DRIVERS AND IMPACT OF MERGERS AND ACQUISITIONS IN

STEEL INDUSTRY

By

Indresh Mishra

ii

ABSTRACT

Driven by slow growth, inability to make sustainable profits and volatility in the steel

industry, companies in steel industry have joined the starting wave of mergers and

acquisitions. Mergers and Acquisitions have become distinctive trend in steel industry

worldwide since the beginning of the 21st

century.

This dissertation examines the results on drivers and impact of recent mergers and

acquisitions (M&A) in steel industry on case study approach. The case study focused on

two recent major acquisitions of Arcelor by Mittal Steel and Corus by Tata Steel during

the recent mergers and acquisitions wave of 2000s.

The important findings of this study is that synergies, overcapacity, extreme

fragmentation, concentration amongst suppliers and better buying power of customers are

some of the other major factors that are driving steel industry into mergers and

acquisitions.

The impact of mergers and acquisitions differed between case studies. In both the case

studies, improvement in post acquisition stock performance of the combined entity was

noticed. In the first case study tremendous increase in post acquisition accounting profit

and operating efficiency was also noticed. It has been predicted that M&A in steel

industry will have positive impact on return on capital employed (ROCE). In the first

case it was found that the company had paid fair price for the acquisition to gain in short

term as well as in long term, while in the second case short term gain seems doubtful.

First case may face issues related to corporate governance, while second may face

compensation related issues. Moreover, in the results of this project the future structure of

steel industry has also been predicted.

iii

v

TABLE OF CONTENTS

ABSTRACT iii

ACKNOWLEDGEMENTS iv

DEDICATION v

LIST OF FIGURES ix

LIST OF TABLES x

CHAPTER 1: INTRODUCTION 1

1.1 Background 1

1.2 Overview of the Dissertation 3

CHAPTER 2: REVIEW OF LITERATURE 5

2.1 Definition 5

2.2 Types of Mergers and Acquisitions 6

2.3 Causes of Corporate Acquisitions 7

2.3.1. Market Power views and growth 7

2.3.2. Tax Argument 8

2.3.3. Efficient and effective Synergies 9

2.3.4. Managerial Incentives 10

2.3.5. Diversification 10

2.3.6. Agency problems 11

2.3.7. Hubris 11

2.4 Financing an acquisition 12

2.5 Human Resource and Cultural factors 14

2.6 Post merger Performance Evaluation criteria 16

2.6.1 Accounting Return 16

2.6.2 Operational efficiency (cost advantage) 17

2.6.3 Technological Progressiveness 18

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CHAPTER 3: THE GLOBAL STEEL INDUSTRY 19

3.1 Iron and steel making compliance history 19

3.2 Growth of the industry 19

3.3 Economic trends 22

3.4 Industry size and geographic distribution 23

3.5 Major Global steel companies 24

3.6 Consolidation as a strategy in the global steel industry 25

CHAPTER 4: RESEARCH METHODOLOGY 27

4.1 Research question and objectives 27

4.2 Case Study Methodology 28

4.3 Company selection 29

4.4 Data collection methods 30

4.5 Analysis Strategies 31

CHAPTER 5: CASE STUDIES 34

5.1. Arcelor-Mittal Case study 34

5.1.1 Background of Mittal Steel 34

5.1.2 Markets and Product Range of Mittal Steel 36

5.1.3 Background of Arcelor 37

5.1.4 Markets and Product range of Arcelor 38

5.1.5 Hostile Takeover of Arcelor 38

5.1.6 Structure of the final Deal and Financing 41

5.1.7 Synergies 41

5.2. Tata-Corus Case study 46

5.2.1 Background of Tata Steel 46

5.2.2 Background of Corus 47

5.2.3 Product range and Markets of Corus 47

5.2.4 Structure of the Deal and Financing 48

5.2.5 Synergies 50

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CHAPTER 6: RESULTS AND ANALYSIS 55

6.1 Motives of Mergers and Acquisitions in steel industry 55

6.2 Swot analysis: 57

6.2.1 Tata-Corus 57

6.2.2 Arcelor Mittal 59

6.3 Post Acquisition Performance measurement: 62

6.3.1 Stock Price comparison 62

6.3.2 Accounting profit comparison 63

6.3.3 Operational Efficiency 64

6.4 Comparison of Tata- Corus and Arcelor- Mittal 65

6.4.1 Financing of the Acquisitions 65

6.4.2 Price paid for the acquisition 66

6.4.3 Margin picture & raw material self-sufficiency 67

6.4.4 Human Resource and Cultural Issues 70

6.5 Factors driving steel industry into consolidation 71

6.6 Future Structure of the Steel Industry 74

CHAPTER 7: CONCLUSION 79

7.1 Implications of the Study 79

7.2 Limitations of the Study 81

7.3 Recommendations for future research 82

REFERENCES 83

viii

LIST OF FIGURES

Figure1: Types of takeover 6

Figure 2: Year wise world steel output in form of graph 21

Figure 3: Country wise steel output in 2006 23

Figure 4: Product Portfolio of Mittal Steel based on 2004 37

Figure 5: Geographical breakdown of 2006 production 43

Figure 6: Shipments by products in 2006 44

Figure 7: Purchasing, marketing and manufacturing synergies of Arcelor-Mittal 44

Figure 8: Raw material self sufficiency and internal distribution centres 45

Figure 9: Product Mix of Corus for 2005 48

Figure 10: Holding company format of Corus 49

Figure 11: Tata Corus Combined steel production 51

Figure 12: Proforma Combination (figures as per FY 2005) 51

Figure 13: Global Presence and customer reach of Tata-Corus 53

Figure 14: Combined markets of Tata-Corus 53

Figure 15: Cultural fit of Tata-Corus 54

Figure 16: Price chart of Tata Steel at BSE from (28th

Aug, 2006 - 24th

Aug, 2007) 62

Figure17: Price chart of Arcelor Mittal at NYSE from (Aug 2005 –Aug 2007) 63

Figure 18: Graph showing world crude steel production and iron ore price trend 67

Figure 19: Iron ore mine assets of Arcelor Mittal 69

Figure 20: Concentration amongst supplier 72

Figure 21: Graph showing number of independent automotive manufacturers 73

Figure 22: Shares of Top five players in N. America, EU, China, Asia &

Worldwide 75

Figure 23: Expected share of top 5 steel producers 75

Figure 24: Cost of production country wise for Hot rolled coil (USD) 77

Figure 25: Prediction of Future Crude Steel consumption 77

Figure 26: Graph showing relation between Consolidated Industries and ROCE 78

ix

LIST OF TABLES

Table1: Definitions of various performance measurement ratios 17

Table 2: List of companies privatised 20

Table 3: Year wise world steel production 21

Table 4: Major steel companies around the world on the basis of output 24

Table5: Major Mergers and Acquisitions in Steel Industry 25

Table 6: Mittal Steel‟s Acquisitions prior to Arcelor 35

Table 7: Markets of Mittal Steel 36

Table 8: Mittal Steel and Arcelor Pro forma 2005 Key Financials 42

Table 9: Major Production Facilities of Corus 47

Table 10: Long term Arrangement of funds by the Tata Steel Board 50

Table 11: Destination of Iron ore consumption 69

x

CHAPTER 1: Introduction

1.1 Background:

Although Mergers and Acquisitions (M&A) has been widely researched topic in several

businesses and industries, M&A in steel industry has gone unnoticed by researchers. This

was because the steel industry is key industry to the other industries, and for this reason it

had been under strict government control until the 1980s. Most of the steel mills were

partly or wholly owned by the state. Therefore, there wasn‟t much scope for M&A in the

industry, till then. Soon after the 1980s, the government realised that privatisation was

required for the efficiency and competitive position of the industry. Hence, 1980-2000

saw the era of privatisation.

Even after the era of privatisation began in the industry, participants faced the challenges

of overcapacity, high level of fragmentation and the cyclicality of the industry. This

threat from the cyclicality of the industry has created considerable pressure on all the

industry participants to merge with or acquire other participants in order to reduce the

cyclicality of the industry and earn sustainable earnings. Since 2000, many Mergers and

Acquisitions have been noticed in the industry at both the top and bottom level.

According to the author, Steel Industry has huge potential for consolidation, and that can

have several impacts on the steel firms and the steel industry as whole. Top 15 players in

the steel industry contribute to just 33 percent of the total output, and the remaining 67

percent is contributed by many integrated and small steel mill firms.

Therefore, this study focuses on mergers and acquisitions in the steel industry. The main

purpose of this study is to find out the drivers and impact of recent mergers and

acquisitions in the steel industry. Since this topic is very broad it has been broken into

several research questions:

1

1. What are the main motives that drive steel firms into Mergers & Acquisitions?

2. Does the acquiring steel firm gain from Mergers and Acquisitions activity?

3. What are the main payment methods used by these firms for Mergers and

Acquisitions?

4. Are the acquiring firms paying abnormally in order to rule out other competitive

buyers?

5. What are the critical issues that steel companies will be dealing with, with respect

to Human Resource and Cultural aspects of Merger & Acquisitions?

6. What are the critical factors that are driving steel industry into Mergers and

Acquisitions?

7. Will these Mergers &Acquisitions help in improving the returns on capital

employed (ROCE) of the steel industry?

In this study, the author is focusing on two recent major acquisitions of steel companies:

Arcelor by Mittal and Corus by Tata as case studies. The significance of the former

merger is that the largest steel company acquired the second largest steel producer of the

world, to create a size three times its nearest competitor. The significance of the Tata

Corus deal is that the 55th

largest company took over the 8th

largest company to become

the 5th largest company in the world. Each case study has been studied in sufficient depth

to comment on the objectives of the research.

In the forthcoming study, each research question will be explained in detail. This

Analysis will be done based on the study of Mergers and acquisitions theory in chapter 2,

global steel industry in chapter 3 and Case studies in chapter 5.

2

1.2 Overview of the Dissertation:

This dissertation consists of six additional chapters. Mergers and Acquisitions theory in

Chapter 2 covers definition and types of mergers and acquisitions. Market power,

taxation issues, effective synergies, managerial incentives, diversification, agency

problems and Hubris have been discussed as the main causes for mergers and

acquisitions. The different methods of financing have also been discussed. Information

regarding Human resource and cultural factors has been examined as well. Accounting

return, investors return, operational efficiency and technological progressiveness have

been discussed as the main post- merger performance evaluation criteria. These

measurements are important because they help in deciding whether the merger or

acquisition has been successful or not.

Chapter 3 discusses the brief history, growth and economic trends of the steel industry.

Industry size, geographic distribution and details of major global steel firms have also

been mentioned. Consolidation has recently been used as a major strategy in the steel

industry and therefore, details of the major Mergers and Acquisitions in the industry have

been provided. This chapter has been used to give the reader an idea about the scenario in

the steel industry before getting into the complexity of the topic.

Chapter 4 shows the research methods used for the study. This section also discusses why

the case study method has been chosen and reasons for choosing particular companies.

Both qualitative and quantitative data collection method has been discussed and has been

used in this study. Analysis strategies for the results and discussion were important to

mention in this chapter because they state the method in which analysis of the literature

and case studies would be carried out, and how conclusions would be drawn.

Chapter 5 includes cases of the two large acquisitions that have been made in the history

of steel industry i.e. Arcelor Mittal and Tata-Corus. Background, markets and product

portfolio of both acquiring and acquired companies have been studied. Structure of the

deal, and payment method used by the acquiring firm has also been studied. Lastly all the

3

financial and operational synergies expected by the acquiring company and research

analysts have been placed. Each company has been provided with the information

depending on the availability. The case studies have been designed in such a way that the

research questions can be solved and analysed.

In Chapter 6 findings of the study are analysed and discussed. In this chapter analysis has

been done on the basis of the analysis strategies mentioned in chapter 4. Furthermore, the

motives behind mergers and acquisitions have been studied. SWOT analysis and post

acquisitions performance measurement has been performed in this chapter to get an idea

of benefits that steel firms derive from mergers and acquisitions. Main payment methods

used, HR and cultural issue to be faced and pricing factors have been explained in this

chapter. The results will also serve the future structure of steel industry. Furthermore, the

impact of consolidation in steel industry on return on capital employed has been

commented on.

Finally, Chapter 7 discusses the limitation and conclusion of this study.

It was found that the cyclicality of the industry, concentration amongst suppliers and

better buying power of customers were the most important drivers behind mergers and

acquisitions in the steel industry. It was also found that mergers and acquisitions have a

positive impact on steel firms as well as on the steel industry as a whole. As the Mergers

and Acquisitions grow in the industry higher return on capital employed can be seen in

the future. This section also includes the limitations of this study. Future research

recommendations of this study have been mentioned as well.

4

CHAPTER 2: Mergers and Acquisition Theory

2.1 Definition:

Mergers, acquisitions, consolidation and takeovers are words often used interchangeably

but they have different meanings.

Ross, Westerfield and Jaffe (2005) defined a merger as the absorption of one firm by

another. He further described that the dominating firm retains its identity and all the

assets of dominating company is acquired by it.

Depamphilis, (2005) explained that an acquisition occurs when a company takes

controlling stake or selected assets of the acquired company and the latter becomes the

subsidiary of the acquirer. The acquisition of stock may start with a private offer from the

management of one firm to another. Sometimes tender offer or public offer to buy shares

of a target firm is made directly to the shareholders of the target firm. In acquisition of

assets one firm acquires another firm by buying all of its assets. This method may be

costly because of the additional transferring costs of assets. [Ross, 2005, PP-797]

A takeover refers to the transfer of control of firm from one to another. Takeover

happens with obtaining of the stock or assets of another company. Sundrasanam, P.S

(1995) explained that a takeover is similar to an acquisition and implies that the acquirer

is larger than the acquired. But when the acquired is bigger than the acquirer then it is

called „reverse takeover‟.

Takeover can occur by acquisition, proxy contests and going private transactions. [Ross,

2005, PP-799]

5

Figure1: Types of takeover

Takeover

Acquisition Proxy contest Going private

Merger or Consolidation

Acquisition Of stock

Acquisition of assets

Source: Ross, westerfield & Jaffe (2005)

Takeovers can also occur with proxy contests. This occurs when a group of shareholders

vote a new director in the company in order to gain controlling seat in the board of

directors. A proxy gives the proxy holder the power to vote on all matters of

shareholders. [Ross, Westerfield and Jaffe (2005), PP-799]

In going private all the shares of the firm are acquired by the internal management or the

group of investors. The shares of the firm are delisted from the stock exchanges and can

no longer be transacted in the open market. [Ross, Westerfield and Jaffe (2005), PP-799]

2.2 Types of Mergers and Acquisitions:

From an economic perspective mergers may be classified as horizontal, vertical and

conglomerate mergers. In a horizontal merger two companies are engaged in the same

industry or similar lines of activity. For example: Oracle and Peoplesoft in business

application software and oil giants such as Exxon and Mobil. Arnold, 2002 added that

motives of horizontal merger are to achieve economies of scale and market power

resulting from reduction in competition. Horizontal mergers may tend towards monopoly

6

which may attract attention of the government and regulatory authorities. [Arnold, 2002

PP-870 & Depamphilis, 2005 PP-6]

Emery et al (2004) explains “a vertical merger involves integrating forward towards

consumer or backward toward the source of supply, in a particular line of business.” For

example, in basic steel industry, backward integration can include mining of iron ore or

coal for raw material supply and cost reduction. On the other hand, metal distribution to

the consumer includes forward integration. Arnold, 2002 mentioned that vertical

integration reduces costs of advertising, communication; contracting and coordination of

production as well increase certainty of supply of raw materials and finished goods.

A conglomerate merger is one in which a combined company is the result of the merger

of two unrelated businesses. For example, US steel acquired Marathon oil in 1980‟s,

where both had different business areas. Arnold, 2002 explained that conglomerate

mergers happen to reduce risk through diversification or by the opportunity of cost

reduction and improved efficiency. He also explained that this kind of mergers can also

be done for product line extension or geographic market extension of the firm.

2.3 Causes of Corporate Acquisitions:

There is numerous number of theories on the causes or motives of the corporate

acquisitions. In this section we will discuss the most important and common motivations

of the in greater details. These motivations are follows:

2.3.1. Market Power views and growth:

Arnold, 2002 stated that market power is one of the most important forces driving

mergers and acquisitions. He also stated that if a firm has large share of market it gets the

ability to exercise some degree of control over the price. Firms in a concentrated market

may agree amongst themselves to charge the customers a higher price. This may also be

7

under watch out of regulatory authorities. Even if the firm does not have the entire

market, reduction in competitors makes price control even easier. For example, mergers

in the airline industry in late 1980s resulted in higher ticket prices. [Depamphilis, 2005,

PP-24]

Arnold, 2002 also stated that a conglomerate can also pressurize its suppliers for price

and credit period. It might also be beneficial for the suppliers because they are getting

volume business. On the other hand a bigger and merged business may also insist its

customers to purchase product from other division as well. Bigger business is also

perceived to be more reliable, and thus attracts customers [Arnold, 2002, PP-875].

Emery et al, 2004 stated that firms can grow more quickly and cheaply by acquiring

firms than through internal development. In order to set up new facilities or establish new

distribution systems it takes time. But it becomes quicker by acquiring the firm which has

already developed infrastructure. In most of the cases firms are bought at a price lesser

than the cost of developing them, which makes it cheaper way to grow [Emery et al,

2004, PP-795].

2.3.2. Tax Argument:

Arnold, 2002 highlighted that in most of the countries, especially USA, a firm making

loss in one year can be adjusted from the profits earned in the future. He added to that

saying that past losses of the acquired company can also be adjusted from the current

profits of the acquirer and hence the company is saved from paying taxes.

Depamphilis, 2005 added to tax benefits stating that the taxable nature of the transaction

is also the key determinant for the purchase price. A properly structured transaction may

help target shareholders to defer any capital gain from the transaction. If a transaction is

not tax free, then seller would charge higher purchase price for the tax liability imposed

from the transaction.

8

Emery et al, 2004 added another point by stating that if a firm has large cash flow and

that cash is distributed amongst the shareholders, then they will have to pay taxes(unless

shares repurchased are at a price lower than the shareholders purchase price). But if the

company acquires another company with that cash then shareholders have to pay no tax.

2.3.3. Efficient and effective Synergies:

Synergy is based on the notion that merger of two companies can create greater value

than when operated separately. Depamphilis, 2005 suggested that there are two types of

operating and financial synergies.

Depamphilis, (2005) also stated that operating synergy is improved by economies of

scale or economics of scope. Economies of scale refer to reduction of average cost of the

company with allocation of fixed costs over increased volume. The merged firms help in

eliminating duplicate facilities, operations or departments. In order to achieve operating

efficiencies when companies are likely to be in same line of business (horizontal merger)

or are involved in forward or backward integration in a particular line of business

[Emery, 2004, PP-794].

“Economies of scope refer to using a specific set of skills or an asset currently employed

in producing a specific product or service to produce related products or services.”

[Depamphilis, 2005, PP-18] For Example, Uniliver ltd uses its marketing skills for a

range of personal care as well as food and tea.

Financial Synergies refers to the impact of merger on the cost of capital of the acquiring

firm or the combined firm. If the firms merged have unrelated cash flow i.e. one has

excess cash and the other who does not have sufficient cash to fund investments, leads to

realizing financial economies of scale from lower interest rates or other securities costs

[Depamphilis, 2005, 18]. Arnold, G further explained synergy as 2 + 2 = 5 effect, stating

that the net cash flow of combined unit is more than the sum of the units separately. This

9

is because combining activities results in cost savings or may also increase the volume

with the same amount of input [Chiplin et al, 1987].

2.3.4. Managerial Incentives

In the modern business scenario, there are large corporations with diffusion of

ownerships. It is not necessary that the managers are the owners of the company. So,

managers act as agents for the shareholder in such a situation. Managers may lack

shareholders‟ interest in order to promote their own interest. Acquisition decisions may

also be taken by the managers to satisfy their own objectives. [Sudarsanam, 1995, PP-15]

Arnold (2002) pointed out that the management team of the acquiring firm gets the

advantage of having higher responsibility leading to higher authority, status, power and

remuneration. This may encourage managers to pay excessive bid premium or enter into

hostile bid with high transaction costs. The reason for this is that managers are given

opportunity to deploy their underused managerial talents and skills. [Arnold, 2002, PP-

880]

Sudarsanam (1995) pointed out that managers also have job security motive. Managers

may acquire a firm whose cash flow is positively correlated thereby reducing overall

variability of the combined entity‟s cash flow. This overall variability minimizes that

probability of financial distress or bankruptcy. Firm‟s bankruptcy may lead the managers

to wind up the firm and consequently loose their job. Managers may also undertake

acquisition to avoid being taken over by another firm, assuming that firm‟s size may

reduce this threat. [Sudarsanam, 1995, PP-17]

2.3.5. Diversification:

Emery et al, 2004 states that diversification is one of the most important motives behind a

conglomerate merger. Depamphilis, 2005 defined diversification as a “strategy of buying

firms outside a company‟s primary line of business.” The primary reason for

10

diversification is for firms to expand their product line and markets so that they can have

high growth [Depamphilis, 2005, PP-20]. Arnold, G, 2002 explains that cash flow from a

wide variety of businesses also reduces volatility of income stream. He also included that

reduced volatility reduces the position of the shareholders. They obtain a reduction in risk

without a decrease in return.

Depamphilis, 2005 added that the acquirer company may attempt to achieve a higher

growth rate by developing and acquiring new products, unfamiliar to the present product,

and sell it in different or less risky markets. This strategy is also used when the present

product of the firm is in decline phase and the firm wants to shift their core business.

2.3.6. Agency problems:

Depamphilis, 2005 explains that agency problems occur due to the differences in the

interest of managers and shareholders. He also stated that this happens when managers

own a very small number of company‟s share. Since the cost of mismanagement is spread

amongst large number of shareholders, managers get inclined towards their job security

and lavish lifestyle rather than shareholders value. This theory leads to mergers to correct

the situation between the managers and owner‟s interest. Mostly these companies become

the target of other efficient companies and the shareholder support the merger to increase

their own welfare [Berkovitch et al, 1993].

2.3.7. Hubris:

One of the other important motives or causes of acquisitions is hubris. Arnold, 2002

defined hubris as a means of weaning self confidence or arrogance. This occurs specially

during the period when companies have had a few good years of growth and managers

are very pleased with themselves.

Depamphilis, 2005 (PP-22) states that managers believe that their own evaluation of a

target firm is superior to the market‟s evaluation. This over-optimism of evaluating

11

merger activities leads to error in the evaluation and they tend to a pay higher price for

the target company. Berkovitch et al, 1993 state that hubris activity leads to no gains

from the acquisition because managers commit errors in estimating the gains.

Depamphilis, 2005 also suggested that senior managers may become very competitive

and their self importance and desire to not loose may lead to excess payment of the

auctioned company.

2.4 Financing an acquisition:

“If a company takes debt to make an acquisition and the deal goes sour, it runs into

financial trouble and the executives are replaced. But if an equity-backed deal goes

wrong, the stock price simply underperforms and nobody can be sure why? One thing is

certain- Unwise acquisitions abound in the market.”

----Michael H. Lubatkin and Peter J. Lane Cited by [Hitt et al, 2001, PP-31]

Acquisitions are mainly financed through cash purchase, as exchange of stock or with the

combination of both stock and cash. The bidder has to select a method that is agreed by

both the target‟s shareholders and bidder itself [Mclaney, 2003]. Consultants, investment

bankers and law firm advice the bidder for the acquisition. Sometimes investment

bankers themselves arrange and help in raising funds required for the acquisition. There

are various methods through which bidder can finance the acquisition.

Cash Acquisition: In cash acquisition the shareholders of the target company gets cash for

the value of their shares. Target shareholders may not wish to hold the bidders‟ share

because it may incur cost and effort to turn it into cash. On the other hand, receipt of cash

may be charged as capital gains tax and thus shareholders may not welcome a cash

acquisition. Bidder may avail cash by public issue, loan stock for cash or other short term

or long term borrowing [Mclaney, 2003].

12

Stock method: In payment through stock method the shareholders of the target become

the shareholders of the bidder. Bidder has benefit adopting stock method because of not

raising cash for acquisitions and thus it doesn‟t have to increase leverage and bear the

burden of interest payment. It is also cost for the bidder because it is loosing opportunity

of issuing those shares for cash [Mclaney, 2003, PP-382].

Acquisitions can also be paid using both stock and cash. In other words, it can be

combination of debt and equity. The proportion of debt and equity depends upon the size

of deal, type of the deal and market conditions. There are other several considerations as

mentioned by Hitt et al (2001) for the selection of medium of financing. These include

tax considerations, accounting treatment, management control issues, financial returns to

the shareholders and the existence of slack or unused financial resources.

Before making debt and equity decision it is important that bidder should check the

dangers and benefits of leverage in the firm. “Total leverage = Total debt/ (Total Debt +

Market Value of equity + Preferred stock)” [Jandik, 2005] According to the study

conducted by Hitt et al, (2001) 83 percent of the successful acquisitions had low to

moderate leverage while 92 percent of the unsuccessful acquisitions had high or

extraordinary leverage. This happened because of the high interest burden of the debt and

their principal instalment burden, which consequently affects the cash flow of the

company and thus increases the chances of bankruptcy.

On the other hand, Grossman and hart (1982) as cited by (Maloney et al, 1993) showed

that high leverage encourages managers to work hard and bond their promise to pay out

future cash flows. He also stated that highly leveraged companies have very little

opportunity to waste resources on unprofitable ventures. Maloney et al, (1993), further

pointed out that debt helps in controlling the agency costs. The reason must be the high

costs of debt may lead to bankruptcy of the firm in long run.

13

The other kind of financing mentioned by Depamphilis (2005) is mezzanine financing.

This kind of financing gets priority at the time of liquidation of the company over

common stockholders. It is generally unsecured debt with fixed coupon rate and maturity

period. It is generally warrant convertible into common stock as per the maturity period

agreed upon. [Depamphilis, 2005, PP-193]

Venture capital firms sometimes also play very important role in acquisitions funding

and business start-ups. These firms demand a large equity stake in the firm in exchange

of the low price per share. The only advantage of VC firms is that they are sometimes

willing to lend when traditional sources like banks, insurance companies and pension

funds are not. This is because they are willing to take higher risk. It is very difficult to

receive funds from VC firms. [Depamphilis, 2005, PP-193]

2.5 Human Resource and Cultural factors:

In mergers and acquisitions retention and integration of Human Resource is prime

importance for successful Merger or acquisition. Many researchers in the past have

discussed about the effect of an acquisition on Human resource policies and culture.

Aguilera (2004) explained that there are many variations in the policies of the Human

Resource not only globally but also within the country. Some of the practices like pay for

performance systems are mostly common at a broader level. But there might some minor

differences that HRM will have to manage. Aguilera (2004) also noticed that in many

acquisitions internally HRM practices were altered. This shows that there is role of HRM

to adjust according to the degree of localization of market economic type in HRM

practices.

Hunt et al (1992) states that there is much more to HRM than just personal issues like

salaries, benefits and pensions which most of the HRM managers tends to neglect. That

is, the processes of social interactions over the time between the acquiring and the

acquired company employees in order to see the long term interventions. Winning of

14

hearts and minds of the employee is the immediate necessity of any acquisition. In other

words, there should be socially constructed processes in the organization for the

integration and solving the problems of individual‟s dilemmas that are formed with the

acquisitions.

Lees (2003) explained that culture concept is related to myths, rituals, values, belief,

religion, customs and practice, law, heritage, language, symbolism, and so on. Every

country has its beliefs, attitudes, values, customs and practices. These basic assumptions

also exist outside and inside the firm. These are either imposed by law or societal

expectations. Mismatch in of values, beliefs or priorities or assumptions on each side of

two merged companies then these effects the performance of the combined entity.

He also explained that in a global corporate acquisition there can be difference in law,

language, legal, history of the country, nature of the economy, socio cultural background,

political context, ways of doing business, management styles, ways of thinking and

values. There can be many other issues which may cause trouble for the acquiring

company.

Krogh et al (1994) mentioned that there can be three types of cultural difference those are

organizational, professional and national culture. He describes that as soon as individual

enter any organization they socialise in their national culture and frequently socialise in

their professional culture which includes academic culture, business culture, engineering

culture, government culture, legal culture and medical culture.

Krogh et al (1994) pointed that there is always cultural difference between an acquiring

firm and acquired firm. He further mentioned that there is cultural risk to integration of

merger or acquisition. Lack of cultural fit may lead to acquisition failure and this happens

mostly due to the regime imposed by the acquiring firm on the acquired firm. He further

suggests that a firm should learn about a target firm‟s organizational culture before

acquisitions and prepare proper strategies to tackle cultural issue which are likely to

happen.

15

2.6 Post merger Performance Evaluation criteria:

After the acquisition, it is important that the acquiring company utilizes the synergetic

advantages properly improving the overall performance of the firm. Fowler & Schmidt,

1988 explained that although there are numerous organizational performance measures

but financial measures is the most popular method.

Cochran and wood (1984) as cited by Fowler & Schmidt (1988) states that financial

performance measurement falls in two categories i.e. accounting returns and investor

returns.

2.6.1 Accounting Return:

Accounting Return is generally measured in terms of Gross profit margin (GPM),

Operating Profit Margin (OPM), Net Profit Margin (NPM), Return on Equity (ROE) and

Return on Assets (ROA). But many authors defined these terminologies in their own

ways.

Becher et al, 2005 emphasised on Return on assets (ROA) stating that it helps in judging

how well the assets have been managed to generate profits but does not consider how

those have been financed, whereas on the other hand Return on Equity (ROE) measures

both, how well assets have been managed to generate profits as well as how assets have

been financed. Normally Earnings before tax is used for calculating ROE but Pilloff,

1996 as cited by Becher et al, 2005 used operating income before provisions to calculate

and found no change in post merger ROE.

Fowler et al, 1990 recommended Return on Capital Employed (ROCE) and Return to

Shareholders (RSH).

Where ROCE = Earnings before tax / Capital Employed

16

And, Capital Employed = Total Assets – Current Liabilities

RSH = (Firm‟s Annual Dividend + Annual per share increase or decrease in the average

price of the stock) / Previous years average share price.

Some of the other ratios mentioned by Cooperman et al, 1989 to measure financial

performance of the firm have been shown in the table below.

Table1: Definitions of various performance measurement ratios.

Performance Ratios Definitions

Return on Equity Earnings before tax (EBT) / Equity

Return on Assets (ROA) EBT/Assets

Net Profit Margin (NPM) EBT/ Total Sales

Asset Turnover (ATO) Revenue/Assets

Debt Equity Ratio Total Debt/ Equity

Gross Profit Margin (GPM) Gross Profit/ Total Sales

Operating Profit Margin (OPM) Operating Profit / Total Sales

Fixed Asset Turnover (FAT) Total Sales/Fixed Assets

Current Asset Turnover Total Sales/Current Assets

Source: Cooperman et al, 1989

2.6.2 Operational efficiency (cost advantage):

Operational efficiency includes operational synergy within the combined firm.

Operational efficiency also includes managerial synergy where bidding and target firm

work together towards the achievement of common goals.

17

Some of the financial measures may be used to measure firm‟s efficiency performance.

Some of these mentioned by Sun & Tang, 2000 are operating income to operating

revenue (operating margin) and net income to operating revenue (net margin). The post

merger performance is compared with the pre merger performance in order to determine

the operational efficiency of the combined firm.

2.6.3 Technological Progressiveness:

Hagedoorn & Duysters, 2002 argues that increasing control over the company in M & A

environment cannot be the only aim of the company; rather it should look for new

opportunities to grow. Therefore, in order to improve performance of the combined

company and to grow it has to take initiative towards technological progress of the

combined entity. He further stated that the increased size of the firm is positively related

to the long term technological performance.

Hagedoorn & Duysters, 2002 also stated that technological performance of the M&A

activity also depends on the type of the acquisition. In horizontal M&A, joint R&D

initiatives and programs of the combined entity will help improve the technological

performance leading to better scale and scope effects. For vertical M&A, the integration

of downstream and upstream helps to identify the new technological requirements. Cost

reduction by integration can be reinvested in the new technology programs. For

conglomerate or unrelated mergers, it is very difficult to find the technological synergies

because these mergers mostly focus on financial synergies.

18

CHAPTER 3: The Global Steel Industry

3.1 Iron and steel making compliance history:

In ancient times, steel was only used for very high value products like swords and

precision instruments because it was produced in small quantities because of production

in very small quantities. This so because the process used for manufacturing was work

intensive and time consuming. In this period steel was manufactured by reverse process

and adding carbon to the carbon free wrought iron. This process was known as

„cementation process‟. This process was very expensive method of extraction was

difficult [Bhaskaran, 2006].

In 1855 the blast furnace process was invented by Henry Bessemer at his steel plant in

England. This process was a new way to produce steel and first less expensive industrial

process for mass production. Further down in 1952, Voest-Alpine introduced „basic

oxygen furnace‟. This was a much more modified version of steel production process.

This process is being used by all modern steelworks. After the invention of this process

steel extraction became less expensive and started being used for construction,

automobiles and capital goods [Bhaskaran, 2006].

3.2 Growth of the industry:

Since 19th

century to early 20th

centuries major steel demand was from munitions and was

controlled by wealthy steel dynasties with political influence. During 1950-1970, steel

industry was highly subsidized, exempted and received many other favours from the

national government. This led to many new investments in big integrated steel plants.

During 1960-1990 was the period of nationalization and increase in state control because

of the excess capacity and inefficiency. Till 1980s most of the steel plants were state

owned either partly or wholly. 1980s to 2000 was the era of re-privatisation of the steel

19

industry. This was done in order to improve the efficiency and competitive position of the

steel companies and to fund economic reforms and improve the financial scenario. Many

steel companies were privatised. Some of them have been included in the table below

[Reynolds, 2006].

Table 2: List of companies privatised

Company Privatisation Year

British Steel 1987

SSAB (Sweden) 1989

Ilva (Italy) 1992-1995

Usinor-sacilor (France) 1995

SN (Portugal) 1995-1996

Voestalpine (Austria) 1995-2003

Aceralia (Spain) 1997

Source: Reynolds, 2006

Even After re-privatisation steel industry was controlled by government. Subsidies and

tariffs were tools that government used in order to control and protect the domestic steel

industry. For example, in March 2001, US government imposed an import tariff of 30

percent in order to protect its domestic steel industry. Whereas Chinese government

introduced number of subsidies in order to boost its steel industry. This consequently

lifted global steel industry to a new height [Rasheeda, 2007].

20

Years World

1995 756

1990 775

1985 721

1980 717

1975 644

1970 595

1965 456

1960 347

1955 270

1950 189

Table 3: Year wise world steel production

Years World

2006 1,244

2005 1,142

2004 1,069

2003 970

2002 904

2001 850

2000 848

1999 789

1998 777

1997 799

1996 755

Source: International Iron and Steel Institute, 2006 (www.worldsteel.org)

Figure 2: Year wise world steel output in form of graph

Source: International Iron and Steel Institute, 2006 (www.worldsteel.org)

21

3.3 Economic trends

During the 20th

century, steel industry grew from just 28 million tons (MT) to 789 MT as

shown in the Table 3 above. The highest growth has been noticed in the period between

1950 and 1975 as shown in figure 2.

The steel industry has always been a cyclical business. As shown in the figure 2, steel

industry grew from 189 million metric tonnes to 684 million metric tonnes in just 25

years. But in 1975, the European, American and Japanese economy stabilised which led

to the flattening of demand. This led reduction in demand from these major steel

consuming countries as compared to the supply. In this period capacity utilisation was

fluctuating between 70 to 80 percent. During this time, demand from the developing

countries started increasing but was not sufficient to meet the supply [Rasheeda, 2007].

Another difficult phase for the steel industry was between 1997 to 2001 due to financial

crisis in Asia and severe recession in the global economy. This led to the imbalance

between demand and supply. Steel prices went down 20 year low in this period and new

capacities became uneconomical. In order to fight this recession, steel industry was

ignited with mergers and acquisitions since 1997. [Bhaskaran, 2006]

Steel industry again showed a sign of recovery in 2002. This happened due to increase in

demand from China and other South Asian countries like India, as these countries were

growing and focused on infrastructure development. Even sectors like housing,

construction and automobiles showed recovery [Bhaskaran, 2006]. Most of the steel

companies in the period of 2002 to 2006 have shown recovery and growth in profits.

Many of the steel companies in Asia pacific regions have added capacity in this boom

period.

In figure 2, cycle of 25 years can be noticed in the steel industry. 1950-1975 has been

noticed as uptrend and 1975-2000 as downtrend in demand. Uptrend again started in the

industry in year 2002 and in just span of 4 years capacity increased by about 27.5 percent

to 1244 in 2006.

22

3.4 Industry size and geographic distribution

In 2003, China emerged as the biggest producer in the world with the production of 220

million metric tonnes. China also imported 43 million metric tonnes of steel in that

period. During 2005, China produced approximately 350 million metric tonnes, an

increase of 25 percent as compared to last year. In 2006 China produced 34 percent of the

world steel production. The other top producing countries of 2006 were Japan with 116.2

million tonnes and US with 98.6 million tonnes [International Iron and Steel Institute,

www.worldsteel.org].

Figure 3: Country wise steel output in 2006

450

400

350

300

250

200

150

100

50

0

Country-wise Steel production in 2006

countrie s

China

Japan

United States

Russia

South Korea

Germany

India

Ukraine

Italy

Brazil

Turkey

Taiwan, China

France

Spain

Mexico

Canada

United Kingdom

Belgium

Source: International Iron and Steel Institute, 2006 (www.worldsteel.org)

23

3.5 Major Global steel companies:

The table 4 shown below shows all the major companies of steel in the world as per the

figure of 2005.

Table 4: Major steel companies around the world on the basis of output

Rank Mmt (2005) Company

1 63.0 Mittal Steel

2 46.7 Arcelor

3 32.0 Nippon Steel

4 30.5 POSCO

5 29.9 JFE

6 22.7 Baosteel

7 19.3 United States Steel

8 18.4 Nucor

9 18.2 Corus Group

10 17.5 Riva

11 16.5 ThyssenKrupp1

12 16.1 Tangshan

13 13.9 Evraz

14 13.7 Gerdau

15 13.6 Severstal

Source: International Iron and Steel Institute, 2006 (www.worldsteel.org)

24

3.6 Consolidation as a strategy in the global steel industry

Steel industry has had its worst time in the 1990s. There was capacity mismatch and

consequently the prices reached the lowest ever. This excess capacity had put too much

pressure on the steel companies globally. During this period steel industry was highly

fragmented and competitive. It had no global player during this time [Sinha, 2006 (A)].

But since the late 1990‟s the rise in consolidation has been noticed in the steel industry.

Booming Chinese economy lead China to become leading consumer as well as producer

of steel and consequently booming the steel industry business cycle [Rasheeda, 2006].

Mergers and Acquisitions strategy was one of the surviving strategies for some of the

large companies. M&A helps the companies to reduce costs and getting better price from

their customers.

During 1990s Mittal steel, which started its business in Indonesia in 1976, had bought 8

companies around the world including Trinidad, Mexico, Germany, Ireland and USA.

[Ghoshal et al, 2001] In the span of just 15 years it became the largest steel producer in

the world after the acquisition of ISG for $4.8 billion in 2004.

Some of the major steel industry acquisitions data has been shown in the Table given

below.

Table5: Major Mergers and Acquisitions in Steel Industry

Year Companies Consolidated Company Formed

1997 Krupp AG + Thyssen ThyssenKrupp

1998 Inland steel company (USA) + Ispat

International NV

1999 British steel (UK) + Koninklijke Hoogovens

(Netherlands)

Ispat Inland Inc (Subsidiary

of Ispat International NV)

Corus

25

2001 Arbed (Luxembourg) + Usinor (France) +

Aceralia (Spain)

Arcelor

2002 LTV (US) + International Steel Group (US) International Steel Group

(US)

2003 Kawaswaki Steel (Japan) + NKK Corp (Japan) JFE Steel

2003 International Steel Group (US) + Bethelem

Steel (US)

2004 Ispat International NV + LNM Holdings

(Netherlands)

International Steel Group

Mittal Steel company NV

2004

2005

Mittal Steel Company NV (Netherlands) +

International Steel Group (US)

Dofasco(US) + Arcelor

Mittal Steel Company NV

(Mittal Steel)

Arcelor

2005 Kryvorizhstal (Ukraine) + Mittal Steel Mittal Steel

2006 Mittal Steel + Arcelor Arcelor-Mittal

2007 Tata Steel + Corus (UK) Tata Corus

Source: Compiled by Author from Rasheeda, 2007 & Business Standard, 2006

In today‟s scenario, there has been tremendous rise in demand and consolidation has been

noticed. The biggest step towards consolidation in the history of steel industry was taken

by Mittal steel‟s acquisition of its biggest competitor Arcelor for $33.7 billion. This

combination of world‟s largest and second largest steel producers would contribute

towards 10 percent of the world steel output (approximately 110 million tonnes). The

other recent major acquisition has been made by Tata‟s buying CORUS for $12.1 billion.

[Business standard, 2006 & The Hindu Business line, 2007]

26

CHAPTER 4: Research Methodology

This chapter describes the research methods used for the study. There are several

methods of doing research on management issues. Some of those include Surveys,

Histories, Questionnaires, Experiments and case studies. Each Strategy has its merits and

demerits depending on three conditions [Yin, 2003, 1, 13].

The type of research question

The control an investigator has over actual behavioral events

The focus on contemporary as opposed to past phenomenon

Amongst all the above points Research Question is the most important.

4.1 Research question and objectives:

The main purpose of this research is to find out the drivers and impact of recent mergers

and acquisitions in steel industry on the acquiring firms and the steel industry as a whole.

All the research questions have already been mentioned in chapter 1.

Research Objectives:

Research objectives have been derived from the research questions and the objectives are:

To indicate/ highlight the motives of steel companies behind Mergers &

Acquisitions.

To enquire if acquiring steel firm get benefits from the Mergers and Acquisitions

activity.

To identify the main payment methods used by these firms for mergers and

acquisitions.

To investigate whether steel companies are paying appropriate price for the

acquisitions.

27

To identify the issues that steel companies will be dealing with, with respect to

Human Resource and Cultural aspects of Merger & Acquisitions.

To determine the critical factors driving steel industry into Mergers and

Acquisitions.

To discuss whether Mergers and Acquisitions will help in improving the returns

on capital employed (ROCE) of the steel industry.

A questionnaire survey would have been appropriate in this case, but that would have

limited the depth of the study. Case study research method was adopted for in-depth

analysis of the background and synergies of the firms involved in the mergers and

acquisitions activity.

In the following sections the theory related to case study, case study selection criteria and

data collection methods will be discussed. Finally the process of analysis will be outlined.

4.2 Case Study Methodology:

Yin (2003) defined case study as “an empirical enquiry that investigates a contemporary

phenomenon within its real-life context, especially when the boundaries between

phenomenon and context are not clearly evident.” Case studies rely on multiple sources

of evidence. It also covers logic of design, data collection techniques and specific

approaches to data analysis [Yin, 2003, p.13 &14].

The main purpose of the study is to analyse the factors driving steel industry into Mergers

and Acquisitions and determine how far mergers and acquisitions can reduce the

cyclicality of steel industry. In this, theory of Mergers and acquisition of steel industry is

the phenomenon and it has to be investigated with reference to the real life example or

context, the boundaries between this phenomenon and real life context has to be studied.

To achieve this case study research has been adopted.

28

Case study includes single or multiple-case studies. Single case study focuses on a single

case only whereas multiple case studies focus on two or more cases within the common

study. Each approach has advantages and disadvantages. Single cases represent the

critical test of a significant theory. This is more appropriate when unique, typical or rare

cases are studied. Moreover, they require less resources and time than multiple case

studies. In multiple case studies, each case should serve the purpose of the overall scope

of study. Analytic conclusions will be more powerful in multiple cases, since there is the

possibility of direct replication and context of cases differ from each other [Yin, 2003,

p.41, 47 & 53].

Case studies may be further classified into: Exploratory, Descriptive and Explanatory

case study. An exploratory case study defines questions and hypothesis of a subsequent

study or determines the feasibility of the desired research procedures. A descriptive case

study describes a phenomenon within its context. An explanatory case study focuses on

data, bearing on cause-effect relationships. All the three methods can also be used while

doing multiple case studies to provide better replication to the research question [Yin

(1993), p.5].

In this research the approach to the case study will be both explanatory and descriptive.

Descriptive because it enables the study has to be within the research context,

explanatory since drivers of mergers and acquisitions is the cause and mergers and

acquisition is the effect and hence establishes cause-effect relationship.

4.3 Company selection:

Yin, 1993 explains three important - case study selection criteria:

Criticality of theory being tested

Topical relevance to the case

Feasibility and access

29

For this particular project the history of steel industry was researched to find out the

major Mergers and Acquisitions that have taken place as discussed in chapter 3. It was

observed that most of the mergers and acquisitions were ignited after 2002. Studies of

different companies with different backgrounds were conducted. It was also explored that

the case study should contain sufficient information to fulfil the objectives of the

research. The other criteria‟s for selection of cases has been cross boarder acquisitions to

focus on the HR and cultural issues, size of the deal to indicate the effect of the merger or

acquisition on the whole industry and relevant comparison of the case studies and the

most importantly availability of data being little researched topic.

The first case study is Mittal Steel‟s Acquisition of Arcelor in June, 2006, which is

considered to the largest deal of all time in the history of steel industry. The largest steel

producer acquired second largest steel producer of the world. The second case study that

will be used is Tata Corus deal. The importance of Tata Steel‟s acquisition of Corus is

that world‟s 55th

largest bought the 8th

largest steel producer of the world to become 5th

largest company in the world. Both the acquisitions are considered to be one of the

biggest deals in the history of steel industry. Both the companies are playing the role in

consolidating the highly fragmented steel industry. It will be interesting to know about

the company‟s motives and their roles in doing so.

4.4 Data collection methods:

There are two kinds of data collection methods: Quantitative research method and

Qualitative research method. Both the methods are commonly used in research and are

chosen depending upon the study. The main purpose for search of quantitative data is to

determine the quantity or extent of some phenomenon in form of numbers. [Neuman,

1994] It is highly developed and builds on applied mathematics. It makes use of statistics,

hypothesis and variables. Neuman, [Neuman, 1994] further explained that researchers

choose from standardized set of data analysis techniques; hypothesis testing and

statistical methods and there less variations across a range of different research projects.

30

The main disadvantage of this method is that data analysis could not be started until all

the data has been collected and been condensed into numbers [Neuman, 1994].

On the other hand qualitative research tends to be unstructured and text based, consisting

of transcription of interviews or discussions, field notes or other written documents. In

this research statistics and numerical data is rarely used. [Hussey & Hussey, 1997] One of

the strengths of this kind of research is that one can begin analysing early in a research

project, even while collecting data. A weakness that researchers find is that qualitative

data analysis analyses small number of cases which can have more than one meaning and

at the same time reduces the validity of the results [Neuman, 1994].

In Mergers and acquisitions, research can be based on both the qualitative and

quantitative methods. The research will be started with the literature review and

collection of information related overview of steel industry, consolidation in the industry,

case study and lastly in-depth analysis of mergers and acquisitions in steel industry. Data

will be collected from journals, news, articles; corporate websites, books and internet. In

order to carry on this Quantitative data will include collection of statistics of steel

industry, study on financial accounts and stock prices of the companies and other M&A

related data. Moreover, qualitative data will also be useful with the in-depth analysis of

M&A in steel industry. With the use of both the methods qualitative research can provide

detailed description along with numerical description that quantitative research provides.

4.5 Analysis Strategies:

Results and Analysis is designed in such a way that purpose of each research objectives

(that has been mentioned in the first section of this chapter) is served one by one.

The first objective of the study is to indicate/ highlight the motives of steel companies

behind Mergers & Acquisitions. This objective has been solved by analysing the

combined motives of both the companies from the data available in the case study. The

31

synergies that the companies and analysts are expecting from the combined company

have been reviewed in depth and thoughts have been generated for this reason.

The second objective is to enquire if steel companies are benefiting from Mergers and

Acquisitions. In order to solve the purpose of this objective SWOT (Strength,

Weaknesses, Opportunities and Threats) analysis will be performed for the combined

firm in both the case studies so that both the flaws and benefits of the merger or

acquisition can be analysed. In order to get even better picture of the benefits, post

acquisition performance measurement criteria that will be discussed in literature review

will be used in practice. Those criteria‟s are stock price comparison, Accounting profit

comparison and operational efficiency.

The third objective is to identify the main medium of financing used for these mergers

and acquisitions. For this purpose case study has been studied and the main financing

method used has been distinguished in both the cases.

The fourth objective is to investigate if steel companies are paying appropriate price for

these mergers and acquisitions. In order to know the appropriate price paid for the

acquisition, Enterprise value per ton (EV per ton) and Enterprise value per EBDIT (EV

per EBDIT) values will be compared. Enterprise value is total value of the company

includes the equity and total debt of the company.

However the above calculation will not be enough to comment on the pricing issue. Raw

materials costs contribute to more than 40 percent of the total costs of the steel industry

and being self sufficient is a big competitive edge. So, iron ore mining assets of Tata-

Corus will be compared with Arcelor-Mittal. Conclusion will be drawn based on the

comparison.

The fourth objective of the company is to identify the issues that steel companies will be

dealing with, with respect to Human Resource and Cultural aspects of Cross Boarder

32

Merger & Acquisitions. This purpose will be served by studying the HR &cultural fit of

both the organisations and generating the issues.

The sixth and main objective of this research is to find out the critical factors driving

Steel industry into mergers and acquisitions. This purpose will be solved by studying the

global steel scenario as shown in Chapter 3 and case study in chapter 5 and analysing the

difficulties or challenges that the steel companies have been facing in present scenario.

Thoughts will also be generated on how mergers and acquisitions can help in minimising

those challenges. If these challenges can be minimised by mergers and acquisitions then

those challenges are the determined factors which are driving steel industry in

consolidation.

The seventh and last objective of the research is to discuss whether M&A will reduce the

cyclicality of the steel industry. In order to serve this purpose the structure of the steel

industry will be studied all around the world and future structure will be predicted on the

basis of the past trends and momentum of the M&A in steel industry. This structure of

the industry will determine the consolidation structure, cost structure and consumption &

production structure. Once the structure is determined steel industry will be positioned

and compared with the other metal and mining industries in terms of consolidation and

return on capital employed (ROCE), conclusion will be drawn thereafter.

33

CHAPTER 5: CASE STUDIES

In this chapter, we will use real life example of two companies to and the company

selection criteria has already been studied in chapter 4. The first company that has been

studied is Arcelor-Mittal, whose combination created the largest steel company in the

world, three times the size of its nearest competitor. The significance of the second

company i.e. Tata-Corus is that the 55th

largest company bought 8th

largest company to

become 5th

largest company in the world. This is very unusual combination.

In this chapter, first background of acquiring and acquired company will be studied in

both the case study. Then structure and payment method used by the deal will be

discussed. Further, Synergies expected by combined company will be stated.

5.1. Arcelor-Mittal Case study:

5.1.1 Background of Mittal Steel:

Mittal Steel has been one of the most successful steel companies in the world with 49.2

million tonnes of crude steel production, and revenues of USD 31.2 billion in 2005. Its

steel production accounted for 6 percent to the total steel market of the world. [Gayathri,

2006 & Mathew, 2006]

Mittal Steel was started by its Chairman and CEO Lakshmi Niwas Mittal. He started his

career working in his father‟s Steel Company during his college times at Calcutta, India.

In 1976, visualising the opportunity in the steel industry he moved on to Indonesia to set

up a steel company and founded Ispat Indo. In 1989 he made his first acquisition of

government-owned steel firm at Trinidad and Tobago and turned it around. He doubled

its output and brought it in profit. Over the years he bought many more government and

privately owned steel enterprises, which have been mentioned in Table 6 [Gayathri, 2006

& Mathew, 2006].

34

Table 6: Mittal Steel’s Acquisitions prior to Arcelor

Year Company and Country Capacity (million tonnes

per annum)

1989 Iron and Steel Company of Triniad & Tobago 0.9

1992 Sibalsa (Mexico) 3.4

1994 Sidbec-Dosco (Canada) 1.4

1995 Hanburger Stahlwerke (Germany) 2.8

1995 Karmet (Kazakhstan) 3.8

1998 Inland Steel Company (USA) 5.3

1999 Unimetal (France) 1.5

2001 ALFASID (Algeria) 1

2001 Sidex (Romania) 3.8

2003 Nova Hut (Czec Republic) 2.9

2004 Polski Huty Stali (Poland) N/A

2004 BH Steel (Bosnia) 0.2

2004 Macedonian facilities from Balkan Steel N/A

2005 ISG (USA) 20

2005 Kryvorizshtal (Ukraine) 7.7

2005 Stelco subsidiaries (Canada) N/A

Source: Compiled by Author from Gayathri, 2006, Sinha, 2006 & Mittal Steel, 2006 (A)

Mittal succeeded largely from turning around state owned loss making firms by cutting

costs, exploiting economies of scale and selling higher-value products. Mittal steel came

into highlight when he merged its companies Ispat International and LNM Holdings and

bought International steel group in 2005 for USD 4.5 billion. Mittal got access to US

markets and thereby began getting orders from automobile and appliance industries for

high margin metal sheets and hence improved company margins. [Gayathri, 2006 &

Mathew, 2006]

35

In 2005, Mittal bought Kryvorizshtal which produced approximately 20 percent

Ukraine‟s Output. Mittal paid USD 4.8 billion (initial bid amount USD 2.8 billion) for

this deal because of the presence of competitor Arcelor. This might have prompted Mittal

Steel to takeover Arcelor. Moreover, in January 2006 Mittal Steel completely changed

the scenario of the Steel industry by placing bid for Arcelor, which was the second largest

steel company with 4 percent of the world‟s steel market. [Gayathri, 2006 & Mathew,

2006]

5.1.2 Markets and Product Range of Mittal Steel

Mittal Steel had strong presence in North America. Mittal Steel was market leader in

Eastern and central Europe, Asian and African market. This shows that Mittal steel had

right mix of developed and developing markets [Sinha, 2006 (B)].

Table 7: Markets of Mittal Steel

Source: Mittal Steel, 2006 (C)

The product portfolio of Mittal as shown in the Figure 4 consisted of mostly low value

products. Still it had very appropriate mix of long and flat products.

36

Figure 4: Product Portfolio of Mittal Steel based on 2004

Source: Mittal Steel, 2006 (B)

5.1.3 Background of Arcelor:

Arcelor was formed in 2002 as a result of the merger of Arbed of Luxembourg, Aceralia

of France and Usinor of Spain. The three companies joined together in order to create the

largest Iron and Steel company in the world in 2002. [Agarwal, 2006]

As of 2005, Arcelor comprised 371 fully consolidated companies and 180 companies that

were consolidated by distributing the equity. Arcelor had 84.39% shares with the public

in the open market and the largest stakeholder being the state of Luxembourg with 5.6

percent stake. Arcelor also used the strategy of growing through acquisitions. In 2005, it

bought Poland‟s Lucchini Group and expanded its operations in Eastern Europe. In early

2006, it acquired Dofasco, the Canadian steel producer and hoped to establish its market

in North America as well. In February 2006, Arcelor acquired 38 percent stake in China‟s

largest producer of sections and beams, Laiwu Steel Group (capacity of 7 million tonnes),

for Rmb 2.1 billion. [Gayathri, 2006]

In 2005, Arcelor had crude steel capacity of 43 million tonnes and was the second largest

steel producer after Mittal steel, which overtook Arcelor in 2004 as the largest producer

37

of Steel in the World with capacity of 63 million tonnes. Arcelor had been declared the

„Corporate jewels of Europe‟. That‟s why Mittal‟s bid for Arcelor created turmoil in

some European countries (especially France and Luxembourg) [Gayathri, 2006].

5.1.4 Markets and Product range of Arcelor:

Arcelor had very rich product mix and 70 percent of the output consists of flat product

and Stainless steels. These occupies higher price per tonne as compared to the normal

steel product [Mathew, 2006]. The company was also market leader in high valued steel

produced for European car makers, construction, household appliances, packaging and

general industrial applications. [Gayathri, 2006]

Arcelor had a strong presence in the European Union, with 71% of its sales coming from

the latter. This made it the market leader. North America, South America and rest of the

world accounted for 9%, 11% and 9 % respectively [Agarwal, 2006]. Its plants were

located mainly in Western Europe with two plants in France, one in Belgium and one in

Spain [Gayathri, 2006].

5.1.5 Hostile Takeover of Arcelor:

On 27th

January, 2006 Lakshmi Nivas Mittal, the founder and chairman of Mittal Steel

(worlds largest Steel Company) launched a hostile bid worth Euro 18.6 billion for

Arcelor, the second largest steel company in the world. The combined entity would be the

Mittal‟s vision to create the world largest steel company in the history of steel industry,

three times the size of its nearest competitor Nippon Steel. It was also considered to be

one of the largest hostile bids in the European History.

38

Time line of the Hostile Takeover: The timeline of the acquisition has been given below

[Compiled by Author from Gayathri, 2006, Sinha, 2006 (A) & The Hindu Business Line,

2006]

Jan. 27:

Mittal Steel announced the open offer for all the Arcelor ordinary shares and convertible

bonds for Euro 18.6 billion (US$ 22.6 billion). The primary offer was mixed cash and

share offer for Arcelor Shares. The deal consisted of 0.8 Mittal Shares and Euro 7.05 for

each Arcelor share.

Jan. 30:

The hostile acquisitions offer of Mittal Steel shocked Europe. Luxembourg, France,

Belgium and Spain government opposed the move stating that proposed bid may put

thousands of employees at risk. Guy Dolle, CEO of Arcelor, ruled out the proposal by

commenting that deal price was very low and they had a different target market culture.

He also pointed to Mittal Steel‟s corporate governance, stating that it is completely a

Mittal family- run enterprise.

Feb 16:

Arcelor declares 85 percent dividend hike disregard Mittal‟s bid.

April 4:

Arcelor unveils some more takeover defences. Arcelor declared payment of US$ 6 billion

to the shareholders and proposed to make recently acquired Dofasco as an independent

Dutuch Foundation control over the unit.

39

April 28:

Some of the institutional shareholders opposed Arcelor‟s opposition to the Mittal Steel‟s

bid.

May 15 2006:

Mittal sweetened the deal going through severe criticism by Arcelor Board by increasing

the bidding price to Euro 25.8 billion (US$ 33 billion). Arcelor Board studied the revised

offer and commented that all decisions will be made protecting the interest of the

shareholders.

May 16, 2006:

The market regulators in France, Belgium, Luxembourg and the Netherlands cleared the

bid.

May 26, 2006:

Arcelor announced a Euro 13.6 billion merger proposal with severstal, leading steel

company of Russia. The proposed merger would have made it number one steel maker,

dislodging Mittal Steel. In this deal, Mardashov (Chairman of Severstal) will own 32.2%

stake and 68.8 % by existing Arcelor shareholders.

June 6:

European Commission approved the merger of Arcelor and Mittal.

40

June 20:

Severstal revised its terms and raised the bid and agreed to settle on the 25 percent rather

than 32.2 percent earlier.

June 23:

Arcelor and Mittal decided to meet on June 25, 2006.

5.1.6 Structure of the final Deal and Financing:

After 5 months of hostility, on June 25, 2006 Arcelor board recommended shareholders

merger with Mittal Steel. Mittal Steel decided to raise its offer to 1.084 Mittal Shares and

Euro 12.55 in cash for each share of Arcelor. This made total of Euro 40.4 per Arcelor

share. Mittal Steel also offered 13 Mittal Steel shares and Euro 188.42 for every 12

convertible bonds of Arcelor. Arcelor shareholders received 69 percent of offer in shares

of Mittal Steel and balance 31 percent in cash. The total offer came to USD 33.7 billion

[BBC news, 2006 & The Tribune, 2006].

After the merger Mittal would hold 43 percent stake in the merged company. Mittal on

terms also agreed to limit his holdings to below 45 percent. This was done so reduce the

control of Mittal family in the combined enterprise [The Tribune, 2006].

The post merger 18 member board will consist of 12 existing board members of Arcelor

and six Mittal nominees. Arcelor chairman Joseph Kinch would become the chairman of

Arcelor Mittal and Lakshmi Mittal would become the president of the Board [The

Tribune, 2006].

41

5.1.7 Synergies:

“ Mittal and Arcelor have both been at forefront of the consolidation in steel sector in the

last 10 years. This combination accelerates this process and leaves us uniquely positioned

to benefit from the opportunities created.”

- Laxmi Niwas Mittal, Chairman and CEO, Mittal Steel as cited by Sinha, 2006 (B)

The combination of Arcelor and Mittal Steel will create a company that will account to

10 percent of the global steel production with capacity of 110 million tonnes per annum.

The combined company will have 61 pants in 27 countries with 320000 employees and

an annual turnover of USD 69 Billion [Agarwal, 2006 & Sinha, 2006 (B)]. The combined

company will generate financial synergies, as shown in Table 8. The other financial

synergies are that the company will also benefit from lower cost of capital, improved

cash flow and improved access to capital markets [Sinha, 2006 (B)].

Table 8:

Source: Mittal Steel, 2006 (B)

42

This combination will enable to create an unmatched geographic presence with very

limited geographic overlapping as shown in figure 5. This would help the company to be

leader in five main markets i.e. South America, NAFTA, European Union, Central

Europe and Africa. The combined assets of the company will give them good

combination of developed and developing markets. [Sinha, 2006 (B)]

Figure: 5

Source: Mittal, L.N. 2007

According to some of the analysts it will create „one stop shop‟ for the customers. This is

so because Arcelor‟s market and high value steel will be complimented by Mittal‟s

market and low cost commercial steel [Mathew, 2006]. The merger would allow the

company to expand its product portfolio and help winning orders from automotive,

appliances, packaging, construction, oil and gas spread across different regions.[Sinha,

2006 (B)] The product portfolio offered by the combined company in 2006 has been

shown in Figure 6.

43

Figure 6:

Source: Mittal, L.N, 2007

The Merger wouldn‟t give synergies in Marketing and product range but also purchasing,

manufacturing and shipping as shown in figure 7. This synergy is expected to be around

USD 1 billion till year 3. Analysts expect that the combined company will give ability to

change the impact of cyclical fluctuations in the economy [Mathew, 2006].

Figure 7: Purchasing marketing and manufacturing synergies of Arcelor Mittal

Source: Mittal Steel, 2006, (B)

44

Other synergy is that significant amount can be saved on use of in-house raw materials of

Mittal Steel. Mittal steel has reserves of iron ore (one of the major raw material for steel

production) in Kazakhstan, Ukraine, North America and Bosnia. Whereas, Arcelor does

not have much of reserve like Mittal but have reserves of Dofasco. The combined

company will make it self- sufficient with 45 percent of iron ore requirement as shown in

figure 8. [Mathew, 2006]

Figure 8: Raw material self sufficiency and internal distribution centres

Source: Mittal, L.N. 2007

The combination of Arcelor and Mittal will also give some synergies in marketing and

trading as the group will have 38 percent of the total distribution by internal centres as

shown in figure 8.

45

5.2. Tata-Corus Case study

5.2.1 Background of Tata Steel:

Tata Group was formed in 1868 by Jamsetiji Nusserwanji Tata. Tata Steel, one of the

main companies of Tata group is India‟s largest private sector steel company and had

been one of the lowest cost steel producers in the world. Tata Steel was formed in 1906

celebrating its 100th

year in 2006 [Rasheeda, 2006 & Bhaskaran, 2006].

Tata Steel Managed turnover of USD 6311million, EBDIT of USD 1815 million and Net

Profit of USD 961 million in financial year 2006-07 (excluding Corus). It also produced

4.93 million tonnes (India) of crude steel and sold 4.79 million tonnes. Over all Tata Steel

has a capacity of 8.8 Million tons. This includes the two subsidiaries, Nat steel and

Millennium Steel (Thailand). Tata Steel is fully integrated across its value chain. It is

100 percent self-dependent as far as raw materials like iron ore and coal are concerned.

Also, it has huge expansion plans in India in years to come. On the other hand, it has its

own distribution networks and centres all over India. [Tata Steel, Annual Report, 2006-

07]

From last few years, Tata steel has been in the process of building a global company.

Therefore it acquired Nat Steel (Singapore) in 2004 and Millennium steel (Thailand) in

2005.

B. Muthuraman, Managing Director of Tata Steel said “In my view, globalisation is a

method by which you put the right part of the value chain in its right place in the world,

and link it up properly-finishing facilities where customers exist, and primarily

manufacturing facilities where manufacturing is competitive” [Bhaskaran, 2006].

46

5.2.2 Background of Corus:

Corus Group is the 2nd

largest steel producer in Europe and 9th

largest producer of steel in

the world. It was formed with the merger of British steel and Dutch Royal Hoogovens in

late 1999. In this merger British Steel and Hoogovens had 61.7 % and 38.3% share

respectively, in the new company. It produced 18.8 Million tonnes of steel for the year,

ending 30th

December 2006. It had manufacturing facilities in UK, Netherlands,

Germany, France, Norway and Belgium with installed capacity of 21.4 million tonnes per

annum. In 2006, Corus had a turnover of GBP 9733 million with operating profit of GBP

457 million [Corus, Annual Report, 2006 & Gupta, 2005].

Table 9: Major Production Facilities of Corus

Source: Corus, Annual Report, 2006

5.2.3 Product range and Markets of Corus:

Product Range: Corus manufactured a large variety of steel products from different

division strip products, Long products, Distribution and building systems division.

47

Figure 9: Product Mix of Corus for 2005

Source: Corus, Annual Review, 2005

In 2006, Hot rolled Coil production was about 60 percent of the total crude steel

produced; 65 percent of these coils being used for further processing into sections, plates,

engineering steels or wire rod. Long products contribute around 21% in the product mix.

The product mix of Corus has been shown in figure 9 [Corus, Annual Report, 2006].

Principal markets for Corus group‟s steel products are construction, Automotive,

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

Europe is the main market for CORUS contributing to 53 percent of the total turnover in

2006. UK, North American, Asian markets follow with 27%, 9% and 8% respectively.

For this reason, Corus has sales office in 30 countries and has a world wide trading

network. [Corus, Annual Report, 2006]

5.2.4 Structure of the Deal and Financing:

In order to drive globalisation strategy Tata Steel made $8.1 Billion offer on 17th

October, 2006 for Anglo-Dutch Steelmaker Corus Group. This deal was at a price of

455p per Corus share. On 20th

October, Tata Steel also got approval of Corus Group for

48

the acquisition. But a twist happened when CSN (Brazilian company) offered 475p

higher than Tata Steel on November 17th

2007. Tata Steel revised its offer to 500p per

share, CSN in made another offer 515p in December, 2006. As the process was extending

the UK panel on takeover and Mergers set a deadline on 30th

January, 2007. An auction

process was held on 30th

January and number of bids went between Tata and CSN. Tata

Steel made final bid for the company of 608p per share or $12.9 Billion and was declared

winner to acquire Corus [Tata Steel Annual Report, 2006, Rasheeda, 2006 & Goldstein,

2007].

Figure 10: Holding company format of Corus

Source: Tata Steel, Annual Report, 2006-07

Initially the acquisition was funded by Tata steel in a mixture of cash resources and

syndicate loans. This amount of USD 2.7 billion was transferred to Tata Steel Asia

Holdings Pte Ltd (TSAH). TSAH raised bridge loans of USD 2.5 billion and mezzanine

loan of USD 0.6 billion was raised by Tulip UK Holdings, which was invested by the

way of equity in Tata Steel UK ltd. The balance of the consideration was raised through

Tulip Finance Netherlands (wholly owned subsidiary of Tata Steel UK ltd) via Senior

Debts of USD 4 billion and Mezzanine bridge of USD 3.1 billion [Tata Steel, Annual

Report, 2006-07].

The details given below in Table 10 is the long term arrangement of funds approved by

the Board of Tata Steel on 17th

April 2007.

49

Table 10: Long term Arrangement of funds by the Tata Steel Board

Source: Tata Steel, Annual Report, 2006-07

The company will contribute USD 4.1 billion as equity finance. This will comprise of

USD 700 million from internal resources, USD 500 million of external borrowings, USD

640 millions from preferential issue of equity shares, USD 862 million from rights issue

to equity shareholders, USD 500 million from foreign issue of equity and USD 1 billion

from rights issue of convertible preference share [Tata Steel, Annual Report, 2006-07].

5.2.5 Synergies:

The Strategic Combination of Tata and Corus is very unusual combination since the

acquirer ranked 55th

while the acquired company ranked 8th

in world steel production.

The combination will make the acquirer the sixth largest steel company in the world with

the Crude steel production of 23.5 million tonnes and capacity of 28 million tons as

shown in figure 11 [Tata Steel, Annual Report, 2006-07].

Moreover this Tata Steel will gain from the economies of scale, greater production

facilities, enhanced R&D capabilities and distribution networks in high end markets.

50

Figure 11: Tata Corus Combined steel production

Source: Tata Steel, 2006

On this matter, Executive director of Pricewaterhouse coopers, Sanjeev Krishnan as cited

by (Rasheeda, 2006), said “The primary reasons for outbound deals appear to be the

necessary scale and size to be globally competitive. This is, in fact, the primary driver for

the Tata-Corus deal apart from being a good fit.” As we can see in figure 12, the

combination of Tata steel and Corus will help the combined entity to increase its sales,

EBITDA, Net Income and crude steel production tremendously. Hence, a huge scale

company will be created.

Figure 12: Pro forma Combination (figures as per FY 2005)

Tata Steel Corus Combined

Source: Tata Steel, 2006

51

Corus have very little access to the mines, which is the main reason for the EBITDA

margin of around 9 percent in comparison to the average 14 percent of the European steel

makers. Tata Steel expects to send low cost slab produced in India for high end finishing

at Corus. Tata Steel also has plans to set up huge capacity Greenfield projects in India

[Tata Steel, Annual Report, 2006-07].

The other synergy is that Tata Steel will be able to get is the benefits of the R&D

capabilities of Corus. This is so because Corus has high skilled 950 researchers in

contrast to 88 researchers in Tata Steel. The R&D department of Corus has been very

successful with introducing new products for automobile and construction industries

[Rasheeda, 2007]

Being Corus in the developed market and Tata Steel in developing market will create a

powerful combination. This is so because this will give Tata Steel would have an

advantage to access markets in both High end developed markets of Europe and low cost

manufacturing facilities of Asia as shown in figure 13. [Rasheeda, 2007]Corus has

dominant market share in UK, with 51 percent market share of carbon steels in 2006

[Corus, Annual Report, 2006-07]. As shown in figure 13, 53 percent market of Corus in

Europe will give Tata Steel direct access to the European High end steel markets.

An industry Analyst Rakesh Arora as cited by Rasheeda, 2006 stated that “It‟s a good

mix of developed and developing country – You have the stability of a developed country

and growth of a developing country. It‟s a win/win situation for both companies – Corus

has been burdened by high raw material costs and Tata steel can provide raw materials

very effectively.”

For the above reasons Tata Steel expects synergies of 350 million to be attained in third

year of merger.

52

Figure 13: Global Presence and customer reach of Tata-Corus

Source: Tata Steel, 2006

Moreover, the combined market of Tata-Corus will provide them wide variety of markets

and appropriate mix of mature markets of Europe and growing markets of Asia as shown

in figure 14.

Figure 14: Combined Markets of Tata-Corus

Source: Tata Steel, 2006

53

Tata-Corus deal is considered to be a friendly transaction and initiation of global

partnerships [Tata Steel, 2006]. The other advantage that there is cultural compatibility of

both the companies as shown in figure 15. Both the companies has same continuous

improvement programme, code of ethics and world class governance.

Figure 15: Cultural fit of Tata-Corus

Source: Tata Steel, 2006

54

CHAPTER 6: Results and Analysis

This chapter is based on the study of the last four chapters. Here the Author analyses and

discusses the main objectives of the research. All the research questions have been

answered in this section. First we will start the discussion with the motives behind

Mergers and Acquisitions.

6.1 Motives of Mergers and Acquisitions in steel industry:

The history of the steel industry has already been discussed in the Global steel industry

chapter. We found that government owned many steel plants were privatised and the era

of consolidation in steel industry begun in 2002. That is why it has become very

important to analyse the motives that is driving steel companies into mergers and

acquisitions.

Improved product portfolio: Tata Steel and Mittal Steel both had acquired companies in

order to improve their product portfolio. Getting the proper mix of low value and high

end steel products to serve the wider range of markets has been one of the main motives

of Steel companies.

Market Share and Global Presence: Both the companies focused on expanding their

operations globally and grabbing the market world wide. It also included the right mix of

markets, i.e. slow growth in developed markets or mature markets and high growth in

developing markets.

Inorganic growth: It takes at least 5 years to set up an integrated steel plant as quoted by

Wharton (2007). It would also take years to fix the market and win customers over their

competitors. Growing inorganically enables the steel companies to expand their capacity

immediately and capture the market along with it. This was the key strategy of Mittal

Steel. It has not set up any Brownfield project and has grown only by acquiring several

steel companies.

55

Proportionate negotiation power with the suppliers and customers: Steel industry has

been the victim of disproportionate negotiation power with its suppliers and customers.

The reason for this is the small number of raw material suppliers to the steel industry, and

a small group of customers for the steel thus produced. Furthermore, the steel industry

has been highly fragmented. Sinha, 2006 stated that three Iron ore major companies

control 75 percent of the supply of Iron ore and top ten auto companies account for 95

percent of automobile production. On the other hand, in the steel industry the top 5

players account for only 20 percent of steel production.

Both the companies (Tata Steel and Mittal Steel) have expected their purchasing and

marketing synergies to improve by reducing the negotiation power of its suppliers and

customers. This has also been steel companies‟ primary motive, behind getting into

mergers and acquisitions.

Strength to face down turn: When steel companies turn big, they have better strength to

face the downturn of the industry. This is so because the combined entity has better cash

flow and a wider range of market than their competitors. More and more acquisitions in

the industry will lead to consolidation, which will help them earn sustainable earnings in

the long run.

Better Service to the Customers: One of the other important reasons for steel

companies‟ interest in M&A is to provide integrated service to the consumers and help in

global procurement. It will also enable the steel companies to carry combined research

and development with their consumers, and come up with the newer products. For

example: Ford Motors can tie up with Arcelor-Mittal to provide them with all the steel

related products like metal sheets and other special steel products. Since both the

companies have global presence Arcelor Mittal can supply steel to all Ford plants

globally. This may enable both the companies to work together towards R&D and new

product development. The motive is to win orders and gain competitive advantage

against their competitors.

56

Economies of scale: Economies of scale is one of the important motives of both the

companies to gain manufacturing and R&D synergies. Economies of scale enable

companies to invest more in research and development. The benefit for them is that they

will have lesser per ton R&D cost and the expertise of both the companies would be

available for the development of better products.

6.2 SWOT Analysis:

In this section SWOT (Strengths, Weaknesses, opportunities, Threats) Analysis of the

both the companies will be done. SWOT Analysis has been chosen so that it can measure

the benefits as well as the drawbacks that company is likely to face in long term and short

term.

6.2.1 Tata-Corus:

Strengths:

The combination of Tata and Corus will make Tata Steel the 5th

largest steel

maker in the world.

The combination will provide them with enhanced product portfolio.

The combination will allow Tata to produce low cost slabs in India and send those

slabs for finishing in the CORUS plants in long term.

It will enable Tata to utilise the distribution network of CORUS to get better price

for the products produced in India.

It will have access to the high end market of Europe and will be able to cater wide

variety of markets as shown in figure 13.

57

It will be able to enhance its R&D capabilities with the highly efficient R&D of

Corus.

Weaknesses:

Since the Tata-Corus deal is leveraged buyout, debt burden will lead to increase in

interest costs and affect debt-equity ratio.

Tata Steel is one of the lowest- cost producers of steel in the world, with 28.75

percent of operating margin in 2005. On the other hand, Corus is a high- cost

producer with 10.13 percent operating margin in 2005 as mentioned in figure12.

Combining both the margins, the overall margin will reduce drastically.

Tata-Corus does not have enough raw materials to source for Corus‟ plants in the

short term. The cost of raw materials constitutes approximately 40% of the total

cost of steel production.

While Tata Steel has expertise in construction steel, Corus specialises in carbon

steel. This may lead to conflict in the interest of the two companies.

Opportunities:

In terms of financing, Tata steel stands a good chance of raising funds on Corus‟s

goodwill. The former can do this by listing in London Stock Exchange, which

might help it in getting a better price for its share.

If further consolidation happens in the industry, there is possibility of reduction of

cyclicality of the steel industry, which may lead to better profits for Corus plants.

58

Tata Steel has an opportunity to turnaround Corus plants in the long run by

acquiring other mining companies abroad and using the raw materials thus

acquired, to feed Corus‟ plants.

Threats:

Due to the cyclicality of the steel industry, it is possible that industry cycle

changes and goes in downturn. If this happens, Corus plants might get into trouble

because of interest- burden caused by leveraged buyout, and the insufficiency of

raw materials.

Although Tata Steel, has gained size with Corus‟s acquisition. If Tata Steel wipes

some of its debts with equity dilution. This combined company may itself become

a victim of hostile takeover by other big companies like Arcelor Mittal and

Severstal.

6.2.1 Arcelor Mittal:

Strengths:

The combined entity will control 10 percent of the global steel market, leading

with 3 times of its nearest competitor, Nippon steel.

The Arcelor Mittal combination will allow them to win customer orders from the

global automakers and construction companies. This is because of their global

presence as discussed in the above-mentioned case study.

The combination of low value steel produced by Mittal Steel and high value steel

produced by Arcelor, along with the wide product range of the Arcelor- Mittal

59

combination, would give the company competitive advantage over business

rivals.

Mittal Steel itself can meet 45 percent of Arcelor-Mittal‟s iron ore requirements,

which would help in reducing the combination‟s costs, and enable it to further

grow along the down-stream supply chain.

The Arcelor-Mittal combination has become a truly global company.

Weaknesses:

Arcelor has been a very innovative company and had thousands of patents; on the

other hand Mittal had only 20 odd patents. Although both the companies had

almost the same size, Mittal Steel did not have much interest in R&D. This might

also affect on the combined entity and consequently affect the business in long

run. [la tribune, 2006]

Mittal Steel had till now been a family-controlled enterprise, with the Mittal

family owning 88 percent stake. Even in Arcelor-Mittal, the Mittal family owns

43 percent stake. Therefore even the combined entity may lack shareholders

value.

Recently Mittal steel was accused of monopoly in United States and South Africa

for charging excess pricing. By virtue of having a combined entity, the company

will be more exposed globally and may get into conflict with several competition

tribunals across the world.

60

Opportunities:

In the era of consolidation, the company can acquire some more government

owned steel units or other steel companies, and expand their operations in other

countries.

Many other companies like Severstal, Tata Steel, Nicor and POSCO are playing a

leading role in consolidating the steel industry. This may help in reducing the

cyclicality of the industry.

Threats:

The deal of Arcelor-Mittal was opposed by the government of France and

Luxembourg. Iron and steel Industry being the key industry for other industries,

government may intervene on price and on further acquisitions.

Both the companies have had a history of acquisitions but there was a difference

in culture. Arcelor being more professional had 12 members in their board. On the

other hand, Mittal Steel was more of a family-run organisation, with most of its

board members belonging to the Mittal family. Therefore, there is a threat of

mismatch of management culture in Arcelor-Mittal.

Although the Steel industry is in the process of consolidation, 70 percent of the

industry is still highly fragmented. Due to this existing high rate of fragmentation,

the cyclicality of the steel industry cannot be reduced, despite the process of

consolidation having begun. Downturn in the industry may lead to drastic

reduction in profit margins.

61

6.3 Post Acquisition Performance measurement:

We have already discussed some of the post acquisition performance measurement

criteria in the literature review. We will use those criteria to measure the performance of

both the companies, and draw a conclusion based on that. We will compare the stock

price performance of both the companies. Accounting return and operational performance

will be measured only for Arcelor- Mittal because Tata- Corus is still in the process of

merger and has not come out with any results.

6.3.1 Stock Price comparison:

In this measurement criterion we will observe the stock market reaction to the merger till

date. Both Tata- Corus and Arcelor-Mittal share price movement will be observed.

Figure16: Price chart of Tata Steel from 28th

August, 2006 to 24th

August, 2007 in

BSE

Source: India Info line, 2007

Tata Steel stocks dropped 10 percent on the news of Tata Steel buying Corus on 31

st

January 2007 (Thiagarajan, 2007). As we can see in the graph shown above in Figure 16,

stock price went down slightly but recovered in April due to high demand of steel. This

shows that market did not take

This shows that the stock market did not take the Tata- Corus deal normally and was

considered to be an over priced deal. But seeing the demand of steel and the consequent

62

rise in the price of steel may make this deal worthwhile in the long term. This reason is

preventing the Tata Steel stock prices from crumbling.

Figure17: Price chart of Arcelor Mittal at NYSE from (August 2005 –August 2007)

Source: Reuters, 2007

As is evident in the graph above (figure 17), there has been an uptrend in the share price

of Arcelor-Mittal since the merger. This shows that stock market reacted positively on

this merger. The stock price almost doubled in just one year of the merger. The uptrend

indicates that the company has been performing very well.

6.3.2 Accounting profit comparison:

Tata Steel is still in the process of integration and current acquisition. It will be

interesting to see its results when it comes out.

Net profit margin has increased from 7.9 percent in half yearly reports of June 2006, to

9.6 percent in the half yearly reports of June 2007. Earnings per share increased from

$2.47 to $3.6 per share, comparing the half yearly results of June in 2007 and 2006.

Gearing (net debt to equity) increased from 35 percent to 42 percent (Market watch,

2007).

63

The ratios calculated above show that although the profits of the company have

increased, the gearing of the company has also increased. But overall profitability of the

company has increased tremendously as compared to the gearing. This shows that the

combined entity has financially benefited from this acquisition.

6.3.3 Operational Efficiency:

EBIDTA (Earnings before Interest, Depreciation, Taxation and Amortisation) of Arcelor-

Mittal increased by 42 percent, as reflected in the half yearly result of June 2007. The

EBIDTA amount has increased to US$ 9672 million, as compared to pro forma half

yearly result of June 2006.

Operating Income for the same half yearly June 2007 has increased by 50 percent and

reached US$ 7687 million. The company claims that this improvement in the

performance has been due to the high demand of steel and higher selling prices for all the

major segments. Operating margin for the period was increased from 11.9 percent to 14.9

percent.

There has been a tremendous improvement in the operating profit as compared to the last

half yearly operating profit of the combined firm. This constitutes the perfect example of

achieving efficiency and higher price for the products through Mergers and acquisitions.

64

6.4 Comparison of Tata- Corus and Arcelor- Mittal:

This section will compare both the case studies mentioned in chapter 5 in terms of

financing, price paid for the acquisitions, raw material self-sufficiency and human

resource & cultural issues.

6.4.1 Financing of the Acquisitions:

As in the case of Arcelor-Mittal, 69%of the acquisition has been paid for by shares, while

31 percent has been paid in cash. On the other hand, Tata Steel bought Corus in hard

cash. Being an all cash deal for Tata Steel, the company plans to raise capital not only

through debt but also equity dilution. More than $ 8 billion of the fund will be raised by

leveraging Corus assets. Thus, it is considered to be a leveraged buyout by many

analysts. The rest of US$ 4 billion will be contributed as equity finance and from internal

resources. The board has planned to convert the loans into equity in the long run.

Mittal Steel paid majority by shares, because of which they were not under pressure to

arrange cash. The other point is that the Arcelor- Mittal deal was among companies that

were almost at par with each other, for they had almost the same capacity. On the other

hand, Tata was a much smaller player in terms of capacity and hence, it did not have

enough market capitalisations to pay by shares. The further equity dilution would

increase the risk for Tata steel of being Hostile Takeover. Therefore, Tata Steel had no

other option but to use debt financing initially and later convert into shares.

In conclusion, Arcelor Mittal deal will not face the burden of debt and will have a normal

debt- equity ratio to face the cyclicality of the steel industry. On the other hand, Corus

being a leveraged buyout would lead to a consequent increase in Tata-Corus‟ interest

burden, which would make it difficult for the company to face a downturn in the steel

industry.

65

6.4.2 Price paid for the acquisition:

The Enterprise Value (EV) of Corus was around USD 13.75 billion which includes debt

of USD 0.85 billion. On the basis of EV per ton, the enterprise value came to USD 751

per ton and calculation has been based on the actual crude production of 2006 (18.3

million tons) and USD 649 per ton based on the crude steel capacity i.e. 21.1 million

tons. [Tata Steel, Annual Report, 2006-07] On the other hand, Enterprise value per ton

paid by Mittal Steel for Arcelor was $ 586 per ton of actual steel capacity [Rediff, 2006].

EV/EBDIT (Enterprise Value / Earnings before Depreciation, Interest and Tax) paid by

Mittal steel for Arcelor was just 6.2 (based on FY05) as compared to more than 8 (based

on FY06), which Tata Steel paid for Corus. [Steelworld, 2007]

It can be easily concluded from the above discussion that Tata Steel paid price much

higher than what Mittal Steel paid. On the other hand, the Mittal Steel deal was prior to

that of Tata Steel and with the expected consolidation in the industry the Enterprise value

and market capitalisation of steel companies has gone sky high. This price will look

cheaper if any other deal takes place with Enterprise value per ton of $ 1000.

It would have taken Tata Steel years to build such a huge capacity and develop such a big

market for steel. If we consider it in that perspective then certainly Tata‟s acquisition

looks viable in the long run. In short term, being a leveraged buyout, the deal may face

some difficulty.

However, just paying higher price than the competitor does not mean that company has

overpaid for its acquisition. Quality of assets and synergies are also very important

criteria. One of the main criteria in the steel industry today is self- sufficiency with raw

materials. This is because raw materials costs include 40 percent of the cost and

sometimes even more. Therefore, in the following section further comment on the pricing

issue will be made, stressing on the raw material sufficiency and other operating

synergies.

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6.4.3 Margin picture & raw material self-sufficiency:

Iron ore and Metallurgical coal are the two major raw materials for steel industry. As

shown in figure 18, iron ore and coking coal prices have surged by 71 % and 111 %,

respectively, in 2005. Although the steel industry has been in its best shape since 2002, as

discussed in chapter 3, iron ore prices have been soaring as the production has been

increasing as shown in figure 18. So, in order to be competitive in the industry it is very

important for steel companies to be self- sufficient in raw materials.

Figure 18: Graph showing world crude steel production and iron ore price trend

Source: Mukherjee, 2007

Tata Steel being one of the lowest- cost producers of steel in the world; it has sufficient

iron ore and coking coal mines in India to feed its plants in India. But it does not have

enough raw materials to feed the plants in Corus.

Most of the raw materials requirements of Corus are purchased from the international

markets. Corus does not own any iron ore or coal blocks around the world to source its

raw material requirements.

Corus imported 25 million tonnes of iron ore from Australia, Canada, South Africa and

South America (Brazil). It also imported 11 Million tonnes of metallurgical coal

67

predominantly from Australia, Canada and USA. The purchase price of these raw

materials is completely dependant on the demand of other international steel producers,

and on the supply capacity of the miners. There was 19% increase in iron ore prices

`between 2005 and 2006. The hard coking coal price decreased by 8% compared to

2005. Besides this, there was also a rise in worldwide energy and natural gas prices.

These prices are mostly driven by hike in oil prices and insufficient UK gas supply

[Corus, Annual Report, 2006].

Tata steel is a 100 year old company. Therefore, most of the depreciation has already

been diluted. Availability of iron ore and coking coal mines, location advantage

(proximity to port for export and import of coking coal, and to mines of iron ore), cheap

labour in India, and the growing market of India, makes Tata Steel one of the lowest-cost

producer of steel in the world. Corus does not enjoy all these advantages together, and is

thus will be unable to manage low- cost production.

Tata Steel might have calculated the synergies but neglected the costs for realising those

synergies. In other words, Tata Steel expects synergies of $ 350 Million for Corus‟

acquisition, neglecting the interest costs that Tata Steel will have to bear in the short

term. In fact, Tata Steel also plans to convert part of its debt into equity in the long term.

Corus buy out has to be a long term strategy of Tata Steel because it will take time to turn

around Corus. Short term gains or improvements in case of Tata steel seem ambiguous.

On the other hand, Arcelor-Mittal has iron ore mining assets all over the world as shown

in figure 19. This gives the company competitive advantage by allowing it to use the

resources closest to the production facility. For example: South African mines can feed

the plants of Arcelor-Mittal in South Africa, and Ukraine ore can be used in the

production facility at Ukraine. The destination of consumption of iron ore has been

shown in Table 11.

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Figure 19: Iron ore mine assets of Arcelor Mittal

Source: Mukherjee, 2007

Table 11: Destination of Iron ore consumption

Source: Mukherjee, 2007

Iron ore is essential to be competitive in the steel industry. Currently Mittal Steel is self

sufficient in 45% of its iron ore requirement. This helps the company to be less reliable or

69

dependent on the suppliers. Suppliers of iron ore in the industry have been dictating terms

because of concentration among them as shown in figure 20 further. Along with self-

sufficiency, Arcelor-Mittal‟s large production capacity around the world can bring huge

purchasing synergies in iron ore, coking coal and other raw materials.

With self- sufficiency of 45 percent, Arcelor- Mittal will be more viable than Tata-

Corus. This is because the latter would have to have to purchase and import 2 tons of raw

materials to produce one ton of steel, at Corus‟ plants. This has been calculated on the

basis of 36 million tons of raw material import and 18 million tons of crude steel

production in 2006, as mentioned in the Annual report of Corus, 2006.

Moreover, Arcelor- Mittal has the supply of ore all around the world, while Tata-Corus

has mines on a single location in India, which are just enough to feed its plants in India.

In order to be more efficient Tata-Corus will have to acquire some more mines abroad

and grow along the supply chain.

In conclusion, Mittal Steel paid fair price to make profits and achieve synergies in short

term as well as long term. Tata Steel paid almost 40 percent higher prices than Mittal

steel. Furthermore, taking into account raw material self-sufficiency Tata steel‟s short

term achievement of synergies looks ambiguous, though it might do well in the long

term.

6.4.4 Human Resource and Cultural Issues:

Tata Steel plans to keep management of Corus intact and just induct senior executives to

sit on each others board [Wharton, 2006]. It seems to be a very justifiable way to do

things slowly and in a manageable way. It also shows that the management of the two

companies wants to understand each other‟s management culture better, before making

any changes. This approach would enable the combined entity to negotiate the

70

differences in the respective management culture of the two companies, and would help

Tata-Corus chart out a mutually accepted management culture for the combined venture.

The Human Resource issue that Tata steel is likely to face is that employees of Tata Steel

are paid salaries and given perks according to the Indian standard. On the other hand,

Corus Employees are paid according to the British Standard. British Standard salary is at

least 4 times that of Indian Standard. Thus, post-acquisition the salary expectations of

Tata‟s employees in India might increase. There might be dissatisfaction among the

Indian employees on the fact that the acquired company‟s employees are getting better

salary than the acquiring company. The same dissatisfaction might arise among members

of Tata‟s top management.

On the other hand Mittal Steel may also face enormous cultural differences. Arcelor had

focused on value- added products, while Mittal steel was more focused on profits and

produced products that can earn good return. Mathew argues that Arcelor was a highly

technical company and focused more on research and development, while Mittal steel

was a more commercial company and stressed less on R&D (Mathew, 2006). Arcelor had

18 members on its board comprising of six nationalities, with no single organisation

holding large stake in it. On the other hand the Mittal family held 88% stake in Mittal

steel and its board members belonged mostly to the Mittal family. This huge difference in

management culture may lead to conflict between the management of Arcelor and Mittal

Steel.

6.5 Factors driving steel industry into consolidation:

This section describes the factors that are driving steel industry as a whole towards

consolidation. These factors are basically the challenges can be minimised by mergers

and acquisitions. Those challenges are as follows:

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Threat from cyclicality of the industry: There is possibility that steel companies are

trying to consolidate the steel industry because of the threat of falling prey to the

cyclicality of the industry, which may lead them to go out of business as it happened

between 1975 and 2002. If handfuls of producers dictate the steel market, they can form a

cartel during the downturn.

Concentration amongst supplier: A few suppliers alone are responsible for providing

raw materials to the steel industry. Top 3 companies controlled 70 percent of the iron ore

supply and top 5 companies controlled 58 percent of the coking coal market in 2005. On the

other hand, only 17.9 percent steel was produced by the top 5 producers of steel. This

has caused imbalance in the negotiation power. Therefore, the raw material suppliers

keep on increasing the iron ore and coking coal price as shown in figure20.

Figure 20: Concentration amongst supplier

Source: Mittal Steel, 2006 (B)

Consolidation in steel industry will allow the steel companies to have proportionate

negotiation power with their suppliers.

Buying power with the customers: Steel industry being fragmented, customers

(Automobile manufacturers) have huge dominance because of the concentration in

automobile industry. Wharton states that Steel industry customers, especially the

72

Automobile industry, had been purchasing from steel suppliers at rates that had driven the

steel industry‟s profit margins to unsustainable levels. Concentration amongst

Automotive manufacturers has been shown below in figure 21 (Wharton, 2007).

Figure 21: Graph showing number of independent automotive manufacturers

Source: JD power cited by Mittal Steel, 2006 (B)

As the industry consolidates, Steel producers would enjoy better negotiation power, and

would be able to provide integrated service to their customers. Consolidation will also

help the steel companies in acquiring mining resources for their backward integration.

High competition and Extreme fragmentation: Steel industry has been highly

fragmented throughout the world. From the beginning there has been high competition

between steel players worldwide, and between smaller steel players within countries. So

there was pressure from global companies as well as many local companies. Figure 22

shows that steel industry was fragmented to such an extent that the top five players

controlled only 14.6 percent of the total steel production in 2000.

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With consolidation, there would more global producers of steel. This would help in

reducing the number of competitors in the industry.

Geographic Price differences: Steel industry has always been a victim of geographical

price differences. The cost of production differed across the world because of the

different economic and political situations of the country. For example: the cost of

production is lower in China than in developed countries because of low labour costs

[Regani, 2005]. This competitive advantage enables China to sell at a lower price;

thereby affecting the profitability of the European firms. Consolidation in steel industry

will create big players with global presence and would reduce the price differentials in

different parts of the world.

Overcapacity: Steel industry has been suffering with over capacity for a long time. Over

capacity leads to higher costs (due to lower capacity utilisation) and price imbalance.

Consolidation will reduce this problem, if top few players form a cartel and manage the

capacity effectively.

6.6 Future Structure of the Steel Industry:

Steel Industry has always been a very fragmented industry because of the several

restrictions imposed on the industry by the state, and the different policies of each state.

This is one of the reasons that the steel industry went through depression in the period

from 1975 to 2002, as shown in figure2.

Since 2002, it has been observed that the industry is going through the period of

consolidation. As shown in the figure 22, the share of top five players in North America,

Latin America and Asia have gone through major consolidation. On the other hand top

five players in the world produced 14.6 percent of the steel in 2000 as compared to 17.9

percent in 2005.

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3 0

2 2 .4

17.9

14 .6

12 .9

Figure 22: Shares of Top five players in North America, EU, China, Asia & Worldwide

Source: Tata Steel, Annual Report, 2006-07

The industry saw regional consolidation in 2002-03, while cross boarder consolidation

was initiated in 2004-06. It is expected that the industry will see many global companies

being formed between 2007 and 2015. Only in China has it been noticed that the share of

top 5 players have decreased from 35.7 percent in 2000 to 19.7 percent in 2005. This has

happened due to many new capacities being added in the last few years due to the

economic boom in China. This boosted economy allowed the regional players to expand

their capacity.

Figure 23: Expected share of top 5 steel producers

Expe cte d s har e of top 5 s te e l pr oduce r s

3 5

3 0

2 5

2 0

15

10

5

0

19 9 5 2 0 0 0 2 0 0 5 2 0 10 2 0 15

Y e a r

75

Figure23 shows the growth of share of the top five steel companies in the last 10 years

and predicted future growth by the author for next 10 years. In 2000 the top 5 players‟

market share increased by 13 percent, as compared to 1995 and in 2005 by 22 percent

compared to 2000. With the momentum that Mittal Steel and Tata Steel have brought in

the consolidation of the industry, it is predicted that more consolidation will take place in

the next five years. The share of the top 5 companies is bound to increase by 25 percent

every 5 years. Consequently it is expected that market share of the top 5 steel producers

would increase to 30 percent till 2015.

It is expected that this inclination towards consolidation in the industry would not remain

restricted to the top level alone, but would also reach the lower levels as well. Since only

33 percent of world steel is produced by the top 15 producers of the world, there is a huge

potential for consolidation in the rest of the 66 percent. As Wharton discusses, for

instance, even in China there are around 125 integrated steel producers. Thus, there is

huge opportunity for Chinese companies to consolidate China‟s production (Wharton,

2007).

Slowly steel producers can shift the production of low end products to low cost countries

and finish these close to the markets of developed countries. This will reduce the cost

tremendously.

As we can see in figure 24, more downstream production will shift to the countries like

Russia, Brazil, India and China (BRIC countries) because of cost advantage and resource

availability. Although China has a higher cost of production than rest of the BRIC

countries, it also has a huge appetite for steel which makes it viable. All the finishing

facilities can be near the market, either developed or developing, so that the product can

be finished according to the customer‟s specification.

76

Figure 24: Cost of production country wise for Hot rolled coil (USD)

Source: Chaudhary, 2007

Figure 25: Prediction of Future Crude Steel consumption

Source: IISI cited by Chaudhary, 2007

Not only are the costs lower in the developing economies, but these economies also

constitute potential markets for steel. As shown in figure 25, International Iron and steel

institute (IISI) has predicted that the production capacity of emerging economies will

77

catapult to 65 per cent of total production by 2020, from 51 percent in 2004. It can be

observed in the figure that most of the future capacity additions and growth has been

expected in developing countries. This is because per capita consumption in these

countries is very low as compared to that of developed countries.

Although initiatives are taken by the leading steel companies to consolidate the industry, the

important question that arises is whether this would help in reducing the cyclicality of

the steel industry and increasing the returns in the steel industry.

Figure 26: Graph showing relation between Consolidated Industries and ROCE

Source: Chaudhary, 2007

Studying the patterns of different commodities, vis-à-vis consolidation and its consequent

impact on the return on Capital employed, as shown in figure 26, one may conclude that

consolidated industries boast of a better return on capital. So, as the steel industry will be

moving towards the left of the graph (figure 26) and become more consolidated, the

cyclicality will reduce with time and Return on Capital Employed will increase

drastically. If the Industry consolidates in the way being predicted in figure 23, the steel

industry might be able to earn a return of more than 10 percent on capital employed.

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CHAPTER 7: CONCLUSION

7.1 Implications of the Study:

In this chapter, the key implications and contributions of this research has been presented.

Apart from the theory and analyst‟s suggestions, in this research, some thoughts were

also generated by the author during the development of this project.

The core objective of this is to find out the motives and impact of mergers and

acquisitions in steel industry. There are several other objectives related to the core

objective of the project which will be concluded one by one.

The first objective of the company was to highlight the motives that drive steel

companies into mergers and acquisitions. It is found that steel firms are acquiring

companies in order to improve their product portfolio, achieve global presence, improve

market share, grow inorganically, gain proportionate negotiation power with the suppliers

and customers, gain strength to face downturn, provide quality service to the customers

and get economies of scale.

The second objective of the company was to enquire if the acquiring firm gets any

benefits from the mergers and acquisitions activity. For this purpose SWOT Analysis was

performed. In SWOT Analysis, it was noticed that economies of scale, better product

portfolio, enhanced R&D capabilities and proper mix of markets were some of the

important benefits that the combined entities enjoyed. High interest and debt burden on

Tata steel, and Mittal Steel‟s corporate governance are the main weaknesses that the

respective companies are likely to face. Better funding in Tata Steel and further growth

through acquisitions by Arcelor Mittal are the opportunities that the respective companies

may avail of in the future. There are certain threats like downturn in the industry and

increase of government intervention which may be faced by both the companies in future.

79

While measuring post-acquisition performance, it was observed that Tata Steel‟s stock

prices dropped by 10 percent on the news of Tata buying Corus on 31st

January, 2007.

However, high demand in steel has helped the stock price to recover since April, 2007.

On the other hand, Mittal Steel‟s stock price doubled within one year. It was also found

that Merger and acquisition had a positive impact on accounting profit and operating

efficiency. This shows a perfect example of achieving efficiency and effectiveness

through Mergers and Acquisitions.

The third objective of the research was to identify the main payment methods used by

steel firms for mergers and acquisitions. It was found that Mittal Steel has used the mix

of shares and cash reserves to fund Arcelor‟s acquisition. On the other hand, Tata Steel

has made a leveraged buyout by leveraging Corus‟s assets. Tata-Corus deal will result in

increase in debt and consequent interest burden on the company, while Arcelor- Mittal

will enjoy a normal debt to equity ratio.

The fourth objective of the research was to investigate whether steel companies are

paying appropriate price for the acquisitions. It was found out that Tata Steel paid 40

percent higher price than Mittal Steel. Mittal Steel paid fair price for the deal to get

immediate returns. This was so because the combined entity will have 45 percent Self

sufficiency in iron ore and less interest burden (compared to Tata Steel) on the company,

because of which the company would enjoy benefits of higher return in short term as well

as long term. On the other hand, Corus‟ buyout being leveraged is a long term strategy

adopted by Tata steel, and it will take time to turn Corus around. From a long term

perspective, it may be said that fair price was paid for Corus‟ Acquisition, though the

combined entity might face hard times in the short term.

The fifth objective of the research was to identify the issues that steel companies will be

dealing with, with respect to Human Resource and Cultural aspects of Merger &

Acquisitions. It was found that the Tata Steel‟s Indian employees might get dissatisfied

on the fact that Corus‟s employees are getting better salary. On the other hand, it was

noticed that Mittal steel is a family-owned commercial company with profit

80

maximisation as its main motive, while Arcelor was a highly technical public company

with no one owner.

The sixth objective was to determine the critical factors driving steel industry into

Mergers and Acquisitions. It was found that the threat posed by the industry‟s cyclicality,

concentration amongst suppliers, High competition, Extreme fragmentation, geographic

price differences, and above all overcapacity and high buying power of the customers,

were the main factors pressurising steel industry to consolidate further.

The seventh objective of the company was to discuss whether Mergers and Acquisitions

will help in improving the returns on capital employed (ROCE) of the steel industry. It

was predicted that the share of top 5 steel producers will be 30 percent by 2015, from 20

percent currently. It has also been predicted that crude steel production in the future will

shift to BRIC (Brazil, Russia, India and China) countries due to expected increase in

demand of steel and low cost advantage of BRIC. Studying the relation between the

consolidation in industries and ROCE (Return on Capital Employed), it has been

observed that consolidated industries get better ROCE. Thus, with its consolidation, the

steel industry might be able to earn a return of more than 10 percent on capital employed,

in the future.

7.2 Limitations of the Study:

However, it is very important to mention the difficulties and limitations that have been

faced during the study. The most crucial limitation of the project is that only a limited

number of companies have been studied.

The second limitation of this research is the unavailability of sufficient data on the topic;

for, the phase of mergers and acquisitions has but begun in the steel industry.

Furthermore, the data available is very recent. Due to these reasons, it would be too early

to confidently comment on the impact of mergers and acquisitions on steel firms.

81

Lastly, the companies studied are the two biggest deals in the steel industry, and

therefore, do not represent the common players in the industry. This study has neglected

the consolidation happening in the bottom level of steel industry.

Nevertheless, what is positive about this study is its potential to constitute the basis for

further research in mergers and acquisitions in the steel industry. This study also takes

into account all the recent data available on the subject, and the project is up to date.

7.3 Recommendations for future research

This study can be extended to see the performance impact on the Tata and Corus merger.

It would also be interesting to know if Tata would be able to turn Corus around, and if

Mittal-Arcelor would be facing any corporate governance issues in the future.

It is expected that this wave of mergers and acquisitions in steel industry will last for

long. There have been many other mergers and acquisitions, as mentioned in Table 5.

More study can be performed on the impact of these mergers and acquisitions taking the

aforementioned case into account.

This study had focused on the mergers and acquisitions at the top level of the steel

industry. It would be interesting to know the impact of mergers and acquisitions at

bottom level of the steel industry. There is huge potential for research in BRIC countries

as they are considered to be the low cost producers and future markets of steel. Study can

be conducted on the evolving steel companies in these countries.

Study can also be conducted to ascertain the potential buyers and seller in the steel

industry. Further study can be done on the major companies like CSN, Severstal, US

steel, POSCO of South Korea, Baosteel of china, Nippon steel of Japan, Arcelor Mittal

and Tata Corus. These companies are expected to play a major role in consolidation of

the steel industry.

82

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