Merger and Acquisition in Steel Industry

“MERGER AND ACQUISITION ACQUISITION WITH REFERNCE TO STEEL INDUSTRY”

DISSERTATION DISSERTATION REPORT 2009

Submitted for the partial fulfillment of the requirement requirement for the award  Of  POST GRADUATE GRADUATE DIPLOMA DI PLOMA IN MANAGEMENT

SUBMITTED BY ARABINDA KAR  Enroll No. : - 7015

UNDER THE SUPERVISION OF Mr. Gurpreet Singh Sachdeva

Department of Management

INSTITUTE OF MANAGEMENT EDUCATION, SAHIBABAD

INSTITUTE OF MANAGEMENT EDUCATION G.T.Road, Sahibabad, Ghaziabad (U.P)

DEPARTMENT OF MANAGEMENT

CERTIFICATE

This is to certify that the disse ssertation entitled “MERG MERGER ER AND AND ACQUISITION WITH REFERNCE TO STEEL INDUSTRY” submitted

  by Arabinda Kar for the partial fulfillment of the requirement of PGDM (Bat (Batch ch 20 2007 07-0 -09) 9),, embo embodi dies es the the bo bona nafi fide de work work do done ne by him him un unde derr my supervision.

____________________  Signature of the Guide

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Acknowledgement It is a matter of great satisfaction and pleasure to present this presentation on “MERGER  take this this AND ACQUIS ACQUISITIO ITION N WITH WITH REFERN REFERNCE CE TO STE STEEL EL INDUST INDUSTRY RY ". I take opportunity to owe my thanks to all my faculty members for their encouragement and able guidance at every stage of this report. There are people who simply by being there influence and inspire me to do thing. I am grateful to Dr. D.P. Goyal , Director Institute of Management Education for creating a conducive environment in the institute for a purposeful education. I am grat gratef eful ul to Dr. assist stant ant dire direct ctor or for for his his encou encoura ragem gemen ent. t. I Dr. Taruna aruna Gautam Gautam, assi acknowledge my gratitude and indebt ness to my internal project guide Mr. Mr. Gurpreet Singh Sachdeva, Sachdeva, faculty of Institute of Management Education, who spared his precious

time in guiding me and for making valuable suggestions in compiling this project report.

I express my gratitude gratitude towards all those people who have helped me directly directly or indirectly indirectly in completing this report.

ARABINDA KAR  PGDM Roll no. - 7015

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ABSTRACT Even though mergers and acquisitions (M&A) have been an important element of corporate strategy all over the globe for several decades, research on M&As has not been able to  provide conclusive evidence on whether they enhance efficiency or destroy wealth. There is thus thus an ong ongoi oing ng glob global al debat debatee on the the effec effects ts of M&As M&As on firm firms. s. Merg Merger erss and and acquisitions have become common in India today. today. However, very little appears to be known about the long-term post-merger performance of firms in India, and the strategic factors that affect this performance. Our study attempts to fill this gap in knowledge about M&As in India. We have carried out statistical analyses of financial data pertaining to 87  pairs of merged firms. These mergers took place in the period 1996 to 2002. Out of these 87 mergers, 64 are between firms belonging to related industries and 23 to unrelated industries. Stock is the predominant method of payment for the acquired firm (in 76 out of  87 mergers), and transfer of corporate control has taken place in 37 of the 87 mergers. Fourteen of the acquired companies were sick and had been referred to the Board for  Industrial and Financial Reconstruction Rec onstruction (BIFR) at the time of their merger. The performance of mergers has been gauged in two ways in this study – by determ determini ining ng whether whether the long-t long-term erm post-m post-mer erger ger financi financial al perfor performan mance ce has changed changed significantly, and by assessing the wealth gains to shareholders of the acquiring, acquired and the combined firms on the announcement of mergers. It is found that the merged firms demonstrate improvement in long-term financial performance after controlling for premerger performance, with increasing cash flow returns post merger, at an annual rate of  4.3%. This improved operating cash flow return is on account of improvements in the postmerger operating margins of the firms, though not of the efficient utilization of the assets to generate higher sales. Increase in market power also appears to be driving gains through mergers mergers in India. As As far as wealth gains on merger merger announcement are concerned, only the shareholders of the acquired firms appear to be enjoying significant positive share price returns of 11.6%. The shareholders of the acquiring firms and the combined firms do not seem to be witnessing any significant change in returns. With regard to the strategic factors affect affecting ing long-t long-term erm post-m post-mer erger ger financi financial al perfor performan mance, ce, relate related d merger mergerss seem seem to be  performing 5.4% lower than unrelated mergers. Both the transfer of corporate control from

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the acquired firm to the acquiring firm, and the business health of the acquired firm are  positively related to the long-term post-merger performance of the firms. The relative size of the acquired firm and the method of payment for the acquired firm do not appear to be  playing a role in affecting post-merger performance. In the case of the effect of the strategic factors on the wealth gains on merger  announcement, we find that the mergers in which there is no transfer of corporate control seem to be conferring significant positive share price returns of 21.1% on the shareholders of the acquired firms. This is not the case for the shareholders of the acquiring firms and the combined firms. In the case of mergers where there is a transfer of management control, none none of thes thesee thre threee grou groups ps of shar shareh ehol olde ders rs witn witnes esse sess any any abno abnorm rmal al retu return rnss on annou announce nceme ment nt of the the mer merger. ger. Th Thee weal wealth th gain gainss to acqui acquire red d firm firm shar shareh ehol olde ders rs on announcement of a merger are positively influenced by the relative size and the pre-merger   performance of the acquired firm. The transfer of corporate control from the acquired firm to the acquiring firm is negatively associated with these abnormal share price returns. The level level of indust industryry-rel relate atednes dnesss of the acquire acquired d and the acquir acquiring ing firms, firms, the method method of   payment for the acquired firm and the business health of the acquired firm do not appear to  be playing a role in affecting the share price returns to the acquired firm shareholders, on announcement of a merger.

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CONTENTS CHAPTER I: INTRODUCTION .............................................................................

Background ………………………… ……………………………………………………… …………………………………... ……... Objective of the study…………………… study………………………………………………… …………………………………… ………

CHAPTER II: LITERATURE REVIEW …………………………………………

a) Global steel industry…… industry……………… …………………… …………………… …………………… …………………. ………...  b) Tata Vs Corus…………… Corus……………………… …………………… …………………… …………………… ……………….. …….. c) Arcellor Arcellor Vs Mittal……… Mittal………………… …………………… …………………… …………………… ……………… ……

CHAPTER III: RESEARCH METHODOLGY ………………………………….

................................................................ CHAPTER IV: DESCRIPTIVE WORK ................................................................ a) Valuation aluation of merger merger and acquisit acquisition ion ………………… …………………………… …………………. ……….  b) Tata Vs Corus Corus – Vision Visionary ary deal or Costly Costly blunder blunder ………………… …………………… … c) Arcellor-M Arcellor-Mittal ittal Vs Tata-C Tata-Corus orus ….………… ….…………………… …………………… …………….. ….. d) Competition Competition analys analysis is of steel steel industry industry………… …………………… …………………… ……………… …… e) SWOT Analysis…… Analysis……………… …………………… …………………… …………………… …………………… ………….. f) Expect Expected ed growth growth……… ……………… …………… …………… ……………… ……………… ……………… ……………. ……... g) Factors Factors holding back back Indian Indian steel industry industry……… ………………… …………………… ………………. ……. h) Recent financia financiall crisis crisis & Indian steel steel industry… industry…………… …………………… ………………. ……. i) Five-F Five-Forc orcee analys analysis is of stee steell indus industry try

CHAPTER V: CONCLUSIONS AND RECOMMENDATIONS ……………….

REFERENCES

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LIST OF TABLES AND FIGURES LIST OF FIGURES

Page no.

Figure 1…………….World 1…………….World steel production………………………… production………………………………………….25 ……………….25 Figure 2…………… Global steel capacity…………………… capacity……………………………………………26 ………………………26 Figure 3…………… Indian steel capacity…………………… capacity…………………………………………….28 ……………………….28 Figure 4…………… Indian steel production………………………………………….29 production………………………………………….29 Figure 5……………. Indian steel consumption………………………………………30 consumption………………………………………30 Figure 6…………… Motives…………………… Motives……………………………………………… ……………………………………44 …………44 Figure 7…………… Procedure of valuation…………………………………… valuation……………………………………….. ….. .46 Figure 8…………… Financing Merger…………………………………… Merger………………………………………………47 …………47 Figure 9……………..Key sector growth……………………… growth………………………………………………64 ………………………64 List of Tables

Table 1………………Steel production share……….…………… share……….…………………………………27 ……………………27 Table 2………………Steel consumption share……………………… share………………………………………..27 ………………..27 Table 3………………Tata steel capacity……………………………………………...32 Table 4………………Global steel output…………………………… output……………………………………………..51 ………………..51 Table 5………………Global steel ranking…………………………… ranking……………………………………………53 ………………53 Table 6……………….Tata-Corus 6……………….Tata-Corus Present capacity…………………… capacity…………………………………..54 ……………..54 Table 7……………….Tata-Corus 7……………….Tata-Corus projected capacity……………………… capacity………………………………...54 ………...54 Table 8……………….Corus Financials……………………… Financials………………………………………………56 ………………………56

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CHAPTER 1: INTRODUCTION

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Background Mergers and acquisitions (M&A) and corporate restructuring are a big part of the corporate finance world. Every day, investment bankers arrange M&A transactions, which bring separate companies together to form larger ones. When they're not creating big companies from smaller ones, corporate finance deals do the reverse and break up companies through spin-offs, carve-outs or tracking stocks. Not surprisingly, these actions often make the news. Deals can be worth hundreds of millions, or even billions, of dollars or rupees. They can dictate the fortunes of the companies involved for years to come. For a CEO, leading an M&A can represent the highlight of a whole career. And it is no wonder we hear about so many of these transactions; they happen all the time. Next time you flip open the newspaper’s business section, odds are good that at least one headline will announce some kind of M&A transaction. Sure, M&A deals grab headlines, but what does this all mean to investors ? To answer this question, this report discusses the forces that drive companies

to buy or merge with others, or to split-off or sell parts of their own businesses. Once you know the different ways in which these deals are executed, you'll have a better idea of  whether you should cheer or weep when a company you own buys another company - or is  bought by one. You will also be aware of the tax consequences for companies and for  investors Defining M&A The Main Idea one plus one makes three: this equation is the special alchemy of a merger 

or an acquisition. The key principle behind buying a company is to create shareholder value over and above that of the sum of the two companies. Two companies together are more valuable than two separate companies - at least, that's the reasoning behind M&A. This rationale is particularly alluring to companies when times are tough. Strong companies will act to buy other companies to create a more competitive, cost-efficient company. The companies will come together hoping to gain a greater market share or to achieve greater  efficiency. Because of these potential benefits, target companies will often agree to be  purchased when they know they cannot survive alone.

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Distinction between Mergers and Acquisitions

Alth Althoug ough h they they are are ofte often n utte uttere red d in the the same same brea breath th and used as thou though gh they they were were synonymous, the terms merger and acquisition mean slightly different things. When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the  buyer "swallows" the business and the buyer's stock continues to be traded. In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals." Both companies' stocks are surrendered and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler or Arcellor and Mittal ceased to exist when the two firms merged merged,, and a new company company,, Daimle DaimlerCh rChry rysle slerr and Arcell Arcellor or-Mi -Mitta ttal, l, was create created. d. In  practice, however, actual mergers of equals don't happen very often. Usually, one company will buy another and, as part of the deal's terms, simply allow the acquired firm to proclaim that the action is a merger of equals, even if it's technically an acquisition. Being bought out often carries negative connotations, therefore, by describing the deal as a merger, deal makers and top managers try to make the takeover more palatable. A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies. But when the deal is unfriendly - that is, when the target company does not want to be purchased - it is always regarded as an acquisition. Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is friendly or hostile and how it is announced. In other words, the real difference lies in how the purchase is communicated to and received by the target company's board of directors, employees and shareholders.

Synergy

Synergy is the magic force that allows for enhanced cost efficiencies of  the new business. Synergy takes the form of revenue enhancement and cost savings. By merging, the companies hope to benefit bene fit from the following:

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Staff reduc reductions tions - As every employee knows, mergers tend to mean job losses.

Consid Consider er all the money money saved saved from from reduci reducing ng the number number of staff staff members members from from accounting, marketing and other departments. Job cuts will also include the former  CEO, who typically leaves with a compensation package. 

Economies of scale - Yes, size matters. Whether it's purchasing stationery or a new

corporate IT system, a bigger company placing the orders can save more on costs. Mergers also translate into improved purchasing power to buy equipment or office supplies - when placing larger orders, companies have a greater ability to negotiate  prices with their suppliers. 

Acquiring new technology - To stay competitive, companies need to stay on top of 

technol technologi ogical cal develop developmen ments ts and their their busine business ss applic applicati ations ons.. By buying buying a smalle smaller  r  company company with unique unique technol technologi ogies, es, a large large company company can maintai maintain n or develop develop a competitive edge. 

Improved market reach and industry visibility - Companies buy companies to reach

new markets and grow revenues and earnings. A merge may expand two companies' marketing and distribution, giving them new sales opportunities. A merger can also improve a company's standing in the investment community: bigger firms often have an easier time raising capital than smaller ones.

That said, achieving synergy is easier said than done - it is not automatically realized once two companies merge. Sure, there ought to be economies of scale when two businesses are combined, but sometimes a merger does just the opposite. In many cases, one and one add up to less than two. Sadly, synergy opportunities may exist only in the minds of the corporate leaders and the deal makers. Where there is no value to be created, the CEO and investment bankers - who have much to gain from a successful M&A deal - will try to create an image of enhanced value. The market, however, eventually sees through this and  penalizes the company by assigning it a discounted share price. We'll talk more about why M&A may fail in a later section of this tutorial.

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Varieties of Mergers

From the perspective of business structures, there is a whole host of  different mergers. Here are a few types, distinguished by the relationship between the two companies that are merging: 

Horizontal merger - Two companies that are in direct competition and share the same

 product lines and markets. 

compan y or a supplier and a nd company. Think of a cone Vertical merger - A customer and company supplier merging with an ice cream maker.

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Market-extension Market-extension merger - Two companies that sell the same products in different

markets. 

Product-extension merger - Two companies selling different but related products in

the same market. 

Conglomeration - Two companies that have no common business areas. There are two

types of mergers that are distinguished by how the merger is financed. Each has certain implications for the companies involved and for investors: inve stors: 

Purchase Mergers - As the name suggests, this kind of merger occurs when one

company purchases another. The purchase is made with cash or through the issue of  some kind of debt instrument; the sale is taxable. Acquiring companies often prefer this type of merger because it can provide them with a tax benefit. Acquired assets can be written-up to the actual purchase price, and the difference between the book value and the purchase price of the assets can depreciate annually, reducing taxes payable by the acquiring company. We We will discuss this further in part four of this tutorial. 

Consolidation Mergers - With this merger, a brand new company is formed and both

companies are bought and combined under the new entity. The tax terms are the same as those of a purchase merger.

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Acquisitions

An acquisition may be only slightly different from a merger. In fact, it may be different in name name only only.. Like Like mer mergers, gers, acqui acquisi siti tion onss are are actio actions ns thro throug ugh h whic which h compan companie iess seek  seek  economies of scale, efficiencies and enhanced market visibility. Unlike all mergers, all acquisitions involve one firm purchasing another - there is no exchange of stock or  consolidation as a new company. Acquisitions are often congenial, and all parties feel satisfied with the deal. Other times, acquisitions are more hostile. In an acquisition, as in some of the merger deals we discuss above, a company can buy another company with cash, stock or a combination of the two. Another possibility, which is common in smaller  deals, is for one company to acquire a cquire all the assets of another company. Company X buys all of Company Y's assets for cash, which means that Company Y will have only cash (and debt, if they had debt before). Of course, Company Y becomes merely a shell and will eventually liquidate or enter another area of business. Another type of acquisition is a reverse merger, a deal that enables a private company to get publicly-listed in a relatively short short time time period period.. A revers reversee merger merger occurs occurs when when a privat privatee company company that that has strong strong  prospects and is eager to raise financing buys a publicly-listed shell company, usually one with no business and limited assets. The private company reverse merges into the public company, and together they become an entirely new public corporation with tradable shares. Regardless of their category or structure, all mergers and acquisitions have one common goal: they are all meant to create synergy that makes the value of the combined companies greater than the sum of the two parts. The success of a merger or acquisition depends on whether this synergy is achieved.

Valuation Matters

Investors in a company that is aiming to take over another one must determine whether the  purchase will be beneficial to them. In order to do so, they must ask themselves how much the company being acquired is really worth.  Naturally, both sides of an M&A deal will have different ideas about the worth of a target company: its seller will tend to value the company at as high of 

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a price as possible, while the buyer will try to get the lowest price that he can. There are, however, many legitimate ways to value companies. The most common method is to look  at comparable companies in an industry, industry, but deal makers employ a variety of other methods and tools when assessing a target company. Here are just a few of them: man y comparative metrics 1. Comparative Ratios - The following are two examples of the many on which acquiring companies may base their offers:

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Price-Earnings Ratio (P/E Ratio) - With the use of this ratio, an acquiring company makes an offer that is a multiple of the earnings of the target company. Looking at the P/E for all the stocks within the same industry group will give the acquiring company good guidance for what the target's P/E multiple should be.

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EnterpriseEnterprise-V Value-to-Sale alue-to-Saless Ratio (EV/Sales) (EV/Sales) - With With this ratio, the acquiring acquiring company makes an offer as a multiple of the revenues, again, while being aware of the price-tosales ratio of other companies in the industry. industry.

2. Replacement Cost

In a few cases, acquisitions are based on the cost of replacing the target company. For simplicity's sake, suppose the value of a company is simply the sum of all its equipment and staffing costs. The acquiring company can literally order the target to sell at that price, or it will create a competitor for the same cost. Naturally, it takes a long time to assemble good management, acquire property and get the right equipment. This method of  establishing a price certainly wouldn't make much sense in a service industry where the key assets - people and ideas - are hard to value and develop. 3. Discounted Cash Flow (DCF)

A key valuation tool in M&A, discounted cash flow analysis determ determine iness a company company's 's curren currentt value value accordi according ng to its estim estimate ated d future future cash cash flows. flows. Forecasted free cash flows (operating profit + depreciation + amortization of goodwill –  capital expenditures – cash taxes - change in working capital) are discounted to a present value using the company's weighted average costs of capital (WACC). Admittedly, DCF is tricky to get right, but few tools can rival this valuation method.

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Synergy: The Premium for Potential Success

For the most part, acquiring companies nearly always pay a substantial  premium on the stock market value of the companies they buy. The justification for doing so nearly always boils down to the notion of synergy; a merger benefits shareholders when a company's post-merger share price increases by the value of potential synergy. Let's face it, it would be highly unlikely for rational owners to sell if they would benefit more by not selling. That means buyers will need to pay a premium if they hope to acquire the company, regardless of what pre-merger valuation tells them. For sellers, that premium represents their company's future prospects. For buyers, the premium represents part of the postmerger synergy they expect can be achieved. The following equation offers a good way to think about synergy and how to determine whether a deal makes sense. The equation solves for the minimum required synergy:

In other words, the success of a merger is measured by whether the value of the buyer is enhanced by the action. However, the practical constraints of mergers, which discussed often prevent the expected benefits from being fully achieved. Alas, the synergy promised  by deal makers might just fall short. What to Look For - It's hard for investors to know when a deal is worthwhile. The burden

of proof should fall on the acquiring company. To find mergers that have a chance of  success, investors should start by looking for some of these simple criteria given as below. 

A reasonable purchase price - A premium of, say, 10% above the market price seems within the bounds of level-headedness. A premium of 50%, on the other hand, requires synergy of stellar proportions for the deal to make sense. Stay away from companies that participate in such contests.

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Cash Cash tran transa sact ctio ions ns - Compa Compani nies es that that pay in cash cash tend tend to be more more care carefu full when when calculating bids and valuations come closer to target. When stock is used as the currency for acquisition, discipline can go by the wayside.

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Sensible appetite – An acquiring company should be targeting a company that is smaller and in businesses that the acquiring a cquiring company knows intimately. Synergy Synergy is hard to create from companies in disparate business areas. Sad ly, ly, companies have a bad habit of biting off more than they can chew in mergers.

Mergers are awfully hard to get right, so investors should look for acquiring companies with a healthy grasp g rasp of reality. reality.

Doing the Deal Start with an Offer When the CEO and top managers of a company decide that they want

to do a merger or acquisition, they start with a tender offer. The process typically begins with with the acquiri acquiring ng company company carefully carefully and discre discreetl etly y buy buying ing up shares shares in the target target company, or building a position. Once the acquiring company starts to purchase shares in the open market, it is restricted to buying 5% of the total outstanding shares before it must file with the SEC. In the filing, the company must formally declare how many shares it owns owns and whet whethe herr it inte intend ndss to buy the comp company any or keep keep the the shar shares es pure purely ly as an investment. Working with financial advisors and investment bankers, the acquiring company will arrive at an overall price that it's willing to pay pa y for its target in cash, shares or   both. The tender offer is then frequently advertised in the business press, stating the offer   price and the deadline by which the shareholders in the target company must accept (or  reject) it. The Target's Target's Response

Once the tender offer has been made, the target company can do one of several things: 

Accept the Terms of the Offer - If the target firm's top managers and shareholders are

happy with the terms of the transaction, they will go ahead with the deal. 

Attempt to Negotiate - The tender offer price may not be high enough for the target

compa company ny's 's shar shareh ehol olde ders rs to acce accept pt,, or the the spec specif ific ic term termss of the the deal deal may not be attractive. In a merger, there may be much at stake for the management of the target their jobs, in particular. If they're not satisfied with the terms laid out in the tender offer, the target's management may try to work out more agreeable terms that let them keep

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their jobs or, even better, send them off with a nice, big compensation package. Not surprisingly, highly sought-after target companies that are the object of several bidders will have greater latitude for negotiation. Furthermore, managers have more negotiating  power if they can show that they are crucial to the merger's future success. 

Execute a Poison Pill or Some Other Hostile Takeover Defense  – A poison pill

schem schemee can can be trig trigge gere red d by a targ target et compa company ny when when a hosti hostile le suit suitor or acqui acquire ress a  predetermined percentage of company compan y stock. To To execute its defense, the target company grants all shareholders - except the acquiring company - options to buy additional stock  at a dramatic discount. This dilutes the acquiring company's share and intercepts its control of the company. company. 

Find a White Knight - As an alternative, the target company's management may seek 

out a friendlier potential acquiring company, or white knight. If a white knight is found, it will offer an equal or higher price for the shares than the hostile bidder.

Mergers and acquisitions can face scrutiny from regulatory bodies. For example, if the two  biggest long-distance companies in the U.S., AT&T and Sprint, wanted to merge, the deal would require approval from the Federal Communications Commission (FCC). The FCC would probably regard regard a merger merger of the two giants as the creation of a monopoly monopoly or, at the very least, a threat to competition in the industry. industry.

Closing the Deal

Finally, once the target company agrees to the tender offer and regulatory requirements are met, the merger deal will be executed by means of some transaction. In a merger in which one company buys another, the acquiring company will  pay for the target company's shares with cash, stock or both. A cash-for-stock transaction is fairly straightforward: target company shareholders receive a cash payment for each share  purchased. This transaction is treated as a taxable sale of the shares of the target company. If the transaction transaction is made with stock instead of cash, then it's not taxable. There is simply an exchange of share certificates. The desire to steer clear of the tax man explains why so many M&A deals are carried out as stock-for-stock transactions. When a company is  purchased with stock, new shares from the acquiring company's stock are issued directly to

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the target company's shareholders, or the new shares are sent to a broker who manages them for target company shareholders. The shareholders of the target company are only taxed when they sell their new shares. When the deal is closed, investors usually receive a new stock stock in their their portfo portfolio lioss - the acquiri acquiring ng company company's 's expande expanded d stock. stock. Sometim Sometimes es investors will get new stock identifying a new corporate entity that is created by the M&A deal. Break Ups

As mergers capture the imagination of many investors and companies, the idea of getting smaller smaller might seem counterintuitiv counterintuitive. e. But corporate break-ups, break-ups, or de-mergers, de-mergers, can be very attractive options for companies and their shareholders. Advantages

The rationale behind a spin-off, tracking stock or carve-out is that "the  parts are greater than the whole." These corporate restructuring techniques, which involve the separation of a business unit or subsidiary from the parent, can help a company raise additional equity funds. A break-up can also boost a company's valuation by providing  powerful incentives to the people who work in the, making it more difficult to attract interest interest from instituti institutional onal investors. investors. Meanwhile, Meanwhile, there are the extra costs that the parts of  the business face if separated. When a firm divides itself into smaller units, it may be losing the separating unit, and help the parent's management to focus on core operations. Most importantly, shareholders get better information about the business unit because it issues separate financial statements. This is particularly useful when a company's traditional line of business differs from the separated business unit. With separate financial disclosure, investors are better equipped to gauge the value of the parent corporation. The parent company might attract more investors and, ultimately, more capital. Also, separating a subsid subsidiary iary from its parent parent can reduce reduce intern internal al competi competiti tion on for corpor corporate ate funds. funds. For  investors, that's great news: it curbs the kind of negative internal wrangling that can compromise compromise the unity and productivity productivity of a company. company. For employees employees of the new separate entity, there is a publicly traded stock to motivate and reward them. Stock options in the  parent often provide little incentive to subsidiary managers, especially because their efforts are buried in the firm's overall performance.

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Disadvantages

That said, de-merged firms are likely to be substantially smaller than their parents, possibly making it harder to tap credit markets and costlier finance that may  be affordable only for larger companies. And the smaller size of the firm may mean it has less representation on major indexes synergy that it had as a larger entity. For instance, the division of expenses such as marketing, administration and research and development (R&D) into different business units may cause redundant costs without increasing overall revenues. Restructuring Methods

There are several restructuring methods: doing an outright sell-off, doing an equity carve-out, carve-out, spinning off a unit to existing existing shareholders shareholders or issuing issuing tracking stock. Each has advantages and disadvantages for companies and investors. All of these deals are quite complex. Sell-Offs

A sell-off, also known as a divestiture, is the outright sale of a company subsidiary. Normally, sell-offs are done because the subsidiary doesn't fit into the parent company's core strategy. The market may be undervaluing the combined businesses due to a lack of synergy between the parent and subsidiary. As a result, management and the board decide decide that that the subsid subsidiary iary is better better off off under under differ different ent owners ownership hip.. (IPO) (IPO) of shares shares,, amounting to a partial sell-off. A new publicly-listed company is created, but the parent keeps a controlling stake in the newly traded subsidiary. A carve-out is a strategic avenue a  parent firm may take when one of its subsidiaries is growing faster and carrying higher  valuations than other businesses owned by the parent. A carve-out generates cash because shares in the subsidiary are sold to the public, but the issue also unlocks the value of the subsidiary unit and enhances the parent's shareholder value. The new legal entity of a carve-out has a separate board, but in most carve-outs, the parent retains some control. In these cases, some portion of the parent firm's board of directors may be shared. Since the   parent parent has a control controllin ling g stake, stake, meanin meaning g both both firms firms have common common shareh sharehold olders ers,, the connection connection between the two will likely be strong. strong. That said, sometimes sometimes companies carveout a subsidiary not because it's doing well, but because it is a burden. Such an intention won't lead to a successful result, especially if a carved-out subsidiary is too loaded with

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debt, or had trouble even when it was a part of the parent and is lacking an established track  record for growing revenues and profits. Carve-outs can also create unexpected friction   between the parent and subsidiary. Problems can arise as managers of the carved-out company must be accountable to their public shareholders as well as the owners of the  parent company. This can create divided loyalties. Spin-offs

A spin-off occurs when a subsidiary becomes an independent entity. The parent firm distributes shares of the subsidiary to its shareholders through a . Since this transaction is a dividend distribution, no cash is generated. Thus, spin-offs are unlikely to be used when a firm needs to finance growth or deals. Like the carve-out, the subsidiary becomes a separate legal entity with a distinct management and board. Besides getting rid of an unwanted subsidiary, subsidiary, sell-offs also raise cash, which can be used to pay off  debt. In the late 1980s and early 1990s, corporate would use debt to finance acquisitions. Then, after making a purchase they would sell-off its subsidiaries to raise cash to service the debt. The raiders' method certainly makes sense if the sum of the parts is greater than the whole. When it isn't, deals are unsuccessful. Equity Carve-Outs

More and more companies are using equity carve-outs to boost shareholder  value. A parent firm makes a subsidiary public through a raider’s initial public offering stock dividend meaning they don't grant shareholders the same voting rights as those of the main stock. Each share of tracking stock may have only a half or a quarter of a vote. In rare cases, cases, holders holders of tracking tracking stock have no vote at all. Like carve-outs, carve-outs, spin-offs spin-offs are usually about separating a healthy operation. In most cases, spin-offs unlock hidden shareholder  value. For the parent company, it sharpens management focus. For the spin-off company, management doesn't have to compete for the parent's attention and capital. Once they are set free, managers can explore new opportunities. Investors, however, should beware of  throw-away subsidiaries the parent created to separate legal liability or to off-load debt. Once spin-off shares are issued to parent company shareholders, some shareholders may be tempted to quickly dump these shares on the market, depressing the share valuation.

20

Tracking Stock 

A tracking stock is a special type of stock issued by a publicly held company to track the value of one segment of that company. The stock allows the different segments of  the company to be valued differently by investors. Let's say a slow-growth company trading at a low (P/E ratio) happens to have a fast growing business unit. The company might issue a tracking stock so the market can value the new business separately from the old one and at a significantly higher P/E rating. Why would a firm issue a tracking stock  rather rather than than spinnin spinning-o g-off ff or carvin carving-o g-out ut its fast fast growth growth busine business ss for shareh sharehold olders ers?? The company retains control over the subsidiary; the two businesses can continue to enjoy synergies and share marketing, administrative support functions, a headquarters and so on. Finally, Finally, and most importantly, importantly, if the tracking stock climbs in value, v alue, the parent company c ompany can use the tracking stock it owns to make acquisitions. Still, shareholders need to remember  that tracking stocks are price-earnings ratio class B Why They Can Fail

It's no secret that plenty of mergers don't work. Those who advocate mergers will argue that the merger will cut costs or boost revenues by more than enough to justify the price premium. It can sound so simple: just combine computer systems, merge a few departments, use sheer size to force down the price of supplies and the merged giant should  be more profitable than its parts. In theory, 1+1 = 3 sounds great, but in practice, things can go awry. Historical trends show that roughly two thirds of big mergers will disappoint on their own terms, which means they will lose value on the stock market. The motivations that drive mergers can be flawed and efficiencies from economies of scale may   prove prove elusiv elusive. e. In many cases, cases, the proble problems ms associ associate ated d with with trying trying to make make merged merged companies work are all too concrete. Flawed Intentions

For starters, a booming stock market encourages mergers, which can spell trouble. Deals done with highly rated stock as currency are easy and cheap, but the strategic thinking behind them may be easy and cheap too. Also, mergers are often attempt to imitate: somebody else has done a big merger, which prompts other top executives to follow suit. A merger merger may often o ften have more to do with glory-seeking than business strategy. strategy.

21

The executive ego, which is boosted by buying the competition, is a major force in M&A, especially when combined with the influences from the bankers, lawyers and other assorted advisers advisers who can earn big fees from clients clients engaged in mergers. mergers. Most CEOs get to where they are because they want to be the biggest and the best, and many top executives get a big  bonus for merger deals, no matter what happens happen s to the share price later. On the other side of  the coin, mergers can be driven by generalized fear. Globalization, the arrival of new technological developments or a fast-changing economic landscape that makes the outlook  uncertain are all factors that can create a strong incentive for defensive mergers. Sometimes the management team feels they have no choice and must acquire a rival before being acquired. The idea is that only big players will survive a more competitive world. The Obstacles to making it Work 

Coping with a merger can make top managers spread their time too thinly and neglect their core business, spelling doom. Too often, potential difficulties seem trivial to managers caught up in the thrill of the big deal. The chances for success are further  hampered if the corporate cultures of the companies are very different. When a company is acquired, the decision is typically based on product or market synergies, but cultural differences are often ignored. It's a mistake to assume that personnel issues are easily overcome. For example, employees at a target company might be accustomed to easy access to top management, flexible work schedules or even a relaxed dress code. These aspects of a working environment may not seem significant, but if new management removes them, the result result can be resentment resentment and shrinking shrinking productivity productivity.. More insight into the failure of mergers is found in the highly acclaimed study from McKinsey, a global consultancy. The study concludes that companies often focus too intently on cutting costs following mergers, while revenues, and ultimately, profits, suffer. Merging companies can focus focus on integr integrati ation on and cost-c cost-cutt utting ing so much much that that they neglect neglect day-to day-to-day -day busines business, s, thereby prompting nervous customers to flee. This loss of revenue momentum is one reason so many mergers fail to create value for shareholders. But remember, not all mergers fail. Size and global reach can be advantageous, and strong managers can often squeeze greater  efficiency out of badly run rivals. Nevertheless, the promises made by deal makers demand the careful scrutiny of investors. The success of mergers depends on how realistic the deal

22

makers are and how well they can integrate two companies while maintaining day-to-day operations.

23

Objective of the Study



Gain an in-depth knowledge about various corporate valuation techniques.



Critically examine the rationale behind be hind the acquisition of o f Corus by Tata Steel.



Understand the advantages and disadvantages d isadvantages of cross-border acquisitions.



Understand the need for growth through acquisitions in foreign countries.



Study the regulations regulations governing governing mergers mergers & acquisition acquisitionss in the case of a cross-borde cross-border  r  acquisition.



Get insights into the consolidation trends in the Indian and global steel industries.

24

Literature Review – The steel industry

THE GLOBAL STEEL INDUSTRY

The current global steel industry is in its best position in comparing to last decades. The  price has been rising continuously. The demand expectations for steel products are rapidly growing for coming years. The shares of steel industries are also in a high pace. The steel industry is enjoying its 6 th consecutive years of growth in supply and demand. And there is many more merger and acquisitions which overall buoyed the industry and showed some good results. The subprime crisis has lead to the recession in economy of different Countries, which may lead to have a negative effect on whole steel industry in coming years years.. Howeve Howeverr steel steel produc productio tion n and consump consumptio tion n will will be suppor supported ted by continu continuous ous economic growth.

CONTRIBUTION OF COUNTRIES TO GLOBAL STEEL INDUSTRY

Fig-1

25

The countries like China, Japan, India and South Korea are in the top of the above in steel  production in Asian countries. China accounts for one third of total production i.e. 419m ton, Japan accounts for 9% i.e. 118m ton, India accounts for 53m ton and South Korea is accounted for 49m ton, which all totally becomes more than 50% of global production. Apart from this USA, BRAZIL, UK accounts for the major chunk of the whole growth. Thee steel Th steel indus industr try y has has been been witn witnes essi sing ng robu robust st grow growth th in both both domes domesti ticc as well well as international markets. In this article, let us have a look at how has the steel industry  performed globally in 2007.

Capacity: The global crude steel production capacity has grown by around 7% to 1.6 bn in

2007 from 1.5 bn tonnes in 2006. The capacity has shown a growth rate of 7% CAGR since 2003. The additions to capacity over last few years have ranged from 36 m tonnes in 2004 to 108 m tonnes in 2007. Asian region accounts for more than 60% of the total production capacity of world, backed mainly by capacity in China, Japan, India, Russia and South Korea. These nations are among the top steel producers in the world.

Fig-2 Production: The global steel production stood at 1.3 bn tonnes in 2007, showing an

increase of 7.5% as compared to 2006 levels. The global steel production showed a growth of 8% CAGR between 2003 and 2007. China accounts for around 36% of world crude steel  production followed by Japan (9%), US (7%), Russia (5%) and India (4%). In 2007, all the 26

top five steel producing countries have showed an increase in production except US, which showed a decline.

Rank

Country

Production (mn tonnes)

World share (%)

1

China

48 9

36.0%

2

Japan

1 20

9.0%

3

US

98

7.0%

4

Russia

72

5.0%

5

India

53

4.0%

6

South Korea

51

3.5% Source: JSW Steel AR FY08

Table-1 consumption grew by 6.6% to 1.2 bn tonnes as compared Consumption: The global steel consumption to 2006 levels. The global finished steel consumption showed a growth of 8% CAGR, in line line with with the the prod produc ucti tion on,, betw betwee een n the the peri period od 2003 2003 and and 2007 2007.. Th Thee fini finish shed ed stee steell consumption in China and India grew by 13% and 11% respectively in 2007. The BRIC countries were the major demand drivers for steel consumption, accounting for nearly 80% of incremental steel consumption in 2007. Rank

Country

Consumption (mn tonnes)

World share (%)

1

China

4 08

36.0%

2

US

10 8

9.0%

3

Japan

80

6.7%

4

South Korea

55

4.6%

5

India

51

4.2%

6

Russia

40

3.3% Source: JSW Steel AR FY08

Table-2 Outlook: As per IISI estimates, the finished steel consumption in world is expected to

reach a level of 1.75 bn tonnes by 2016, growth of 4% CAGR over the consumption consumption level of 2007. The steel consumption in 2008 and 2009 is estimated to grow above 6%

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Indian Steel Industry India, which has emerged among the top five steel producing and consuming countries over  the last few years, backed by b y strong growth in its economy. economy. Capacity: Steel capacity increased by 6% to 60 m tonnes in FY08. It registered a robust

growth of 8% CAGR between the period FY04 and FY08. The capacity expansion in the country was primarily through brown field expansions as it requires lower investments than a greenfield expansion.

Fig-3

Production: Steel production has registered a growth of 6% to reach a level of 54 m tonnes

in FY8. The production has grown nearly in line with the capacity expansion and registered a growth of 7% CAGR with an average capacity utilization of 92% between the period FY04 FY04 and and FY08 FY08.. Indi Indiaa is curre current ntly ly the the fift fifth h lar largest gest produ produce cerr of steel steel in the the worl world, d, contributing almost 4% of the total steel production in world. The top three steel producing companies (SAIL, Tata Steel and JSW Steel) contributed around 45% of the total steel  production in FY08.

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Fig-4

Consumption: Steel consumption has increased by 10% to 51.5 m tonnes in FY08.

Consumption Consumption growth has been exceeding production growth since past few years. It grew at a CAGR of 12% between FY04 and FY08. Construction & infrastructure, manufacturing and automobile sectors accounted for 59%, 13% and 11% for the total consumption of steel respectively in FY08. Although steel consumption is rapidly growing in the country, country, the per  capita steel consumption still stands at 48 kgs. Moreover, in the rural areas in the country, country, it stands at a mere 2 kg. It should be noted that the world’s average per capita steel consumption was 189 kg and while that of China was 309 kg in 2007.

29

Fig-5 Trade equations: equ ations: India became net importer of steel in FY08 with estimated net imports of 

1.9 m tonnes. In the past few years, its exports have remained at more or less the same levels while on the other hand, imports have increased on the back of robust demand and capacity constraints in the domestic markets. The imports showed a growth of around 48% while exports declined by around 6% in FY08. Outlook: As per IISI estimates, the demand for steel in India are expected to grow at a rate

of 9% and 12% in 2008 and 2009. The medium term outlook for steel consumption remains extremely bullish and is estimated at an average of above 10% in the next few years.

Tata Vs Corus Corus

The Corus was created by the merger of British Steel and Dutch steel company, Hoogovens. Corus was Europe’s second largest steel producer with a production of 18.2 million tonnes and revenue of GDP 9.2 billion (in 2005). The product mix consisted of  Strip steel products, Long products, Distribution and building system and Aluminum. With the merger of British Steel and Hoogovens there were two assets the British plant asset which was older and less productive and the Dutch plant asset which was regarded as the crown jewel by every one in the industry. They have union issues and are burdened with more than $ 13 billion of pension liabilities. The Corus was making only a profit of $ 1.9  billion from its 18.2 million tonnes production per year (compared to $ 1.5 billion form 8.7 million tone capacity by Tata). The Corus was having leading market position in construction and  packaging in Europe with leading R&D. The Corus was the 9th largest steel producer in the world. It opened its bid for 100 % stake late in the 2006. Tata (India) & CSN (Companhia Siderurgica

Nacional)

emerged

as

most

powerful

bidders.

CSN (Companhia Siderurgica Nacional)

CSN (Companhia Siderurgica Nacional) was incorporated in the year 1941. The company initially focused on the production of coke, pig iron castings and long products.

30

The company was having three main expansions at the Presidente Vargas Steel works during the 1970’s and 1980’s. The first completed in the year 1974, increased installed capacity capacity to 1.6 million tons of crude steel. The second completed in 1977, raised raised capacity to 2.4 million tons of crude steel. The third completed in the year 1989, increased capacity to 4.5 million tons of crude steel. The company was privatized by the Brazilian government  by selling 91 % of its share. The Mission of CNS is to increase value for the shareholders. Maintain  position as one of the world’s lowest-cost steel producer. Maintain a high EBITDA and strengt strengthen hen positi position on as a global global player player.. CNS is having having fully fully integr integrate ated d manufa manufactu cturin ring g facilities. The crude steel capacity was 5.6 million tons. The product mix consisted of  Slabs, Hot and Cold rolled Galvanized and Tin mill products. In 2004 CSN sold steel  products to customers in Brazil and 61 other countries. In 2002, 65 % of the steel sales were in domestic market and operating ope rating revenues were 70 %. In 2003, 2 003, the same figures were 59 % and 61 % and in 2004 the same figures figures were were 71% and 73 %. The principal principal export export mar markets kets

for

CSN CSN

wer were

Nort orth

Amer Ameriica

(44% (44%)),Eur ,Europ ope( e(32 32%) %)

and and

Asia( sia(1 11%). 1%).

Tata Steel

Tata steel, India’s largest private sector steel company was established in the 1907.The Tata steel which falls under the umbrella of Tata sons has strong pockets and strong financials to support acquisitions. Tata steel is the 55th in production of steel in worl world. d. Th Thee

com company pany has has comm commiitted tted itse itself lf to

atta attaiin

Production capacity of Tata steel is given in the table below:-

31

glob global al scal cale

oper operat atio ions ns..

Table-3 The product mix of Tata steel consist of flat products and long products which are in the lower value chain. The Tata steel is having a low cost of production when compared to Corus. Corus. The Tata steel steel was already already having its capacit capacity y expans expansion ion with with its indigenous indigenous  projects to the tune of 28 million tones.

Indian Scenario

After liberalization, there have been no shortages of iron and steel materials in the country. Apparent consumption of finished (carbon) steel increased from 14.84 Million tonnes in 1991-92 to 39.185 million tonnes (Provisional) in 2005-06. The steel industry

32

which was facing a recession for some time has staged a turn around since the beginning of  2002. Demand has started showing an uptrend on account of infrastructure boom. The steel industry is buoyant due to strong growth in demand particularly by the demand for steel in China. The Steel industry was de-licensed and de-controlled in 1991 & 1992 respectively. Today, India is the 7th largest crude steel producer of steel in the world. In 2005-06,  production of Finished (Carbon) Steel was 44.544 million tonnes. Production of Pig Iron in 2005-06 was 4.695 Million Tonnes. The share of Main Producers (i.e. SAIL, RINL and TSL) and secondary producers in the total production of Finished (Carbon) steel was 36% and 64% respectively during the period of April-November, April-November, 2006. Corus decides to sell Reasons for decision: 

Total debt of Corus is 1.6bn GBP



Corus needs supply of raw material at lower cost



Though Corus has revenues of $18.06bn, its profit was just $626mn (Tata’s revenue was $4.84 bn & profit $ 824mn)

 

Corus facilities were relatively old with high cost of production Employee cost is 15 %( Tata Tata steel- 9%)

Tata Decides to bid: Reasons for decision: 

Tata is looking to manufacture finished products in mature markets of Europe.



At pre presen sentt man manufa ufactu ctures res low value lon long g and fla flatt ste steel el pro produc ducts ts whi while le Cor Corus us  produces high value stripped products



A diversified product mix will reduce risks while higher end products will add to  bottom line.



Corus holds a number of patents and R & D facility. facility.



Cost of acquisition is lower than setting up a green field plant and marketing and distribution channels



Tata is known for efficient handling of labour and it aims at reducing employee cost and improving productivity at Corus



It had already expanded its capacities in India.



It will move from 55th in world to 5th in production of steel globally.

33

Tata Steel Vs CSN: The Bidding War

There was a heavy speculation surrounding Tata Steel's proposed takeover of  Corus ever since Ratan Tata had met Leng in Dubai, in July 2006. On October 17, 2006, Tata Steel made an offer of 455 pence a share in cash valuing the acquisition deal at US$ 7.6 billion. Corus responded positively to the offer on October 20, 2006. Agreeing to the takeover, Leng said, "This combination with Tata, for Corus shareholders and employees alike, represents the right partner at the right time at the right price and on the right terms." In the first week of November 2006, there were reports in media that Tata was joining hands with Corus to acquire the Brazilian steel giant CSN which was itself  keen on acquiring Corus. On November 17, 2006, CSN formally entered the foray for  acquiring Corus with a bid of 475 pence per share. In the light of CSN's offer, Corus announced that it would defer its extraordinary meeting of shareholders to December 20, 2006 from December 04, 2006, in order to allow counter offers from Tata Steel and CSN... Financing the Acquisition

By the first week of April 2007, the final draft of the financing structure of the acquisition was worked out and was presented to the Corus' Pension Trusties and the Works Council by the senior management of Tata Steel. The enterprise value of Corus including debt and other costs was estimated at US$ 13.7 billion The Integration Efforts

Industry experts felt that Tata Steel should adopt a 'light handed integration’ approach, which meant that Ratan Tata should bring in some changes in Corus but not attempt a complet completee overha overhaul ul of Corus' Corus'sy syste stems ms (Refer (Refer Exhibi Exhibitt XI and Exhibit Exhibit XII for project projected ed financials of Tata-Corus). N Venkiteswaran, Professor, Indian Institute of Management, Ahmedabad said, “If the target company is managed well, there is no need for a heavyhanded integration. It makes sense for the Tatas to allow the existing management to continue as before. The Synergies

Most experts were of the opinion that the acquisition did make strategic sense for Tata Steel. After successfully acquiring Corus, Tata Steel became the fifth largest   produ producer cer of steel steel in the world, world, up from from fiftyfifty-six sixth th positi position.T on.Ther heree were were many likely likely synergies between Tata Steel, the lowest-cost producer of steel in the world, and Corus, a

34

larg largee play player er with with a sign signif ific ican antt pres presen ence ce in valu valuee-ad adde ded d steel steel segm segmen entt and a stro strong ng distribution network in Europe. Among the benefits to Tata Steel was the fact that it would  be able to supply semi-finished steel to Corus for finishing at its plants, which were located closer to the high-value markets. The Pitfalls

Though the potential benefits of the Corus deal were widely appreciated, some analysts had doubts about the outcome and effects on Tata Steel's performance. They pointed out that Corus' EBITDA (earnings before interest, tax, depreciation and amortization) at 8 percent was much lower than that of Tata Steel which was at 30 percent in the financial year 200607. The Road Ahead

Before the acquisition, the major market for Tata Steel was India. The Indian market account accounted ed for sixty nine percen percentt of the company company's 's total total sales. sales. Almost Almost half half of Corus' Corus'  production of steel was sold in Europe (excluding UK). The UK consumed twenty nine  percent of its production.

After the acquisition, the European market (including UK) would consume 59 percent of  the merged entity's total production.

35

Arcellor- Mittal Deal

A new steel steel giant is to be created out of a bitter battle, after Arcelor formally agreed on a  €26.5 billion takeover by rival Mittal Steel. The deal combines Arcelor - a symbol of  successful successful,, pan-European pan-European cooperation and economic economic revival, revival, with operations that span Luxembourg, Luxembourg, Belgium, Belgium, France and Spain - with a fast- growing conglomerate conglomerate founded by the India-born Lakshmi Mittal, who built a fortune turning around sick steel plants in rapidly expanding markets from Trinidad to Kazakhstan. Kaza khstan. The deal, valued at $33.1 billion, is the latest sign that shareholder activism is marching through the once staid and sleepy boardrooms of Europe. The agreement to pair  with Mittal caps a wrenching turnaround for Arcelor's management, which once dismissed Mittal as a "company of Indians" but was forced to backtrack after shareholders threatened to revolt. Politicians in Europe who once criticized Mittal have remained mum in recent days, and the merger brings hope that protectionist barriers against such deals may be eroding in Europe. Mittal is paying €40.37 a share for Arcelor, nearly double what the company was trading at when Mittal first made an offer in January. The new company named Arcelor-Mittal and headquartered in Luxembourg. Joseph Kinsch, chairman of Arcelor, is chairman of the new company, company, and succeeded by Mittal when Kinsch retires next year. "It's been a long struggle," for investors and Mittal board member. "Now that we have had an opportunity to be inside, with management’’.The deal would create "global leadership in steel" not just by ton but by value. Getting to this point has involved a bruising fight for both sides. Mittal first made an unexpected €18.6 billion offer for Arcelor and was swiftly and harshly rebuked by Arcelor management and a chorus of European politicians who criticized everything from his grammar to his Indian origins to the quality of his company's steel. Arcelor's bare-

36

knuckled knuckled defense defense strategy strategy included refusing refusing to meet with Mittal until a string string of demands were met, and simultaneou simultaneously sly orchestrating orchestrating a €13 billion deal with Severstal Severstal of Russia to keep him away.

The case……



Mittal makes surprise €18.6 billion bid for Arcelor in January 2006



Arcelor management announce large dividend



Arcelor makes very positive profit report, which is later found to be inflated



Arcelor makes rosy forecast for future performance



Arcelor management and European politicians criticize Mittal



Arcelor management refuses to meet with Mittal until a string of demands were met



Arcelor tries to get Luxembourg government to write a takeover law shutting out Mittal



Arcelor unions fear job cuts, reduction in social standards



Arcelor managers fear Mittal will shift emphasis from long- to short-term goals



Arcelor Arcelor commits commits to buy North American American steel company that will cause Mittal Mittal anti-trust problems o



Agreement contains clause making it costly to not go through with sale

Arcelor made €13 billion deal with Severstal of Russia, including break-up fee of €140 million



Arcelo Arcelorr, Mittal Mittal,, and Severs Severstal tal engage engage in heavy heavy adverti advertisin sing, g, meetin meetings gs with with investors and politicians



Arcelo Arcelorr arrange arrangess for shareh sharehold older er meetin meeting g where where Severs Severstal tal deal would would be approved unless 50% plus one of shareholders were present and voted it down, an unusually high percent. The meeting isn’t scheduled until after Severstal deal has been nearly finalized.

37



Mittal Mittal raises raises offer offer to €26 €26.5 .5 billion, billion, and agreed to cede some some managemen managementt control and family voting rights o

nearly double the price per Arcelor share Arcelor was trading at prior to Mittal’s Mittal’s bid in January



Arcelo Arcelor’ r’ss instit instituti utional onal shareh shareholde olders rs and hedge hedge funds funds voice voice disapp disapprov roval al in Severstal deal, support Mittal deal o

Arcelo Arcelorr managem management ent fears fears shareh sharehold olders ers will will vote vote down down share share buyback  buyback  necessary for Severstal deal to go through

o



Shareholders threaten to oust Arcelor management and sue Arcelor board

Six percent of Arcelor shareholders sued Arcelor’s board for selling for too low a price o

Unlikely to succeed, given very high premium on Arcelor shares relative to  pre-takeover-battle price



Arcelor-Mittal sells valuable Maryland steel mill in August 2007 to satisfy U.S. anti-trust authorities

38

CHAPTER – 3: RESEARCH METHODOLOGY

39

Research Methodology Most sciences ha have ve th thei eirr ow own n sp speci ecifi ficc scient scientific ific metho methods ds,, wh whic ich h ar aree su supp ppor orte ted d by methodologies (i.e., rationale that support the method's validity). The social sciences are methodologically diverse using qualitative qualitative,, quantitative quantitative,, and mixedmethods appr approach oaches. es. Qua Qualit litati ative ve met methods hods inc includ ludee the ca case se st study udy,,  phenomenology  phenomenology,, grounded theory, and ethnography, among others. Quantitative methods include hypothesis testing,,  powe testing  powerr analy analysis sis,, Ratio analysis, analysis, observational studies, studies, re sampling, sampling, randomized controlled contro lled trial trialss, regres regression sion analys analysis is,, multi multilevel level modeli modeling ng,, and high-d high-dimens imensional ional data analysis,, among others. analysis

Types of Research

The research study under consideration is exploratory type. Basically there are two broad kinds of researches



Expl Ex plor orat ator ory y Res Resea earc rch h:

Thiis see Th seeks ks to disc discov over er new new rel relat atiions onships hips..



Conc Concllusiv usivee Res Resea earc rch h :

It is is des desig igne ned d to to hel help p exe execu cuttive ive cho choos osee the the var various ious Course of action.

As research design applicable to exploratory studies are different from objectives firmly in mind while designing the research. Which searching for hypothesis, exploratory designs are appropriate; when hypothesis have been established and are to be listed, conclusive designs are needed. It should be noted however, that the research process tends to become circular  over a period of time. Exploratory Ex ploratory research may define hypothesis, which are then tested b y

40

conclusive conclusive research; research; but a by product of the conclusive conclusive research may be a suggestion of a new opportunity or o r a new n ew difficulty. difficulty. Other Other char charact acter eris isti tics cs of explo explora rato tory ry rese resear arch ch are are flexi flexibi bili lity ty and inge ingenui nuity ty,, whic which h characterize the investigation. As we proceed with the investigating it must be on the alert to recognize new ideas, as it can then swing the research in the new direction until they have exhausted it or have found a better idea. Thus they may be constantly changing the focus of invest as new possibilities come to attention. It should be added here h ere that formal design in the researcher is the key factor. factor.



Study of secondary sources of information.

The reason for selecting this mode of research for this type is that it’s a probably quickest and most economical way for research to find possible hypothesis and to take advantage of  the work of to others and utilize their own earlier efforts. Most large companies that have mainta maintaine ined d marketi marketing ng resear research ch program programss over a number number of years years have have accumul accumulate ated d significant libraries of research organizations furnishing continuing data.

Procedure As it is a secondary research, all the data is selected after rigorous analysis of articles from newspapers, magazines and internet. All the research collected is done by professional analyst across the world and is compiled in this project to understand the financial and business impact of merger and acquisition more effectively.

41

CHAPTER 4: DESCRIPTIVE WORK 

42

Valuation of Merger and acquisition A merger is a combination of two corporations in which only one corporation survives and the merged corporation goes out of subsistence. Alternatively, in merger two corporations combine and share their resources in order to accomplish mutual objectives and both companies bring their own shareholders, employees, customers and the community at large. Acquisition takes place when one firm is purchasing the assets or shares of another  company.

Mergers are often categorised as horizontal, vertical, or conglomerate. A horizontal merger  is one that takes place between two firms in the same line of business whereas vertical merger involves companies at different stages of production. The buyer expands backwards in the direction of the source of the raw material or forward in the direction of the customer customer.. The last one, i.e., conglomerate conglomerate merger involves companies companies in unrelated line of   business.  business. This distinction distinction is very much necessary to make and understand understand the reasons reasons for  the mergers.

The scale and the pace at which merger activities are coming up are remarkable. The recent  booms in merger and acquisitions suggest that the organisations are spending a significant amount of time and money either searching for firms to acquire or worrying about whether  some other firm will acquire them. Also, mergers are regarded as one of the activities the  purpose of business expansion or a measure of external growth in contrast to internal growths. The recent phenomenon booms in mergers and acquisitions would increase at a much faster rate in near future because the world markets are becoming more integrated  because of open trade policies and hence more and more companies are adopting and

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forming strategic alliances in order to compete in the competitive world and to maintain there market shares.

Merger and acquisition decision is an investment decision. This is the most important decision, which influences both the acquiring firm and the target firm, which is to be acquired. An organization cannot make that crucial decision without incisive analysis by financial planners and corporate managers. The acquiring firm must correctly value the firm to be acquired and the acquired firm must get the returns for the goodwill they have create created d over the years years in the market. market. Growth Growth through through acquis acquisiti ition on is occurr occurring ing in an unprecedented number of companies today as strategic acquisitions replace the once prevalent hostile takeovers by corporate raiders. In the current business environment, it is vital to understand how to blend strategic and financial concepts to evaluate potential acquisitions. Motives

The findings from the theoretical material and the empirical investigation will be analyzed  both horizontally and vertically according to the following: -

Fig-6

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There are two types of motives involved in merger and acquisition and these are Explicit and Implicit motives. Explicit Motives 

Synergy: Synergy means that the merged firm will have a greater value than

the sum of its parts as a result of enhanced enh anced revenues and the cost base. 

Economies of Scale: Economic of scale refer to the reduction in unit cost

achieved by producing a large volume of a product. Horizontal mergers aim at achievi achieving ng economi economies es of scale. scale. This This phenome phenomenon non continu continues es while while the firm firm grows to its optimal size, after which a firm experiences diseconomies of scale. 

Economies Economies of Vertical Integration: Integration: Economies of vertical integration are

achieved in vertical mergers. It makes coordination of closely related operating activities easier. easier. 

Entry to New Markets and Industries: A firm that wants to enter a new

market but lacks the know-how can do so through the purchase of an existing  player in that product or geographical market. This makes the two firms worth more together than separately. 

Past loss losses es of an acqui acquire red d subs subsid idia iary ry can can be used used to Tax Advantages: Advantages: Past minimize present profits of the parent company and thus lower tax bills. Thus, firms have a reason to buy bu y firms that have accumulated tax losses.



Diversification: One of the reasons for conglomerate mergers is diversification

of risk. There are two types of risks associated with businesses- systematic and unsystematic risk. Systematic variability cannot be removed by diversification and hence mergers are not able to eliminate this risk. Though, unsystematic risk can be spread through mergers. 

Managerial Motives: The management team of the acquiring firm tends to

 benefit from the merger activity. The four most important managerial motives for merger are empire building, status, power and remuneration. Implicit Motives 

Hubris: It is like a maturity test for the owners and the company boards of 

directors when they see the opportunity to form a new business cycle.

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

Excess of Money: When a company has excess of money, the question of what

to do with it eventually comes up and this leads towards merger and acquisition.

Steps Involved in an Acquisition Valuation Procedures for Analyzing Valuation of the Firm

46

Fig-7

An acquis acquisiti ition on valuat valuation ion program programme me can be segreg segregate ated d into into five five distin distinct ct steps steps like: like:

Step 1: Establish a motive for the acquisition.

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Step 2: Choose a target. Step 3: Value Value the target with the acquisition motive built in. Step 4: Choose the accounting method for the merger/acquisition - purchase or pooling. Step 5: Decide on the mode of payment - cash or stock.

Evaluations Implicit Motives •

Financing Mergers

Fig-8

The triangle in the figure provides a view of acquisition financing mechanism. As the options options for financing the acquisition acquisition would increase, increase, the layers in the triangle would also increase. But the basic question that arises or the consideration that comes is whether the transaction should be made in cash or stock as it has different effect on the various stakeholders of both the organizations the acquiring firm as well as the target firm. The influen influence ce of method method of paymen paymentt on post-m post-mer erger ger financi financial al perfor performan mance ce is ambigu ambiguous ous..

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Post merger performance maybe affected by the means of payment in the takeover. There are mainly two ways, in which mergers can be financed, 

Cash



Stock 

Using cash for payment helps the acquirer's shareholders to retain the same level of control over the company company.. Anothe Anotherr obv obviou iouss reason reason of financi financing ng merger mergerss through through cash cash is the simplicity and preciseness that gives a greater chance of success. Another advantage of  using cash to the target's shareholders is that it is more certain in its value. Also, the recipients can spread their investments by purchasing a wide-ranging portfolio. There is also a disadvantage to target shareholders. They may be liable to pay capital gains tax. This is payable when a gain is realized. 

Estimating

Cost

When

the

Merger

is

financed

by

Stock 

The cost depends on the value of the shares in the new company received by the shareholders of the selling company. company. Cost = N * P of AB - PV of B

Where,  N = the number of shares received by the sellers P of AB = price per share of the merged firm PV of B = present value of o f B (selling firm)

Workings of Mergers Merger accounting

A merger can be either treated as a purchase or a pooling of interests. Under this method, assets of the acquired firm must be reported at the fair market value on the books of the acquiring firm. Under this method, goodwill, which is the excess of the purchase price over  the sum of the fair market values of the individual assets acquired, is generated. Under the

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second method, pooling of interests, the assets of the merged firm are valued at the same level as they were carried out in acquired and acquiring firms. Tax Considerations Consid erations

An acquisition can be taxable or tax-free. In a taxable acquisition, shareholders of the selling firm are treated for tax purposes as having sold their shares and are liable to pay tax on any capital gains or losses. In a tax-free acquisition, the selling shareholders are viewed as exchanged their old shares for similar ones, and they do not experience any capital gains or loss losses es.. The taxes taxes paid by the the merg merged ed firm firm also also depen depend d on the the taxtax-st stat atus us of the the acquisition. There is no revaluation of assets in a tax-free acquisition, whereas, in a taxable acquisition, the assets are devalued and any increase or decrease is treated as a taxable gain or loss. The Impact of Mergers

Merger Mergerss have a univer universal sal impact impact,, practi practical cally ly everyo everyone ne from from society society,, shareh sharehold olders ers,, employees, and directors to financial institutions. Society can benefit from the merger if it resu result ltss in prod produc ucin ing g good goodss at low low cost costss due due to econ econom omie iess of scal scalee or impr improv oved ed management. The acquiring shareholders usually get poor returns and therefore very small average gains. However, However, target target shareholder shareholderss usually usually gain from mergers, mergers, as the acquirers have have to pay a subs substa tanti ntial al premi premium um over over the the prepre-bi bid d shar sharee pric pricee to conv convin ince ce targ target et shareholders to sell. Employees may gain or lose from a merger activity. Mergers generate significant gains to the target firm's stockholders and buyers generally break even, there are  positive benefits from mergers. The yardstick to measure a successful merger is the profit level. Profitability is the only overall ov erall significant identifier. identifier.

Tata - Corus: Visionary deal or costly blunder? 50

After four months of twists and turns, Tata Steel has won the race to acquire Corus Group. The bidding war between Tata Steel and Brazilian company CSN was riveting and ended in a rapid-fire auction. Initial reactions to the deal were highly diverse and retail investors were completely puzzled by the market reaction. Going by the stock market reaction, the acquisition was a big  blunder. The stock tanked 10.5 per cent after the deal was announced and another 1.6 per  cent. Investors were worried about the financial risks of such a costly deal. Media reaction to the deal had been just the opposite. Almost all the reports were adulatory while editorials praised the coming of age of Indian industry. A prominent financial daily  presented  presented the deal almost as revenge of the natives against the old colonial colonial masters with a  picture of London covered in our national colours. Its editorial warned the market 'not to  bet against Tata', citing the previous instances when skeptics were proved wrong by the group. Official reaction had been no different and the finance minister even offered all  possible help to the Tata Tata Group. Was the acquisition too costly for Tata Steel? Was price the only criterion while evaluating an acquisition? Should managers focus on keeping shareholders happy after every quarter  or should should they focus focus on the long-term long-term,, big picture? picture? These These are tough questio questions ns and, unfortunately, unfortunately, answers would be clear only after many years - at least in this case.

When could the steel cycle turn?

The last few years were some of the best ever for the global steel industry as robust demand from emerging economies like China pushed up prices. Profits of steel steel manufa manufactu cturer rerss across across the globe globe swelle swelled d and their their market market capital capitaliza izatio tions ns have multiplied many times.

Global Steel output (in million tonnes)

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Country

2005

2006

% change

China Japan

35 5 .8

418.8

17.7

112.5

116.2

3.3

US

94.9

98.5

3.8

Russia South Korea

66.1 47.8

70.6 48.4

6.8 1.3

Germany

44.5

47.2

6.1

India

40.9

44.0

7.6

Ukraine Italy

38.6 29.4

40.8 31.6

5.7 7.5

Brazil

31.6

30.9

(2.2)

World production

1,028.8

1,120.7

8.9

Table-4 How long will the good times last? Tata Steel believes the steel cycle is in a long-term up trend and the risk of a downturn in prices is low. In fact, managing director B Muthuraman said the global steel industry might witness sustained growth as during the 30-year period  between 1945 and 1975. The massive post-war infrastructure build-up in Western countries led to the sustained steel demand growth in that period. The coming decades would see similar infrastructure spending in emerging economies and steel demand would continue to grow, according to this view. Thee Inte Th Interna rnati tion onal al Iron Iron and Steel Steel Inst Instit itut utee (IIS (IISI) I),, a resp respect ected ed stee steell rese resear arch ch bod body y, corroborates this in its outlook. The growth in demand for global steel would average 4.9  per cent per year till 2010 according to the IISI. Between 2010 and 2015, demand growth is expected to moderate to 4.2 per cent per annum according to IISI forecasts. Much of this demand growth would come from China and India, where the IISI estimates growth rates to  be 6.2 per cent and 7.7 per cent annually from 2010 to 2015.  Now let’s consider steel prices. Expectations of sustained demand growth have already led to massive capacity additions, mostly in emerging markets. Chinese steel capacity has expanded significantly over the last decade while a large number of mega steel plants are  being planned in India. Capacity additions by Russian and Brazilian steelmakers would also be significant in future as they have access to raw material.

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Would the capacity additions outrun the demand growth and lead to subdued steel prices? Under normal circumstances, that could have been a very strong  possibility. But many industry leaders believe that the global steel industry would see a structural shift in the coming years. Some of the inefficient steel mills in mature markets would face closure while others would shift production to high value-added products using unfinished and semi-finished steel supplied by steel mills in locations like India, Russia and Brazil with access to raw material. This would limit aggregate supply growth and keep p rices stable in future. Major global steel makers are also not unduly worried about the possibility of large-scale exports from China, which would depress international steel prices. Chinese capacity is expected to continue to grow in the coming years, but so would the demand. Besides, Chinese steel plants are not expected to emerge very efficient as they depend on import imported ed raw materi materials als,, which which limit limit their their pricin pricing g power power.. Many steel steel analys analysts ts expect expect significant consolidation in the Chinese steel industry as margins erode further in future. The Chinese government has already started squeezing the smaller units by withdrawing their raw material import permits.

The need for scale

Going by the IISI forecasts, global steel demand would be 1.32 billion tonnes   by 2010 and 1.62 billion tonnes by 2015. Even Arcelor-Mittal, the largest global steel  player by far, has a present capacity, which is just 6.8 per cent for projected demand in 2015. To maintain its current share, share, Arcelor-Mit Arcelor-Mittal tal would have to add another another 50 million million tonnes of capacity by then. This confirms the view that there is still considerable scope for  consolidation in the steel industry indu stry..

Global steel ranking Company

Capacity (in million tonnes)

Arcelor - Mittal

110.0

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Nippon Steel

32.0

Posco

30.5

JEF Steel

30.0

Tata Steel - Corus

27.7

Bao Steel China

23.0

US Steel

19.0

Nucor

18.5

Riva

17.5

Thyssen Krupp

16.5

Table-5 As the industry consolidates further, Tata Steel - even with its planned greenfield capacity additions - would have remained a medium-sized player after a decade. This made it absolutely vital that the company did not miss out on large acquisition opportunities. Apart from Corus, there are not many among the top-10 steel makers, which would become  possible acquisition targets in the near future.

Tata Steel - Corus : Present capacity (in million tonnes per annum)

Corus Group (in UK and The Netherlands)

19

Tata Steel - Jamshedpur

5

Nat Steel - Singapore

2

Millennium Steel - Thailand

1.7

Aggregate present capacity

27.7

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Table-6 Tata Steel - Corus : Projected capacity(in million tonnes per annum)

Corus Group (in UK and The Netherlands)

19

Tata Steel - Jamshedpur

10

Tata Steel - Jharkhand

12

Tata Steel - Orissa

6

Tata Steel - Chhattisgarh

5

Nat Steel - Singapore

2

Millennium Steel - Thailand

1.7

Aggregate projected capacity

55.7

Table-7

With Corus in its fold, Tata Steel can confidently target becoming one of the top-3 steel makers globally by 2015. The company would have an aggregate capacity of close to 56 million tonnes per annum, if all the planned greenfield capacities go on stream by then. Neat strategic fit

Corus, Corus, being the second largest largest steelmaker in Europe, would provide provide Tata Steel access to some of the largest steel buyers. The acquisition would open new markets and product segments segments for Tata Tata Steel, Steel, which would help the company to de-risk de-risk its businesses businesses through wider geographical reach. A presence in mature markets would also provide Tata Steel an opportunity to go further up the value chain as demand for specialized and high value-added products in these markets is high. The market reach of Corus would also help in seeking longer-term deals with buyers and to explore opportunities for pushing branded products. Corus is also very strong in research and technology development, which would add to the competitive strength for Tata Steel in future. Both companies can learn from each other and achieve ach ieve better efficiencies by adopting the best practices.

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But at what cost?

 Now that Tata Steel has achieved its strategic objective of becoming one of the major   players in the global steel industry and steel demand growth is likely to be robust over the next decade, has the company paid too much for Corus? Even those analysts analysts and industry industry observers who agree on the positive outlook for steel demand growth and the need to achieve scale believe so. The enterprise valuation of Corus at around $13.5 billion appears too steep based on the recent financial performance of Corus. Tata Steel is paying 7 times EBITDA of  Corus for 2005 and a higher 9 times EBITDA for 12 months ended 30 September 2006. In compa compari riso son, n, Mitt Mittal al Steel Steel acqu acquir ired ed Arcel Arcelor or at an EBIT EBITDA DA mult multip iple le of aroun around d 4.5. 4.5. Considering the fact that Arcelor has much superior assets, wider market reach and is financially much stronger than Corus, the price paid by Tata Steel looks almost obscenely high. Tata Steel's B Muthuraman has defended the deal arguing that the enterprise value (EV) per tonne of capacity is not very high. The EV per tonne for the Tata-Corus deal was around $710 is only modestly higher than the Mittal-Arcelor deal. Besides, setting up new steel plants would cost anywhere between $1,200 and $1,300 per tonne and would take at least five years in most developing countries. But, are the manufacturing assets of Corus good enough to command this price? It is a well-known fact that the UK plants of Corus are among the least efficient in Europe and would struggle to break even at a modest decline in steel prices from current levels. Recent financial performance of Corus would dent the hopes of Tata Steel shareholders even furthe furtherr. EBITDA EBITDA margins, margins, after after adjust adjusting ing for one-ti one-time me incomes incomes,, have have steadil steadily y declined over the last 3 years. For the 9-month period ended September 2006, EBITDA margins of Corus were barely 8 per cent as compared c ompared to around 40 per p er cent for Tata Tata Steel. Corus Financials Year Revenues EBITDA EBITDA Margin (%) Operating Profits Operating Profit Margin (%) Net Profit Net Profit Margin (%)

2004 2005 Jan-Sep 2006 18.32 19.91 14.10 1 .91 1.86 1.12 10.44 9.34 7.96 1 .30 1.17 0.75 7 .09 5.89 5.29 0 .8 7 0.72 0.25 4 .73 3.63 1.77

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Figures in $ Billion Table-8 The price of an asset is more a factor of its future earnings potential than its past earnings record. Operating margins of Corus can be significantly improved if Tata Steel can supply slabs and billets. Tata Steel is targeting consolidated EBITDA margins of around 25 per  cent as and when it starts supplying crude steel to Corus. If the company can sustain such margins on the enlarged capacities, it would be quite impressive. But that is a long way off as Tata Steel would have sufficient crude steel capacity only when its proposed new plants become operational. Till then, the company is targeting to maximize gains through possible synergies between the two operations, which are expected to yield up to $350 million per annum within three years. In the meanwhile, Tata Steel has to make sure that cash flows from Corus are sufficient to service the huge amount of debt, which is being availed to finance the acquisition. According to the details available so far, Tata Steel would contribute $4.1 billion as equity component while the balance $9.4  billion, including the re-financing of existing debt of Corus after adjusting for cash balance, would be financed through debt. The debt facilities are believed to be structured in such a way that they can be serviced largely from the cash flows of Corus. Interest rates on credit facilities for such buy-outs are often higher than market rates  because of the risks involved. At an expected interest rate of 7 per cent per annum, the interest outgo alone would be over $650 million per year. Along with repayment of   principal, the annual fund requirement to service this debt would be around $1.5 billion assuming a 10-year repayment horizon. The current cash flows of Corus are barely sufficient to cover this, even after considering the synergy gains. If international steel prices decline even modestly, Tata Tata Steel would have ha ve to dip into its own cash flows or find other sources like an equity dilution to service the debt. Besides, funds may also be required for upgrading some of the Corus plants to improve efficiencies. Tata Steel would have to manage all this without jeopardizing its greenfield expansion plans which may cost a staggering $20 billion over the same 10-year period.  No wonder investors are deeply worried!

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To its credit, the Tata Steel management has acknowledged that it would not be an easy task  to manage the next five years when Corus would have to hold on to its margins without the help of cheaper inputs supplied by Tata Steel. If the group can survive this initial period without much damage, life may become beco me much easier for the Tata Steel management. Inve Invest stor orss woul would d cons consid ider er Coru Coruss a burd burden en for for Tata ata Steel Steel unti untill such such time time there there is a   percept perceptibl iblee impro improveme vement nt in its margin margins. s. That would keep the Tata Tata Steel Steel stock stock price price subdued and any decline in steel prices would have a disproportionately negative impact on the stock. However, long-term investors would appreciate that right now steel manufacturing assets are costly and Corus was a prized target which made it even more costly. With the strategic importance of such a large deal in mind, Tata Steel management has taken the plunge. If it can pull it off, even after a decade, the Corus acquisition would become the deal, which would transform Tata Steel.

Mittal-Arcelor Vs Tata-Corus The combined entity of Tata-Corus will have a tremendous beneficial reach and scale of 24 million tonne per annum and many synergies, but the market is not willing to wait for the  benefits to come through. Besides, at an EV/EBITDA (enterprise value/earnings before interest, tax and depreciation) of more than 8 times CY06 financials on consensus estimates and a replacement value of $679 per tonne, analysts believe the transaction valuation is stretched. In the Mittal Steel-Arcelor deal, the EV/EBITDA was 6.2 times. In terms of  EV/ton EV/tonne ne too, too, Tata Steel' Steel'ss price, price, at $70 $700-7 0-710 10 per tonne tonne is higher higher than what what Arcelor  Arcelor  commanded at $586 per tonne. Also, in case of Mittal Steel-Arcelor, the deal involved a share swap along with cash. Tata Steel will have to shell out hard cash for Corus. And that means not just more debt on the Tata Steel balance sheet, but also an equity dilution. The company’s gearing is low at around 0.26:1, so it is in a position to take on debt of around Rs 8,000 crore, without the debt-equity ratio going for a toss. As for the equity dilution, Tata Steel has issued warrants to Tata Sons in July 2006, Tata Sons was issued 2.7 crore shares of Rs 10 each at a price of Rs 516 per share aggregating Rs 1,393 crore. The leading steel groups that follow Arcelor Arcelor Mittal are quite a distance distance from owning owning 50 million million tonne capacity each. In an industry with a capacity of nearly 1.3 billion tonne, the ideal scene

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woul would d be half half the the capa capaci city ty bein being g owned owned by not not more more than than ten ten group groups. s. Tata ata Steel Steel's 's audacious, but successful bid for Corus at an enterprise value of £6.7 million, including debts of £500 million, gives it a capacity of 28 million tonne, including 8.7 mt of its own. But the immediate stock market reaction to Tata Steel running away with the trophy in a head to-head bidding with Brazil's CSN was negative, as market participants thought Corus at 608 pence, representing a premium of 153 pence on the opening offer, was an expensive  buy. Whether the Tatas are paying a inflated price for Corus will remain a subject of debate for some time. Ratan Tata is emphatic that he is not paying anything that is beyond  prudence. It may not look so at this point, but the acquisition cost for the Tatas will be  justified, as the valuation of steel assets around the world will keep on rising. Corus got sold at 9 times its earnings (EBITDA). Some months ago, Mittal muscled his way into Arcelor by paying 6.2 times the target company's earnings. To put it differently, differently, Corus costs the Tatas $700 for each tonne of steel against Mittal's payment of $670 a tonne for Arcelor. But, we know that a recent steel deal in the US were clinched at nearly $1,000 a tonne.

COMPETITION COMPETI TION ANALYSIS ANALYSIS OF STEEL INDUSTRY

Concentration Ratio

In Economics the concentration ratio of an industry is used as an indicator of the relative size of firms in relation to the industry as a whole. This may also assist in determining the market form of the industry. One commonly used concentration ratio is the four-firm concentration ratio, which consists of the market share, as a percentage, of the four largest firms in the industry. In general, the N-firm concentration ratio is the percentage of market output generated by b y the N largest firms in the industry. industry.

→

The 4 firm concentration ratio of the Iron and Steel Industry is 71%.

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→

Thiis impl Th impliies that hat ther theree is olig oligop opol oly y in the the indus ndusttry as it is domi domina natted my few major players. Major percentage of market output is generated by the 4 largest firms in the industry.

Herfindahl Index:

The Herfindahl index, also known as Herfindahl-Hirschman Index or HHI, is a measure of  the the size size of firm firmss in rela relati tions onshi hip p to the the indu indust stry ry and and an indi indica cato torr of the the amoun amountt of  competition among them. It is an economic concept but widely applied in competition law and antitrust. It is defined as the sum of the squares of the market shares of each individual firm. As such, it can range from 0 to 1 moving from a very large amount of very small firms firms to a single single monopo monopolis listic tic produce producerr. Decrea Decreases ses in the Herfin Herfindah dahll index index general generally ly indicate a loss of pricing power and an increase in competition, whereas increases imply the opposite.

→

Value of Herfindahl index for Indian Steel Industry is .2470. . 2470.

→

It implies that the competition in the steel industry is medium to high and high concentration.

MERGERS AND ACQUISITIONS

Acti Active ve mer mergers gers and and acqui acquisi siti tions ons (M&A (M&A s) among among play player erss were were indi indica cati tive ve of the the consolidation dynamics within the steel industry indu stry globally. globally. Consolidation among top steel companies would continue in 2008 since industry players are engaged in an unfettered rush for scale. In so doing steelmakers are pursuing two main objectives: by purchasing additional production capacity they aim to both improve their  cost structure and increase their market clout. The merger of the world’s two biggest steelmakers steelmakers Mittal Steel (Netherland (Netherlands) s) and Arcelor (Luxembourg) (Luxembourg) will create an industry industry giant whose output is nearly four times as much as that of the next biggest player (Nippon Steel) and eight times as much as SAIL’s. If it continues like this 35% of steel production confined in the top 10 companies within the next five years. Consolidation among industry   playe players rs would would be driven driven by strate strategic gic fits fits betwee between n compani companies, es, rather rather than than financi financiall ally y

60

centered deals. A company can be a good strategic fit for merger if it has, among other  things things,, attrac attractiv tivee access access to raw materi materials als,, product production ion capabil capabiliti ities, es, proven proven succes successs in complementary markets, new technologies or patented products and a successful global supply network. In India the three biggest steelmakers, whose combined output is almost 20 million tons, have a market share of 51%. Their domestic domestic competitors competitors are numerous numerous medium sized and smallish companies. One of these, for example, is Ispat with an output of 2 million tons. More mergers can be expected between companies of this size as these firms need to improve their position with regard to the powerful suppliers of raw materials. But till now there is no sign of acquisition or mergers of Indian steel companies within India because most of the major producers are public. As different major global steel producers like Arcelor-Mittal, Posco and others are setting up plants in India, competition in the future will increase. In that case several mid-size domestic companies may go for mergers. But if  we see from the current position of the industry we can say that in future Indian steel industry will remain oligopoly or can become a competitive one.

Global mergers and acquisitions

The ideal way to make headway in production

The steel industry has been witness to some mega deals recently through mergers and acquisitions, with Mittal Steel reaching the pinnacle in steel production across the globe, while others have only been too keen to followed suit. The foremost reason for this strategy is to increa increase se commer commercia ciall produc productio tion n capacit capacity y within within the stipul stipulate ated d time time period period with with minimum investment. The latest to join the bandwagon is Tata Steel which bought out Rawme Rawmett Ferr Ferrou ouss Indu Indust stri ries es,, an unli unlist sted ed Kolk Kolkat ataa-ba base sed d Ferr Ferro o alloy alloyss play player er,, for for an undisclosed amount. Rawmet has a Ferro alloy plant near Cuttack consisting of two 16.5 MVA semi closed electric arc furnace having the production capacity of around 50,000 tonnes of high carbon Ferro chrome per annum. The agreement was signed in Bhubaneswar   by Tata Steel and representatives of IMR Metallurgical Resources, which holds a 66.46% equity stake in Rawmet. Officials of Rawmet Commodities, which holds 12.48% equity

61

stake, were also present during the occasions. Rawmet Ferrous Industries is planning to set up a Ferro alloy plant along with a waste-based power plant and a coke oven battery at Anantapur village in Cuttack district. The development of the facility will be implemented in four phases. The total cost of the entire e ntire project is projected to be Rs 326.50 crore.

MITTAL BAGGED ARCELOR:

Arcelor SA accepted India-born L N Mittal group's takeover bid with improved quoting by 10% to 25.9 billion Euros ($32.4 billion), thus creating the world's largest steel entity. This acquisition positioned Mittal Steel as the largest steel producer in the world with about 10  per cent of total steel production worldwide. Arcelor had entered into a strategic tie up Severstal which was perceived to be as a last ditch effort to thwart Mittal's bid, which ultimately proved unsuccessful. The final decision preferring Mittal to Russian steel giant Severstal was taken after a marathon meeting of the Board at the company's headquarters. The merger created the world's largest steelmaker, to be called Arcelor-Mittal, with annual   produ producti ction on capacit capacity y of more more than than 110 110 millio million n tons tons per annum. annum. While While the combin combined ed company will control 10 percent of the world's steel production, it's not a monopoly by any means, means, commen commented ted expert experts. s. Geogra Geographi phical cally ly,, the compani companies es don don't 't overla overlap p nor do they compete with each other; prior to this deal Mittal didn't have a presence in Europe, where Arcelor was essentially concentrated. About 150 of the plant's nearly 2,500 Workers took  voluntary layoffs up to a month. They could be called back if needed. Mittal officials estimate the outage will cost the company 250,000 tons of iron-making, nearly a month's work. The loss should be covered by insurance.

Tata and Corus:

In addition to Tata Steel's bid for Corus, the largest largest private sector steel producer in India has made a mark and consolidated it is presence in the foreign land, through acquisition his latest one's being in Indonesia. In case of Corus, only time will tell whether Tata Steel would succeed or not, but in other endeavours the company has already succeeded in acquiring some steel plants. Tata Steel, the country's largest private sector steel company, was in talks with Anglo American of South Africa to acquire its 79 per cent stake in Highve Highveld ld Steel. Steel. While While the Highve Highveld ld acquisi acquisitio tion n is still still going going through through the evaluat evaluation ion

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  proce process. ss. Accordi According ng to analys analysts, ts, if the acquis acquisiti ition on of Highvel Highveld d Steel Steel goes through through to completion, Tata Steel's production capacity will go up to 6 million tonne from the current level level of 5 mill millio ion n tonne tonne.. High Highve veld ld,, the the larg larges estt vanad vanadiu ium m produ produce cerr in the the worl world, d, manufactures steel, vanadium products, Ferro-alloys, carbonaceous products and metal containers and closures. Analysts observe a clear trend in Tata Steel's plans to expand capacities. But Highveld was not supposed to be the first global acquisition for Tata Steel. In February 2005, the company completed the acquisition of Singapore's largest steel company, NatSteel Asia, which has a two-million tonne steel capacity with presence across Singapore, Singapore, Thailand, China, Malaysia, Malaysia, Vietnam, Vietnam, the Philippines Philippines and Australia Australia.. As per the deal, the enterprise value of NatSteel Asia was pegged at Rs 1,313 crore. Tata Steel has  plans to establish steel manufacturing units in Iran and Bangladesh too. With a stated vision to become a 20-25 million tonne company by 2015, the company has also signed a few  joint ventures and announced organic expansion plans. SWOT ANALYSIS OF THE STEEL INDUSTRY

Strengths

1. Availability Availability of iron ore and coal 2. Low labour wage rates 3. Abundance of quality manpower  4. Mature production base

Weaknesses

1. Unscientific mining 2. Low productivity 3. Coking coal import dependence 4. Low R&D investments 5. High cost of debt 6. Inadequate infrastructure

Opportunities

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1. Unexplored rural market 2. Growing domestic demand 3. Exports 4. Consolidation

Threats

1. China becoming net exporter  2. Protectionism in the West West 3. Dumping by competitors

EXPECTED GROWTH

The International Iron and Steel Institute(IISI) has fore casted that the steel demand will go of from 1.12 billion ton to 1.19 billion ton in 2008.And this will further increase in a higher  rate up to 2010.In 2010.In India the growth growth will be more prominent prominent because of the growth growth in Real estate, Aviation, Aviation, Manufacturing, Automobile sectors.

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Fig-9

FACTORS HOLDING BACK THE INDIAN STEEL INDUSTRY

The growth of the Indian steel industry and its share of global crude steel production could  be even higher if they were not being held back by major deficiencies in fundamental areas. Investment in infrastructure is rising appreciably but remains well below the target levels set by the government due to financing problems. 65

. Energy supply

Power shortages hamper production at many locations. Since 2001 the Indian government has been been endea endeavou vouri ring ng to ensur ensuree that that powe powerr is avai availa labl blee nati nation onwi wide de by 201 2012. 2. Th Thee deficiencies have prompted many firms with heavier energy demands to opt for producing electricity with their own industrial generators. India will rely squarely on nuclear energy for its future power generation requirements. In September 2005 the 15th and largest nuclear reactor to date went on-line. The nuclear share of the energy mix is likely to rise to roughly 25% by 2050. Overall, India is likely to be the world’s fourth largest energy consumer by 2010 after the US, China and Japan.

Problems procuring raw material inputs

Since domestic raw material sources are insufficient to supply the Indian steel industry, a considerable amount of raw materials has to be imported. For example, iron ore deposits are finite and there are problems in mining sufficient amounts of it. India’s hard coal deposits are of low quality. For this reason hard coal imports have increased in the last five years by a total of 40% to nearly 30 million tons. Almost half of this is coking coal (the remainder is power station coal). India is the world’s world’s sixth biggest coal co al importer. The rising output of electric steel is also leading to a sharp increase in demand for steel scrap. Some 3.5 million tons of scrap have already been imported in 2006, compared with just 1 million tons in 2000. In the coming years imports are likely to continue to increase thanks to capacity increases.

Inefficient transport system

In India, insufficient freight capacity and a transport infrastructure that has long been inadequate inadequate are becoming increasingl increasingly y serious serious impediments impediments to economic economic development. development. Although the country has one of the world’s biggest transport networks – the rail network is twice as extensive as China’s – its poor quality hinders the efficient supply of goods. The story is roughly the same for port facilities and airports. In the coming years a total of USD

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150 bn is to be invested in transport infrastructure, which offers huge potential for the steel industry. In the medium to long term this capital expenditure will lay the foundations for  seamless freight transport

RECENT FINACIAL CRISIS AND INDIAN STEEL INDUSRRY

We have witnessed in last few months, the unfolding of financial crises starting from United States and expanding world over. The exact magnitude and extent of the crises is fiercely debated among the financial experts. However, this real impact on economy can easily be observed across many, many, if not all sectors. The steel industry has not been spared with the impacts of the financial crises. The total market valuation of Arcelor Mittal, Nippon steel and JEE has dropped by approx $165  billion. The price of billet in Dubai market has dropped from its height of $125/ton in June 2008 to a recent low of $350 /ton. One of the steepest drops witnessed in recent history. The wide spread drop in demand for all types of steel required companies to cur production globally. Arcelor Mittal, one of the largest steel producers, alone has recently announced more than 30% reduction in production. It is only human to be frustrated and uncertain of the future. However, over long term, do we really need to be? We explored the steel production data going back to 1900 during last 100 years the worst drop (13.52%) in steel industry accrued between 1979-82. This four year drop in global steel production is horrendous. However, if we look at year  over year growth changes in steel industry during a 100 year period from 1900 to 2000 a more optimistic pictures emerges. There is not even one instance when industry saw a consecutive four year of negative year over year growth. The worst case situation is three years of declining year over year growth during 1930-32, 1944-46, and 1980-82. Extending the past patterns of data to predict future is fraught with peril. It is none the less an important reminder to us that during tumultuous 100 year period the steel industry has  been able to successfully weather world wars ,recession and crises of all the genre. Steel is a resilient industry. It is not to say that the current financial crises should not be taken seriously. It should be however, however, if history holds the chances the impact of current current crises extending beyond 2009

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are low. The leading steel companies should take these opportunities to improve their  operational efficiency and effectiveness to better prepare themselves for impending growth in coming years.

Five-Force Analysis Analysis of Steel industry Backe Backed d by robu robust st volume volumess as well well as real realiz izat atio ions ns,, stee steell Indus Industr try y has has regi regist ster ered ed a  phenomenal growth across the world over the past few years. The situation in the domestic industry was no exception. In fact, it enjoyed a double digit growth rate backed by a robust growing economy. However, the current liquidity crisis seems to have created medium term hiccups hiccups.. In this this articl article, e, we have have analyz analyzed ed the domesti domesticc steel steel sector sector through through Michael Michael Porter’s five force model so as to understand the competitiveness co mpetitiveness of the sector. sector. Barriers to entry:

We believe that the barriers to entry are medium. Following are the factors that vindicate our view. view. 

Steel indust industry ry is a capita capitall intens intensive ive busine business. ss. It is Capital Requirement: Requirement: Steel estimated that to set up 1 mtpa capacity of integrated steel plant, it requires  between Rs 25 bn to Rs 30 bn depending upon the location of the plant and technology used.



Economies of scale: As far as the sector forces go, scale of operation does

matter. Benefits of economies of scale are derived in the form of lower costs, R& D expenses and better bargaining power while sourcing raw materials. It may be noted that those steel companies, which are integrated, have their own mines for key raw materials such as iron ore and coal and this protects them for  the potential threat for new entrants to a significant extent. 

Thee gove govern rnme ment nt has has a favo favora rabl blee poli policy cy for for stee steell Governm Government ent Policy: Policy: Th manufacturers. However, there are certain discrepancies involved in allocation of iron ore mines and land acquisitions. Furthermore, the regulatory clearances and other issues are some of the major problems for the new entrants.



Steel has very very low low barr barrie iers rs in term termss of prod product uct Product Product differentiation differentiation:: Steel differentiation as it doesn’t fall into the luxury or specialty goods and thus does not have any substantial price difference. However, certain companies like Tata

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Steel still enjoy a premium for their products because of its quality and its brand value created more than 100 years back. Bargaining power of buyers: bu yers: Unlike the FMCG or retail sectors, the buyers have a low bargaining power. However, the government may curb or put a ceiling on prices if it feels the need to do so. The steel companies either sell the steel directly to the user industries or through their own distribution networks. Some companies also do exports. Bargaining power of suppliers

The bargaining power of suppliers is low for the fully integrated steel plants as they have their own mines of key raw material like iron ore coal for example Tata Steel. However, those who are non-integrated or semi integrated has to depend on suppliers. An example could be SAIL, which imports coking coal. Competition

It is medium in the domestic steel industry as demand still exceeds the supply. India is a net importer of steel. However, a threat from dumping of cheaper   products does exist. Threat of substitutes

It is medium to low. Although usage of aluminum has been rising continuously in the automobile and consumer durables sectors, it still does not pose any sign signif ifica icant nt thre threat at to stee steell as the the latt latter er canno cannott be repl replace aced d comp comple lete tely ly and the the cost cost differential is also very high. After understandin understanding g all the above view points points and the current global scenario, we believe that the domestic steel industry will likely to maintain its momentum in the long term. However, the growth may get affected in short run. Investors need to focus on companies that are integrated, integrated, have economies of scale and sell premium quality  products

Articles from Newspaper on steel industry India aiming to double steel production by 2011-12 2011-12 Sunday, 14 December 2008

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India is aiming to more than double its steel production to 124 million tonnes by 2011-12 and further raise it to 280 million tonnes by 2020, Steel Minister Ram Vilas Paswan told Rajya Sabha today. Replying to supplementary during Question Hour, Paswan said India ranked eighth in world steel production when UPA Government took office in 2004 and has today climbed to 5th spot with 54 million tonnes of annual steel production. "Our National Steel Policy had targeted 124 million tonnes of steel production by 2020. But we have now  brought the target forward to 2011-12 and for 2020 we are aiming to raise production capacity to 280 million tonnes," he said. Steel Ministry, he said, was of the view that high quality iron ore, the reserves of which in the country are very limited, should not be exported or their export discouraged through high export duties. The exports cannot be fully stopped as iron ore mines employ some 500,000 people and their employment cannot be risked, he said adding export duty on iron ores has already  been levied. The global economic slowdown has seen growth in steel consumption in the country fall to 1.75 per cent from a high of 13 per cent. Also, prices of steel products have fallen fallen since since June. June. Paswan Paswan said said his Minist Ministry ry has been been holding holding consul consultat tation ionss with with the industry and recently the Government rolled back export duty on all categories of steel items, except melting sap, to help producers tide over fall in consumption levels in the country. STEEL IMPORT STRENGTHEN 70% IN NOV

(Source-economic times 13th December)

India’s steel imports jumped more than 70% to 1.4 mn tonnes last month against 8 lakh tonne in the same month a year ago. The sharp rise in imports was due to low-priced shipments coming from China, Thailand and Ukraine into India at $450-500 per tonne, 25% cheaper than the international international price, price, then ruling at $600-700 per tonne. The steel ministry’s Joint Planning Committee that collects data on iron and steel on a monthly basis shows that steel imports dipped 10.7% to 5.25 million tonnes in April-October against 5.88 million million tonnes in the correspondi corresponding ng period period a year ago. Availabi Availability lity of low-priced low-priced imports from some countries resulted in huge imports in November. This happened when domestic steel makers were cutting production due to lower demand. Last month, the government imposed 5% import duty on steel products to protect domestic industry against cheap

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imports. But steel producers feel the move is insufficient to bring down imports as china as withdrawn export tax on some steel products to get rid of surplus stock. The government has also initiated investigation into dumping from China but steel firms feel it’s a lengthy  process and will take at least 8-9 months to complete.

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CHAPTER 5: CONCLUSION AND RECOMMENDATIONS RECOMMENDATIONS

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Conclusion The liberalization liberalization of industrial industrial policy and other initiatives initiatives taken by the Government Government have given a definite impetus for entry, participation and growth of the private sector in the steel indust industry ry.. While While the existi existing ng units units are being being modern modernize ized/e d/expan xpanded, ded, a large large number number of  new/Greenfield steel plants have also come up in different parts of the country based on modern, cost effective, state-of-the-art technologies. Indian steel players, now, concentrate on the global market as they know the trend of world market of steel. The recent movement of Tata steel is also a big evidence for the development of Indian steel industry. The acquisition of Corus Steel immediately increases the production of capacity of Tata steel by 12 mt. One size doesn't fit all. Many companies find that the best way to get ahead is to expand ownership boundaries through mergers mergers and acquisition acquisitions. s. For others, separating separating the public ownership of a subsidiary or business segment offers more advantages. At least in theory, mergers create synergies and economies of scale, expanding operations and cutting costs. Investors can take comfort in the idea that a merger will deliver enhanced market market power power. By contra contrast, st, de-mer de-merged ged compani companies es often often enjoy enjoy improv improved ed operat operating ing   performance thanks to redesigned management incentives. Additional capital can fund growth organically or through acquisition. Meanwhile, investors benefit from the improved information flow from de-merged companies. M&A comes in all shapes and sizes, and investors need to consider the complex issues involved in M&A. The most beneficial form of equity structure involves a complete analysis of the costs and benefits associated with the deals. What we learned in this: 

A merger can happen when two companies decide to combine into one entity or  when one company buys another. another. An acquisition acquisition always involves the purchase purchase of  one company by b y another.



The functions of synergy allow for the enhanced cost efficiency of a new entity made from two smaller ones - synergy is the logic behind mergers and acqu isitions.



Acquiring companies use various methods to value their targets. Some of these methods are based on comparative ratios - such as the P/E and P/S ratios replacement cost or discounted cash flow analysis. anal ysis.

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

An M&A deal can be executed by means of a cash transaction, stock-for-stock  transaction or a combination co mbination of both. A transaction struck with stock is not taxable.



Break up or de-merger strategies can provide companies with opportunities to raise additional equity funds unlock hidden shareholder value and sharpen management focus. De-mergers can occur by means of divestitures, carve-outs spin-offs or  tracking stocks.



Mergers can fail for many reasons including a lack of management foresight, the inability to overcome practical challenges and loss of revenue momentum from a neglect of day-to-day operations.

Finally, Finally, our dissertation suggests-

→

The econo economi micc indi indica cato tors rs are are all all favo favora rabl blee for for Grow Growth th,, temp tempor orall ally y slum slump p is ephemeral.

→

Indian steel industry exudes optimism

→

Investment in infrastructure is crucial to step up demand for steel.

→

Supply may have to be rationalized in line with the demand (Dom + exports)

→

Integrated Mills would hold the key in future growth of Indian Steel supplies.

→

 New technologies to use indigenous natural resources would have to be developed

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SUGGESTIONS AND RECOMMENDATIONS

In a giant leap, Tata Tata Steel's Steel's acquisition acquisition of the Anglo-Dutch Anglo-Dutch steel major Corus has vaulted vaulted the former to the fifth position from 56th in global steel production capacity. With the exception of Arcelor Mittal, which has combined production capacities of 110 million tonnes, Tata Corus, with a capacity of 23.5 million tonnes, will be only 5-7 million tonnes shy of the next three players — Nippon Steel, Posco and JFE Steel. At the same time, it will also have players such as Bao steel, US Steel, Nucor and Thyssen Krupp breathing down its neck in the global sweepstakes. Spelling out the rationale for the deal, Mr. Ratan Tata, Chairman, Tata Sons, has claimed, "... it will take several years for us (Tatas) to build a 19-million-tonne enterprise from scratch, leave alone establishing it in Europe with a brand name." In that sense, it is obviously an important strategic move for Tata Steel with long-term global implications in a consolidating sector. sector. This hotly-contested mega deal has, however, h owever, come at a stiff price of $12.1 billion in equity value and with a debt component of around $1.5 billion Corus as an enterprise is worth $13.6 billion. That takes the winning final bid for the shares of Corus 34 per cent higher  than the initial offer the Tatas made on October 20. The Tata Steel stock has shed over 10 per cent since the acquisition and has also been a sharp under-performer relative to the broad market and its sectoral peers over the past six months. With the debate on "overvaluation' and "winner's curse" hanging over this deal, here is a look at the implications from a short- and long-term investment perspective:

Short-Term Implications Investors with a one-to-two year perspective may find the Tata Steel stock unattractive at current price levels. While the potential downside to the stock may be limited, it may consolidate in a narrow range, as there appears to be no short-term triggers to drive up the stock. The formalities for completing the acquisition may take three to four months, before the integration committees get down to work on the deal. In our view, three elements are stacked against this deal in the short run:

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Equity dilution :

The financing of the acquisition is unlikely to pose a challenge for the Tata group, but the financial risks associated with high-cost debt may be quite high. Though the financing  pattern is yet to be spelt out fully, initial indications are that the $4.1 billion of the total consideration will flow from Tata Steel/Tata Sons by way of debt and equity contribution   by these two and the balance $8 billion, will be raised by a special investment vehicle created in the UK for this purpose. Preliminary indications from the senior management of  Tata Steel suggest that the debt-equity ratio will be maintained in the same proportion of  78:22, in which the first offer was made last October.

The Corus steel factory in Ijmuiden, the Netherlands.

Based on this, a 20-25 per cent equity dilution may be on the cards for Tata Steel. The equity component could be raised in the form of preferential offer by Tata Steel to Tata Sons, or through GDRs (global depository receipts) in the overseas market or a rights offer  to shareholders. This dilution is likely to contribute to lower per share earnings, whose impact will be spread over the next year or so. As Tata Steel also remains committed to its six-milliontonne greenfield ventures in Orissa, its debt levels may rise sharply in the medium term. Margin picture:

Short-term triggers that may help improve the operating profit margin of the combined entity seem to be missing. In the third quarter ended September 2006, Corus had clocked an operating ope rating margin of 9.2 per cent compared with 32 per cent by Tata Steel for the third quarter ended December 2006. In effect, Tata Steel is buying an operation with substantially lower margins. This is in sharp contrast to Mittal's acquisition of Arcelor, where the latter's operating margins were higher than the former's and the combined entity was set to enjoy a better  margin margin.. Despit Despitee that, that, on the basis basis of conventi conventional onal metrics metrics such such as EV/EBI EV/EBITDA TDA and EV/tonne, Arcelor Mittal's valuation has turned to be lower than Tata Corus. On top of that, Tata is making an all-cash offer for Corus vis-à-vis the cash-cum-stock swap offer made by Mittal for Arcelor.

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Corus has been working on the "Restoring Success" programme aimed at closing the competitive gap that existed between Corus and the European steel peers. The gap in 2003 was about 6 per cent in the operating profit level when measured against the average of  European competitors. And this programme is expected to deliver the full benefits of 680 million pounds in line with plan. With this programme running out in 2006 and being repl replac aced ed by `The `The Coru Coruss Way', ay', the the scop scopee for for Tata ata Steel Steel to brin bring g about about shor shortt-te term rm improvements in margins may be limited. Even the potential synergies of the $300-350 million a year expected to accrue to the  bottomline of the combined entity from the third year onwards, may be at lower levels in the first two years. years. As outlined outlined by Mr. Mr. B. Muthuraman, Managing Managing Director Director of Tata Steel, syner synergie giess are expecte expected d in the procur procureme ement nt of materi material, al, in the market marketpla place, ce, in shared shared services and better operations in India by adopting Corus's best practices in some areas.

The steel cycle

While the industry expects steel prices to remain firm in the next two-three years, the impact of Chinese exports has not been factored into prices and the steel cycle. There are are clea clearr indi indicat catio ions ns that that steel steel impor imports ts into into the the EU and and the the US have have been been risi rising ng significantly. At 10-12 million tonnes in the third quarter of 2006, they are twice the level in the same period last year and China has been a key contributor. contributor. This has led to considerable uncertainty on the pricing front. Though regaining pricing  power is one of the objectives of the Tata-Corus deal, prices may not necessarily remain stab stable le in this this fragm fragment ented ed indus industr try y. The top top five five play player ers, s, even even afte afterr this this roun round d of  consolidation, will control only about 25 per cent of global capacities. Hence, the steel cycle may stabilise stabilise only if the latest latest deal triggers a further further round of consolidation consolidation among the top ten producers.

Long-Run Picture Whenever a strategic move of this scale is made (where a company takes over a global major with nearly four times its capacity and revenues), it is clearly a long-term call on the structural dynamics of the sector. And investors will have to weigh their investment options only over the long run.

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Over a long time-frame, the management of the combined entity has far greater room to maneuver, and on several fronts. If you are a long-term investor in Tata Steel, the key developments that bear a close watch are: Progress on low-cost slabs

Research shows that steel-makers in India and Latin America, endowed with rich iron ore resources, enjoy a 20 per cent cost advantage in slab production over  their European peers. Hence, any meaningful gains from this deal will emerge only by 2009-10, when Tata Steel can start exporting low-cost slabs to Corus. This This is unlike unlikely ly to be a short short-te -term rm outcom outcomee as neithe neitherr Tata Steel' Steel'ss six-mi six-milli llionon-ton tonne ne greenfield plant in Orissa nor the expansion in Jamshedpur is likely to create the kind of  capacity that can lead to surplus slab-making/semi-finished steel capacity on a standalone  basis. Second, there may be further constraints to exports as Tata Steel will also be servicing the requir requireme ements nts of NatSte NatSteel, el, Singapo Singapore, re, and Millen Millenniu nium m Steel, Steel, Thaila Thailand, nd, its two recent recent acquisitions in Asia. However, this dynamic may change if the Tatas can make some acquisitions in low-cost regions such as Latin America, opening up a secure source of slab-making that can be exported to Corus's plants in the UK. Or if the iron ore policy in India undergoes a change over the next couple of years, Tata Steel may be able to explore alternatives in the coming years. Restructuring at Corus :

The raison d'etre for this deal for Tata Steel is access to the European market and significantly higher value-added presence. In the long run, there is considerable scope to restructure restructure Corus' high-cost plants at Port Talbot, Talbot, Scunthorpe Scunthorpe and the slab-making slab-making unit at Teesside. The job cuts that Tata Steel is ruling out at present may become inevitable in the long run. Though it may be premature at this stage, over time, Tata Steel may consider the  possibility of divesting or spinning off the engineering steels division at Rotherham with a  production capacity of 1 million tonnes. The ability of the Tatas to improve the combined operating profit margins to 25 per cent (from around 14 per cent in 2005) over the next four  to five years will hinge on these two aspects.

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In our view, two factors may soften the risks of dramatic restructuring at the high-cost   pla plant ntss in UK. UK. If glob global al cons consol olid idat atio ion n gath gather erss mome moment ntum um with with,, say, say, the the mer merger of  Thyssenkrupp with Nucor, or Severstal with Gerdau or any of the top five players, the likelihood of pricing stability may ease the performance pressures on Tata-Corus. Tata-Corus. Two, if the Tatas contemplate global listing (say, in London) on the lines of Vedanta Resources (the holding company of Sterlite Industries), it may help the group command a much higher price-earnings multiple and give it greater flexibility in managing its finances.

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Reference



ANALYSIS FROM CRISIL.



ECONOMIC TIMES,EXIM NEWSLETTER 



WWW.WORLDSTEEL.ORG



WWW.CRISIL.COM



WWW.INDIANINDUSTRY.COM



HTTP://STEEL.NIC.IN/



HTTP://EN.WIKIPEDIA.ORG/WIKI/STEEL

 

 Newspapers like Hindu, Economic Times, Business standard etc. Search engine like Google.com, Yahoo.com etc.

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