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India Inc.: We are the world! - Views on News from Equitymaster
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  • Jan 31, 2007

    India Inc.: We are the world!

    Tata Steel has finally won in its bid to acquire the assets of the Anglo-Dutch steel manufacturer Corus Group, agreeing to pay a buyout consideration of US$ 11.3 bn. The company has agreed to offer Corus investors 608 pence per share in cash, and in the consequence, outbidding the offer of 603 pence from Brazilian Companhia Siderurgica Nacional (CSN). The final offer from Tata Steel is 34% higher than the initial offer of 455 pence per share made in October 2006.

    As reported, at 608 pence per share, Tata Steel has valued Corus at 7 times its forecast EBIDTA for 2006. Importantly, this is well above the 4.6 times EBIDTA multiple that Mittal Steel had paid for Arcelor when it acquired the latter in June 2006. But that is the nature of consolidation, especially when the 'to-be-acquired' entity is expected to fill in a very strategic gap in the acquirer's scheme of growth. As for Corus' acquisition by Tata Steel, it is in line with the latter's growth objective of entering new, higher end markets and acquiring a sophisticated customer base. Enhanced scale will position the combined group as the fifth largest steel company in the world by production and will create a vertically integrated global steel company with crude steel output of more than 23 MT. As was indicated earlier, the acquisition will take place through a wholly owned indirect subsidiary of Tata Steel, Tata Steel UK. Tata Steel will inject US$ 3.5 bn in Tata Steel UK for funding the acquisition while the balance will be mobilised through debt.

    Cost concerns had forced Corus to search for a strategic partner. Tata Steel is the world's lowest cost producer of steel, while Corus' cost of production is almost twice that of the former. Interestingly, this will be India's largest ever-foreign takeover, extending a wave of consolidation in the fragmented steel sector after Mittal Steel's US$ 31 bn acquisition of Arcelor.

    Company overview

    Tata Steel: Tata Steel is India's largest private sector steel company with revenues of US$ 5.0 bn and crude steel production of 5.3 million tonnes (MT) across India and South-East Asia in FY05-06. It is a vertically integrated manufacturer and is the world's lowest cost producer and one amongst the few value creating steel companies. The company has rich iron, dolomite, chromium and manganese mining and related assets in India and even abroad. It currently produces approximately 9 MT of iron ore.

    Corus Steel: Corus is an international company, providing steel and aluminium products and services to customers worldwide. The company is the world's seventh largest and Europe's second largest steel producer with revenues of 9 bn (approx. US$ 11.6 bn) and crude steel production of 18.2 MT in 2005. It has approximately 50% of the UK carbon steel market and around 11% of the European (including UK) carbon steel market. The company is comprised of four divisions - Strip Products, Long Products, Distribution & Building Systems and Aluminium, and has a global network of sales offices and service centres. It has got manufacturing operations in many countries, with major plants located in the UK, The Netherlands, Germany, France, Norway and Belgium.


    To Tata Steel:

    • Tata Steel will leapfrog from the fifty-sixth largest steel producer in the world to the fifth position.

    • The company will have better geographical mix. Tata Steel will have access to 40 countries across the globe, transforming it into a major global player from a domestic player.

    • It will also achieve access to high-developed markets and premium customer base.

    • There will be a transfer, from Europe to India, of technology, and expertise, research and development capabilities in the automotive, packaging and construction sectors, increased procurement knowledge and in effect, a better bargaining power.

    To Corus, the primary benefit:
    Corus does not have any significant mining interest or asset since the second half of 2002, when it sold off its minority holding in Avesta Polarit to Outokumpu. On the other hand, the link-up with a low-cost producer with access to raw materials will enable Corus to compete on a global scale.

    Post acquisition: Tata Steel's interest in acquiring Corus is in line with its growth objective of entering new, higher end markets and acquiring sophisticated customer base. The logic behind the acquisition is de-integration, the powerful combination of low cost upstream production in India with the high-end downstream processing facilities in end-user markets. Corus has strong relationships with customers in continental Europe, especially in high margin segments like construction, automobile and aerospace industry, the benefits of which eventually will be passed on to Tata Steel.

    The combined entity, Tata Steel-Corus will benefit from the deal but the concern remains with the cost synergies of the acquisition. While the combined entity will enjoy synergies in procurement, distribution and logistics, it is not clear as to how and over what time period, the production costs are likely to come down. In medium to short term, synergies are less likely to be seen, but long-term prospects are good.

    Further, Corus has high exposure to spot prices and a higher operational gearing among the larger European steel companies. In contrast, Tata Steel has about 70% of its supplies routed through long-term contracts. The combine is, thus, likely to reduce the element of volatility associated with pricing, one of the key elements in determining profitability of a commodity company.

    Like with any other acquisition, this too will have its share of soft issues like the speed at which integration takes place and how fast the synergies could be exploited, differences in working culture of the two companies and this too is likely to test the mettle of Tata Steel. On the financial front, if the steel prices soften considerably from hereon, servicing the debt could put a strain on the cash flows of the company. Hence caution needs to be exercised to that extent. As mentioned earlier, long-term prospects of the alliance does look bright.

    India Inc. - Global ambitions
    As for India Inc. the Corus takeover would be the latest in a string of overseas acquisitions by top Indian companies, which are seeking global visibility after decades of thriving on government protection. We believe that the most critical factor working in their (India Inc.'s) favour is the radical change in international perception that Indian firms are creditworthy and that many have the potential to become global companies. Over that, the changes in government policy, such as easing foreign currency restrictions, have also helped the cause of the 'Indian multinationals'.

    However, the global growth strategy is not merely an 'inside-out' phenomenon but also has an 'outside-in' angle to it. Not only are Indian companies going global, even global majors in industries like retailing, auto and technology are moving to Indian shores in search of more business, more talent and more supplies. But the basic underlying point is that these companies, like their Indian counterparts (except the technology majors), have a strong domestic presence, which is vital for sustaining international ambitions.

    We are of the view that the decision to globalise is ultimately driven by the need to create competitive advantages and sustainable stakeholder value. Overseas markets may bring higher revenues and volumes and opportunities for growth enhancing acquisitions, but there is a lot of value at stake as there are a great deal of risks involved in such a strategy. On a global platform, Indian companies will have to compete aggressively for input supplies, talent, innovation, and new customers. While the task at hand might be tough, time will remain to tell the tale.



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