Group net debt/Ebitda may not change materially because of merger with Thyssen; risk-reward unfavourable
Tata steel has signed an MoU with Thyssen to merge their European steel assets. Target synergies are in line with market expectations, but would be back-ended. JV debt would be de-consolidated, but Group net debt/Ebitda may not change materially. Recent stock price rally appears to be factoring deal positives and while steel prices/spreads have surprised positively, we think this would not sustain. At 7.9x FY19E Ebitda, risk reward appears skewed to the downside. Tata signs MoU with TKA for 50:50 JV: As part of the deal, Tata would inject €2.5 billion into the JV, while Thyssenkrupp (TKA) would transfer €4.0 billion of liabilities including €3.6 billion of pension to the JV. The final deal agreements are expected to be signed by March 18 and deal closure is expected by December 2018.
Target synergies within expected range: Proposed JV is targeting €400 million-600 million of cost synergies, broadly in line with our est. range and market expectations. This equates to 2.7%-4.1% of proforma costs vs. initial synergies of 2.5%-3% of proforma costs targeted by past deals (Arcelor-Mittal, SSAB-Ruukki). Tata expects synergy gains to be realised in 2-3 years post deal closure (2021). Deal to drive consolidation; Tata debt transfer lower: With proforma deliveries of 21.4 million tons, proposed JV would become the second largest player, with a market share of ~25%. Liability injection terms appear more favourable for TKA vs Tata given Tata would push debt at 4x FY18E EBITDA vs. liabilities injected at 4.9x EBITDA by TKA. Tata would effectively push around 36% of TSE debt (March 17) and 87% of TSE external debt into the JV, while the remaining debt would have to be serviced by JV dividend and parent cash flows.
Valuation upside possible, but already discounted:Without synergies the deal could be potentially 3-4% value dilutive as per our est. given unfavourable debt transfer, but assuming 50% of target €0.5 bn synergies are realised in year 1, our SoTP could rise to Rs 467 (FY19 proforma basis). JV cash flows should be comfortable at net debt (ex pension)/EBITDA 1.7x (3.8x including pension). We estimate proforma net debt to EBITDA at Tata would be around 4x despite de-consolidation (3.95x pre deal). Valuation/Risks: Tata Steel is trading at 7.8x FY19E EBITDA (avg 6x FY1 ex post). We find risk reward unfavourable. Our Rs 424 PT values India ops. at 6.5x FY1E EBITDA and TSE at 6x FY1 EBITDA (March 18E). Upside risks: Higher prices, lower coking coal cost, higher TSE margins.