Column: A bad buy, a better sale

Written by Shobhana Subramanian | Updated: May 15 2013, 08:40am hrs
Without Corus, Tata Steels standalone market cap could be R75,000 croretoday, it is less than half that

Theres the story of how Arun Gandhi, the veteran M&A strategist for the Tata Group, actually hand-delivered the winning bid for Corus because the computer packed up. That bid of 608 pence per share was made in the ninth and final round of the auction for the Anglo-Dutch steelmaker after Gandhi reportedly rushed, on a bike, to hand in the papers. Six years after shelling out $12.04 billion, in an all-cash deal, its the Brazilian steelmaker CSN, whose bid was lower by 5 pence, that must be celebrating. Corus hasnt brought anything to the table so faron the contrary, the parent has invested an estimated $2-3 billion in the subsidiaryand given where the global economy is, especially Europe, its unlikely to in a hurry. In hindsight, even the original bid of 455 pence per share seems high because while Tata Steels capacity may have risen multi-fold, so did its debt net debt at the end of December 2012 was nudging $10 billion, the bulk of it belonging to Corus.

That things werent going right with the Tata Groups biggest acquisition was clear even in 2009. In an interview to the Wall Street Journal, in November 2009, Ratan Tata, then chairman Tata Sons, answered a question on whether the purchases of Corus and JLR had been a financial burden saying his view was that if you want to buy a house and that house is of a particular value, then it may not be there if you wait. On that basis, we bought those two companies.

Tata was right when it came to JLRthe Tata Motors management was able to turn the company around in quick time and today its the JLR operations that are actually bringing home the bacon.

However, its been quite a different story with Tata Steel. The Corus acquisition, coming as it did a couple of years before the financial crisis hit Wall Street, forcing the global economy into a downturn, was particularly ill-timed. Being a converter, Corus was always vulnerable to iron ore prices spiking and supplying billets from India, if ever the management thought along those lines, was never a sensible idea. Without any captive ore Coruss earnings collapsed as it struggled to sell at remunerative prices; average hot-rolled coil realisations per tonne of $1,240 in FY09, slipped to $981 in FY10, recovering to $1,225 in FY12 but likely to be lower for FY13; consequently the ebitda per tonne has dropped off from $103 in FY10 to $10 in FY12 and analysts fear it will end up at $2 for FY13. Even before Tata Steel said on Monday it will take a $1.6 billion impairment chargea non-cash write-down on goodwill and assetsits been clear that Corus is in bad shape.

So, should Tata Steel sell off Corus in the unlikely event it finds a buyer In some sense, the management has been divesting or mothballing parts of the businessTeesside and Port Talbot facilitiesso that capacity has been rolled back; volumes are down to 14 million tonnes from close to 23 million tonnes in FY08. That Tata Steel will be far better off without a Corusa pure converter without backward linkagesis evident. A one-year forward standalone ebitda of R13,000-14,000 crore for the domestic business at an Enterprise Value/ebitda multiple of 6.5 times, translates into an EV of R85,000-90,000 crore. Assuming a net debt of some R10,000-15,000 crore, Tata Steels standalone market capitalisation could be R75,000-80,000 crore. Today, its at less than half those levels.

The question is how much more Corus will bleed. Tata Steel has attempted to reorganise the business by right-sizing the operations and some balance sheet managementit refinanced the outstanding loans of 2.8 billion with a term loan plus a revolving credit facility from a syndicate of 13 banks, albeit at a higher cost of 350 basis points over Libor compared with 207 basis points earlier. It also managed to mop up close to R4,000 crore by selling shares in January 2011 with the equity being diluted by just under 6%. But these steps can only help at the margin. With little visibility on when demand in Europe could bottom outCorus notched up a loss of $178 million in the December 2012 quarter with steel realisations slipping sequentially and restructuring expenses adding to costs, its worst performance in three yearsthe management faces its biggest challenge yet. And Tata Sons chairman Cyrus Mistrys new team of young executivesthe Group Executive Council (GEC)must figure out quickly whether it wants to hive off the enterprise, piece by piece, and cut its losses or put in place a strategy by which Corus can be supplied semis at a viable price. The Tata conglomerate might be a lot smaller if Corus is sold off, but it will be far less leveraged and a lot more profitable. In January this year, soon after he took over, Mistry said the group planned to invest R45,000 or roughly $8 billion in the next couple of years. Little of that presumably will be spent on big-ticket acquisitions.

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