 million amortizing

loan and a seven-year minimally amortizing term loan of USD 2,907

million. Corus net debt amounting to USD 846 million has been taken over

by the company. The balance amount of USD 2,662 million has presently

been raised in the form of bridge finance in Tata Steel Asia Singapore as

quasi equity. Tata Steel would be raising additional equity share capital

(face value) in the range of about Rs. 2500 – 2800 million, depending on

the final pricing of the various issues. This increase in equity capital will

come into effect only in stages during the three financial years FY2008-

FY2010, therefore easing the burden of servicing. The refinancing of debt

will enable the company to save around USD 100 million per annum and

USD 1,000 million over the life of the loan purely on interest cost.7|Page

9. Analysis of Corus Acquisition by Tata Steel5. Corus Reformulation For

this reformulation, we referred to the Corus Annual reports for 2006 and

2005, which gave us complete financial data for 3 years – 2004-2006. Here

are some significant notes during the process of reformulation: Financial

year for Corus was 1st January to 31st December All numbers are in

million pounds, unless stated All page number references are from

„Corus Report & Accounts 2006‟ For the income statement „Group

Turnover‟ is consider „Revenues from Sales‟ as Note 1 (pg 89) shows

income from each of the four divisions. Restructuring charge, disposal of

assets, income from joint ventures & associates, other operating income

are all separate line items that is normally adjusted to obtain Revenue from

Sales. The Costs for Sales is arrived at by adjusting the „Total operating

Cost‟ figure by removing restricting charges, profits from disposal of PPE

and profit from disposal of group undertakings (Note 2, Table 2, pg 95).

Tax on operating income is arrived at using the normal adjustments of

impact of tax on other operating income and finance costs (Notes 2, 5 and

6). Other operating income is calculated from Notes 1 and 2. All items

under Restructuring & Impairment costs are clubbed together. Tax Rate

is assumed at 35%, as the marginal rate is not mentioned in the notes to

financial statements. The effective tax rate as a weighted average tax rate

for the group undertakings is given in Note 6, Table 2, pg 99 but it is not

helpful for adjustments in reformulation. Financial Costs and Financial

Income are taken as is, since all items in Note 5 are financial items, so

there was no need to take each line item separately for reformulation.

Minority Interest was deducted to obtain the net profit available for common

shareholders. The final figure for Net profit available to common was

matched against the figures in Income statement and found to be correct.8|

Page

10. Analysis of Corus Acquisition by Tata Steel Most of the balance sheet

items were easily classified as operating or financial. Only items that

required consideration from notes are mentioned below. Trade & other

receivables contain a small component that is financial derivative

instruments. According to Note 17 and 24, it is clear that this is a very small

number and it is hedge for operating transactions and future cash flow.

Hence we chose to classify it as operating assets. Similarly, Trade &

other payables has a component for financial derivative instruments as a

hedge for operating activities. So considering Notes 20 & 24, we classified

these as operating liabilities. Cash and short-term deposits were split as

follows – all cash was considered operating and short-term deposits were

considered financial (note 18). The Consolidated Statement for

Shareholders Equity was not reported in the Annual report, and

reconciliation data was available in Note 30. We did not recreate the SSE

as we didn‟t find the relevant information. The number of outstanding

shares was obtained from Note 9 for per share computations.6. Corus

Valuation & Sensitivity Analysis We attempted both SF2 and SF3 valuation

models to find the value of equity for Corus, using the reformulated

financial statements. The weighted average cost of capital is taken as

9.5%, as given in the annual report. Using SF2 valuation model, we get the

equity value as 2473 million pounds, which is 276 pence per share. We

compare this value with the price offered by Tata Steel to acquire Corus

and see that both the initial and final offers are more than the intrinsic

value. Using SF3 valuation model, we get a negative intrinsic value as the

Core RNOA is only 6%, whereas cost of capital is 9.5%. So why did Tata

pay for a Corus if it has negative intrinsic value? While a simple forecast

model like SF3, does not capture all the fundamental aspects of equity

valuation, we can still do a sensitivity analysis and see where the deal may

make sense9|Page

11. Analysis of Corus Acquisition by Tata Steel for Tata. Corus was in a

bad shape as it has both RNOA and Core RNO lower than required rate of

return, but Tata Steel has been the lowest cost producer globally and it‟s

management has the skills and experience to manage costs. So, if Tata

Steel can decrease costs, thereby increasing RNOA and Core RNOA, plus

manage growth in ReOI, the price paid (5441 million pounds) can make

sense for them. From the Valuation Grid, we can see that if any of the

combination of growth in ReOI and core RNOA in green is achieved, the

price paid by Tata can be justified. Sensitivity Analysis - Valuation Grid

Core RNOA -8495.47 8% 9% 10% 11% 12% 13% 0% 3,188.4 3,682.8

4,177.2 4,671.6 5,166.1 5,660.5 2% 2,990.6 3,616.9 4,243.1 4,869.4

5,495.7 6,121.9 growth (g) 4% 2,649.0 3,503.0 4,357.0 5,211.0 6,065.0

6,919.0 6% 1,917.0 3,259.0 4,601.0 5,943.0 7,285.0 8,627.0 7% 1,111.8

2,990.6 4,869.4 6,748.2 8,627.0 10,505.8 8% -767.0 2,364.3 5,495.7

8,627.0 11,758.3 14,889.7 9% -10,161.0 -767.0 8,627.0 18,021.0 27,415.0

36,809.07. Tata Steel Reformulation For this reformulation, we referred to

the Tata Steel Annual reports for 2007-08 and 2006-07, which gave us

complete financial data for 3 years – 2005-2007. Here are some significant

notes during the process of reformulation: Financial year for Tata Steel

was 1st April to 31st March All numbers are in Crore Rupees Cash

including checks in hand and remittance in transit were considered as

operating asset[schedule I Pg 236] All balances in Current and Deposit

accounts have been assumed to be financial assets The assets

miscellaneous expense corresponds to part of the Employee separation

scheme which has not been expensed in the current year1 Unpaid and

Proposed dividend have been added as part of Shareholders equity1

Schedule M pg 23510 | P a g e

12. Analysis of Corus Acquisition by Tata Steel Interest accrued but not

due which was part of current liabilities has been assumed to be due to

outstanding financial liabilities Tax rate assumed to be 36% Sports

infrastructure expenditure added this year is a part of Corus‟s corporate

Social responsibility Minority Interest was deducted to obtain the net profit

available for common shareholders. The final figure for Net profit

available to common was matched against the figures in Income statement

and found to be correct. Tax on operating income is arrived at using the

normal adjustments of impact of tax on other operating income and finance

costs8. Tata Steel Valuation Here are some significant notes during the

process of valuation: Risk Free Rate has been obtained from the 91-day

Treasury Bill rate as of Jan07 and Jan08. Market Rate of Return has

been taken from the Sensex 5-year return as of Dec06 and Dec07. The 5

year market rate of return has been taken since the value of synergy was

assumed by 2010. Since the long term borrowing rate was not mentioned

in the annual report, we have assumed it to be 12% Beta values have

been fetched for Tata Steel from Capitaline database as of Jan 31st07 and

Jan 31st08. Growth rate has been taken as 6% as it was mentioned in

Tata Steel annual report 2006-07. Share prices are being taken as of

31st Jan07 - the day of agreement of deal between Tata Steel and

Corus.11 | P a g e

13. Analysis of Corus Acquisition by Tata Steel9. Ratio Analysis Looking at

the Ratios for Tata Steel and Corus, some insights can be found: For

Corus, RNOA is 7.48% that is less than NBC 12.65% and WACC 9.5%,

hence we see that ROCE 6.12% is lower than RNOA as the SPREAD

become negative. In 2006, RNOA has fallen from 12% to 7.48%, hence

the company was struggling and an acquisition target in a consolidating

steel industry. A low RNOA indicates that traditional valuation methods

may give very low or negative value as the company is losing value. We

see that in SF3 valuation, when we get negative value. For Tata Steel,

we see the impact of external financing for the acquisition as the FLEV

jumps to 79.25% and CSE increases by 123.78%. The SPREAD

decreases as the analysts downgrade Tata Steel, and its net borrowing

cost goes up to 23.5% from 8.6%. The core RNOA decreases slightly

from 22.22% to 21.47%, but the RNOA increases from 26.19% to 32.7%.

This could be due to other adjustments and increased effects of operating

liability leverage. OLLEV increases from 38.04% to 55.88%. Overall

ROCE for Tata Steel jumps from 30.55% to 47.08% after the merger. This

is mostly due to financial and operating leverage, as the operations are

merged. But since the fall in Core RNOA is very small, we can conclude

that the first year of consolidation has not eroded value for the

shareholders.12 | P a g e

14. Analysis of Corus Acquisition by Tata Steel10.ConclusionFrom the

analysis of Corus and Tata Steel financial statements, we can conclude

that Tata Steelpaid more than 120% premium over the intrinsic value

(using SF2 model). The model canrefined by forecasting ReOI considering

the steel industry data and outlook. But there will stillbe a significant

premium over intrinsic value. From the sensitivity analysis, we can assume

thatTata is relying on it‟s competence to manage costs and access to low

cost raw materials.Increasing Core RNOA is the shortest path to increasing

the value of Corus operations.Also looking at the Tata Steel valuations, we

can see that there is a jump in value from Rs 12,399crores to Rs 51,893

crores from consolidated statements analysis. Tata paid 42,444 crores

forCorus a year before, so reconciling we get (51893-12399) = 39494

crores difference isapproximately from Corus which cost shareholders

42,444 crores in an all cash deal. So approx.2950 crores is value lost for

shareholders in first year of integration of Corus with Tata Steel. Aswe

didn‟t value effect of other components of Tata Steel (only looked at

consolidated statements)we cannot attribute the loss to Corus

operations.13 | P a g e

15. Analysis of Corus Acquisition by Tata Steel11.References Corus

Annual Report 2005

(http://www.tatasteeleurope.com/file_source/StaticFiles/Functions/

Financial/2005_Re portAccounts_20-F.pdf) Corus Annual Report 2006

(http://www.tatasteeleurope.com/file_source/StaticFiles/Functions/

Financial/2006_A nnual_Report.pdf) Tata Annual Report 2007

(http://www.tatasteel.com/investors/pdf/100-Annualreport.pdf) Tata

Annual Report 2008 (http://www.tatasteel.com/investors/annual-report-07-

08/annual-report-07-08.pdf) Tata Prevails in the Corus Battle. Dated: 31st

January 2007 http://www.forbes.com/2007/01/31/corus-tata-steel-update-

markets-equity- cx_cn_rd_0131markets12.html S&P downgrades Tata

Steel on Corus Debt. Dated: 12th July 2007

http://www.forbes.com/2007/07/12/tata-corus-downgrade-markets-equity-

cx_rd_0712markets3.html The Tata-Corus Saga

http://www.rediff.com/money/tatacorus.html Tata Steel Company Profile

http://www.tata.com/company/profile.aspx?

sectid=jsA69xFbDUA=12.Exhibits Excel spreadsheet tables attached.14 |

P a g e