Project

TATA CORUS MERGER

A report submitted to ISB&M, Delhi Campus as a part

fulfillment of Full time Postgraduate Program in
Business Management.

Abhishek Kumar
ENR NO.: 1101
Batch: 2005-2007
E-mail: [email protected]

International School of Business & Media, Delhi

7th Floor, Aggarwal Millennium Tower
Netaji Subhash Place, Wazirpur District Centre,
Pitampura, Delhi 110 034

Index
Serial Topic Page
No. No.

I Introduction: M&A
II Industry Overview

III Tata Steel

IV Corus Perspective

V Key Contributors towards Merger

VI TATA-CORUS Merger :Positive
Aspects

VII TATA-CORUS Merger: The Negative

Aspects

Introduction
M&As are taking place all over the world irrespective of the
industry, and therefore, it is necessary to understand the
basic concepts pertinent to this activity.
The term merger involves coming together of two or more
concerns resulting in continuation of one of the existing
entities or forming of an entirely new entity. When one or
more concerns merge with an existing concern, it is the case
of absorption. The merger of Global Trust Bank Limited
(GTB) with Oriental Bank of Commerce (OBC) is an example
of absorption. After the merger, the identity of the GTB is
lost. But the OBC retains its identity. Consolidation or
amalgamation involves the fusion of two or more companies
and forming of a new company. The merger of Bank of
Punjab and Centurion Bank resulting in formation of
Centurion Bank of Punjab; or merger of Indian Rayon Ltd,
Indo Gulf Fertilizers Limited (IGFL) and Birla Global Finance
Limited (BGFL) to form a new entity called Aditya Birla Nuvo
is an example of amalgamation.
Acquisition is an act of acquiring effective control by a
company over the assets or management of another
company without combining their businesses physically.
Generally a company acquires effective control over the
target company by acquiring majority shares of that
company. However, effective control may be exercised with
a less than majority shareholding, usually ranging between
10 per cent and 40 per cent because the remaining
shareholders, scattered and ill organized, are not likely to
challenge the control of the acquirer. When the acquisition is
‘forced’ or against the will of the target management, it is
generally called takeover. Takeover generally takes the
form of tender offer wherein the offer to buy the shares by
the acquiring company will be made directly to the target
shareholders with out the consent of the target
management. Though, the terms ‘merger’, ‘amalgamation’,
‘consolidation’, ‘acquisition’ and ‘takeover’ have specific
meanings, they are generally used interchangeably.

Mergers may be
 • Horizontal,
• Vertical or,
• Conglomerate.

Horizontal merger is a combination of two or more firms in

similar type of production, distribution or area of business.
Vertical merger is a combination of two or more firms
involved in different stages of production or distribution.
Conglomerate merger is a combination of firms engaged in
unrelated lines of business activity. Further, they may be
friendly or hostile. Generally, mergers are friendly whereas
tender offer takeovers are hostile.

M&As aim at optimum utilization of all available resources,

exploitation of unutilized and under utilized assets and
resources including human resources, eliminating or limiting
the competition, achieving synergies, achieving economies
of scale, forming a strong human base, installing an
integrated research platform, removing sickness, achieving
savings in administrative costs, reducing tax burden and
ultimately improving the profits.
Industry Overview

Indian Steel Market: An Out-look

All Set for High Growth.

The steel industry is expanding worldwide. For a number of

years it has been benefiting from the exceptionally buoyant
Asian economies (mainly India and China). The economic
modernisation processes in these countries are driving the
sharp rise in demand for steel.

Above Global Average Growth.

It is forecasted that Indian crude steel production will rise

from 38 million tonnes in 2005 to 68 million tonnes (+6%
p.a.) in 2015. Extensive capacity increases are planned for
this same period. Global crude steel output should increase
somewhat less vigorously during the forecast period (by
around 5% p.a.) to 1,800 million tonnes. Despite the stellar
increase in production India’s share of global crude steel
output is forecast to rise to just under 4% in the next ten
years. This is still comparatively tiny compared to China’s
share of 41%.

Technology Making Inroads

The biggest boost to efficiency in the steel industry has

come from the increased use of continuous casting – an
indicator of the modernity of the production process. Its
share of Indian crude steel output has climbed from 38% in
the mid-1990s to 66% now. India is thus well on its way to
joining the ranks of the leading steelmakers among the
industrial nations (share in EU-25: 96%). However, in India
some 6% of crude steel is still made using the outdated
open-hearth process (EU-25: 0.3%), which suggests there is
restructuring potential.
Companies Are Bursting Onto The World Market.

The Indian steel ministry plans to raise the export share

from 15% at present to 24% in the next 15 years. Big
companies like SAIL and Tata Steel want to become global
players by acquiring stakes in foreign firms.

India is one of the world’s top ten steelmakers

Over the past ten years India’s crude steel output rose
nearly 6% per year to 38 million tonnes, while global crude
steel output increased by 4% (Germany managed an
increase of just under 1% p.a.). Although India is the world’s
eighth largest steel producer, its 3%-plus share of global
steel output is still very low; it is roughly the same as
Ukraine’s share of world steel production. China, the world’s
biggest steelmaker, produces nearly ten times as much as
India.

In 2005 India’s crude steel output of 38 million tonnes was

17% higher than in 2004; only in China was the growth rate
considerably higher at 25%. By contrast, production volumes
fell in the US and the EU-25 by nearly 5% and roughly 4%
respectively. In the first five months of 2006 Indian steel
production continued to expand unabated, rising 19% yoy.

The foundations for the modern Indian steel industry were

laid as long ago as 1953 with a contract for the construction
of an integrated steelworks in Rourkela (in the state of
Orissa) signed by the Indian government and the German
companies Fried. Krupp und Demag AG. The initial plan was
an annual capacity of 500,000 tonnes, but this was
subsequently raised to 1 million tonnes. The capacity of
Rourkela Steel Plant (RSP), which belongs to the SAIL (Steel
Authority of India Ltd.) group, is now nearly 2 million tonnes.

At a very early stage the former USSR and a British

consortium also showed an interest in establishing a modern
steel industry in India. This resulted in the Soviet-aided
building of a steel mill with a capacity of 1 million tonnes in
Bhilai and the British-backed construction in Durgapur of a
foundry which also has a million tonne capacity. India’s steel
industry facilities are concentrated in the east, south and the
west of the country. The integrated foundries are located in
the east, while electric steel is produced predominantly in
the south and the west.
Tata Steel

A Six-Point Strategy

A Strong Base in India

Tata Steel has been planning its long-term strategy. Tata

Steel’s strategy, in terms of what it wanted to do over a
period of time of 10 years, between 2002-03 and 2015, was
to grow from four million tonnes per annum, which it were at
that time, to about 30 million tonnes plus, beyond the shores
of India, multinational, and continuing to be in a low-cost
position and continuing to be EVA [?] positive. That strategy
had six elements. One of them was that it would build a
strong base in India, which is why it is expanding
Jamshedpur from five to 10 million, and it is building three
greenfield projects.

De-Integration
The second part of the strategy was that it adopts a de-
integrated strategy where it believed that the world steel
industry, over the last 150 years or so, had adopted a
certain model of making from iron to finished steel in one
location, irrespective of where the raw materials were. TATA
always believed that this model will change, because steel
has to compete with other materials and, for the sustainable
competitiveness of steel, it is necessary that this business
model will undergo a change. TATA wanted to be at the
forefront of that change in business model, so it said it would
look for private steelmaking in countries which are rich in
iron ore and coal or gas. So it thought of plants in India,
Bangladesh and Iran.

Raw Material Security

The third part of the strategy was raw material security. It’s
important that TATA Steel have raw material security to be
competitive and sustainable in this world. Tata Steel has
raw material security on a 100% basis for their existing
operations in Jamshedpur. It has a large extent of self-
sufficiency for coal. Each of their three greenfield projects in
India will carry with it raw material iron ore security. Tata
Steel has some strategic types and some strategic positions
in terms of coal and limestone beyond the shores of India.
Tata steel said it should continue to look for raw material
security, both in India and overseas.

Getting More Out of Steel

The next part of their strategy was getting more out of steel,
which is by branding, by going downstream, by positioning
the products, getting into construction solutions and so on.
It is with that aim they formed the joint venture with
BlueScope. It is with that strategy that they started having a
joint venture with Ryerson of the US, for going downstream
into processed materials.

Control over Logistics

The next part of the strategy was control over logistics. No

large company – no large steel company – can be
sustainably competitive over a period of time without some
control on the efficiency and costs of logistics, so Tata Steel
decided to build a port in Orissa to connect Indian operations
with their overseas operations. We decided to start a
shipping company with NYK of Japan, and these are all in
progress.

Acquisition of Corus

Tata’s acquisition of Corus and their partner in Corus to form

a joint entity is part of this strategy, and it is part of this
strategy that they have been talking about for the last few
years. Just like Mr Leng mentioned, Corus had a strategy,
and the partnership with Tata Steel was part of that
strategy. Tata had looked at it exactly in the same manner,
and they believe that this entity, which will become, in terms
of scale, number five in the world, has the potential to
consolidate the steel industry even further.

Corus Perspective

The Need for a Strategic Partner

The headlines of this strategy were that our exclusive

presence in Western Europe, within a global and
consolidating industry, was unsustainable in the medium-to-
long term. We identified the need to have a strategic
partner and a presence in a lower-cost country with a
growing economy and raw material availability and where
we could use and fully exploit our technology. As to where,
we had an initial focus on Brazil, on Russia and, of course, on
India. Our subsequent travels and discussions in the past
year were diligent and comprehensive. I won’t go into the
specifics, with which we had discussions, but today’s
announcement is the result of this activity, and we’re
delighted and, indeed, honoured to be associated with Tata.

India – A Favored Location

India, with its strong and growing economy, indigenous raw

materials, rising consumer demand and infrastructure
needs, plus the country’s long relationship with the UK, was
always a favoured location. Philippe and I travelled to India
to meet Ratan Tata and his team in November of 2005.
Over the next several months, we had several meetings, and
our respective teams examined various business options,
from JV (joint venture) to new plants and technology
transfer. It became increasingly clear that the best long-
term solution could only be realised through a complete
merger of our two businesses, the result of which is today’s
announcement, which carries the unanimous
recommendation of my Board. This will be a unique global
partnership.

Key Contributors towards Merger

Need for modernisation:

Although India has modernised its steelmaking considerably

over the past decades, nearly 6% of its crude steel is
nevertheless still produced using the outdated open-hearth
process (EU-25: just 0.3%). However, SAIL’s Corporate Plan
2012 does contain a variety of measures to modernise its
plant and processes. These include the closure of those
crude steel capacities that use the traditional open-hearth
process. The biggest boost to efficiency in the Indian steel
industry has come from continuous casting, which is seen as
an indicator of modernity. The continuous casting share of
crude steel output has risen from nearly two-fifths in the
mid-1990s to two thirds now (EU-25: 96%), according to the
International Iron and Steel Institute (IISI). This means that
although India is still a long way behind the leading
industrial nations it is in the process of narrowing the gap.

High share of long products because of strong

construction demand:

Although the production structure of the Indian steel

industry has in the past shifted towards flat products, its
plants still produce a lot of simple sectional steel – as in
Eastern Europe. In India the ratio of sectional (long) products
to flat products is currently around 50:50, while EU
manufacturers consider a 40:60 split to be competitive.
However, it should be remembered that the construction
industry is much more important than in Europe because it
is a buyer of sectional steel in India. There is also catching-
up to be done in the production of stainless steel, which is
primarily required by the plant and equipment,
pharmaceutical and chemical industries.

Labor Costs & Productivity in India:

On top of this, labor productivity in India is still very low.

According to the German Steel Federation, crude steel
output at the biggest Indian steelmaker is roughly 144
tonnes per worker per year, whereas in Western Europe the
figure is around 600 tonnes. However, labour costs in India
are very low at EUR 1 per hour worked compared with EUR
26 per hour in Germany and EUR 18 per hour in Japan, for
example.

India also has some catching-up to do on the steel service

centre front. Steel service centres are positioned between
steel mills and end-consumers. As a rule they provide
services like warehousing, further processing and assembly.
The service centres currently cover only about 5% of total
Indian steel production and are usually operated by the
steelmakers (share in Germany: 11%). The Indian steel
group Tata Steel estimates that steel service centres will
process around 25% of Indian steel output in the coming
years as demand is growing for smaller batches and shorter
lead times.
Strong Import demand

Even though India is now one of the world’s top ten

steelmakers its domestic output is insufficient to meet the
demand in all segments. In 2005, some 4.7 million tonnes of
steel were imported, compared with only 2.2 million ten
years earlier (an annual increase of 8%). The growth in
Indian import demand in 2005 of around 2 million tonnes is
roughly equivalent to the total annual output of Hungary.
Low steel prices smooth the way for imports from Russia,
Ukraine and Kazakhstan. The geographical proximity of
Japan, South Korea and China makes them important
suppliers as well. India is not expected to be self-sufficient in
many segments over the medium term. There are several
reasons for this: firstly, steel consumption is rising very fast
as a consequence of the prospective dynamic economic
growth. Secondly, there is demand for high-quality products
which India will not be able to supply in sufficient quantities
for the foreseeable future. These include products with
surface finishing that helps them to be more durable and
retain their value for longer. In general, the trend towards
weight-optimized components persists; this improves the
prospects for Western European exporters in the Indian
market.
As a member of the WTO (since 1995) India is obliged to
gradually abolish import restrictions, so importing steel
should be far less problematic in future.

On the road to Globalisation:

Steel exports have long been of only minor importance in

India. Ten years ago the steel export share was merely just
under 6%. Thanks to improvements in competitiveness
between 1995 and 2005 exports rose 15% p.a. on average
and the share has more than doubled. The most important
exporting countries are China, Indonesia and the Philippines.

As the Indian steel industry is reliant on imported raw

material inputs, various cooperation agreements have been
required to secure long-term supplies. For example, the
cooperation between SAIL and the Australian commodities
group BHP Billiton was intensified. The contract is primarily
focused on the investment in BHP’s coking coal mines since
in the coming years SAIL will have to rely largely on imports
to satisfy its rising demand for coke. This is why more
potential acquisitions are being screened.
Keeping in the mind the forecasted growth and demand in
the domestic and global market the merger will help TATA
Steel to exploit the opportunities in the near future.

The following data will help us understand the forecasted

situation of the market in the near future.

Medium-term development of the Steel market

It is forecasted that a significant increase in output by the

Indian steel industry over the medium term. The entire
industry’s contribution to gross domestic product should rise
in the coming years to more than 30% – compared to just
under 27% at present. The growth drivers are the expanding
client industries automotive engineering (production up 16%
p.a. between 2000 and 2005), mechanical engineering (up
10% p.a.) and construction (up 6% p.a.).
Further large increase in steel capacity inevitable

Given the expanding economy, it is not surprising that

India’s steel industry capacities are to be increased
significantly in the years ahead to meet the prospective
demand. Many more basic oxygen steelmaking plants are
planned than electric steel mills. The “oxygen steel route”
(in which iron ore and coke are the key raw material inputs)
makes flat products for the automotive, iron & steel and
metalworking industries, for example. By contrast, electric
steel making (in which scrap is used) provides long products
that are primarily used in the construction and mechanical
engineering sectors. Whether the planned capacity
increases can be realised in their entirety is however
doubtful as the firms’ first priority is only to secure access to
iron ore deposits.

In mid-2006 the Rotterdam-based Mittal Steel announced

that the disadvantaged province of Orissa would become the
site for a new steel mill costing nearly EUR 7 bn with an
intended annual output of 12 million tonnes. That is the
equivalent of Belgium’s total annual steel output.

Support from dynamic economy

India is the economic region that has enjoyed the world’s

most sustained boom. The Deutsche Bank Research Formel-
G econometric model forecasts average real GDP growth of
5.5% p.a. for India between 2006 and 2020 O followed by
Malaysia (5.4%) and China (5.2%). In all, the analysis
covered 34 economies that generate some 85% of global
GDP. The growth drivers are population growth, human
capital, opening of the economy and rising investment.
Despite the sharp increase in India’s population, per-capita
GDP – in purchasing power parity terms – should rise by
nearly 4% per year until 2020. Since the model does not
take sufficient account of the country’s major initiatives in
the infrastructure area, average growth until 2020 might
turn out to be even closer to 6%. In fact, by the end of the
decade India could replace Japan as the world’s third biggest
economy after the US and China.

An important factor in the future demand for steel is the

huge amount that needs to be invested in infrastructure. The
construction industry accounts for a very high proportion of
steel demand at 43%, followed by mechanical engineering
(32%) and automotive engineering (5%). This breakdown is
unlikely to change much in the coming years.
Positive stimuli from construction industry

The steel companies are pinning their hopes largely on the

expanding construction industry. The industry is one of the
key drivers of India’s economic growth. Up to 10 million new
homes need to be built each year until 2030. Strong
population growth, rising incomes and decreasing household
sizes are forcing comprehensive measures to be taken in the
housing sector. The pent-up demand for housing is
estimated at around 20 million units by the Indian
Construction Association; the Ministry for Urban
Development and Poverty Alleviation claims that no less
than 31 million dwellings are needed. The hosting of the
Commonwealth Games in New Delhi in 2010 should
generate additional stimulus for the construction industry
and thus boost demand for steel. In addition to the sports
facilities, accommodation for competitors and visitors is
planned. The government has announced that some 40
hotels with a total of 15,000 beds are to be built. The Indian
office market is benefiting from the ongoing off shoring
activities of industrial nations. Indian insourcers are
concentrated in the software development and software
product segments. Their second main business area is
assuming the responsibility for entire support processes, or
business process outsourcing (BPO). These segments still
look set for growth.6 Furthermore, the construction sector is
benefiting from major infrastructure projects. Capital
expenditure is to be focused on road building and the rail
network, as well as on the construction and expansion of
ports and airports.

Strong growth in mechanical engineering

Mechanical engineering output has increased some 10% p.a.

over the past five years. Thanks to the march of
technological progress the prospects for domestic suppliers
should improve going forward, while import growth is slightly
crimped. Demand is greatest for building machinery and
plastic-moulding machines as well as machine tools and
textile machinery. Since the domestic textile and apparel
industry, for example, is focusing further up the value chain,
firms have to make numerous investments in modernising
and expanding their machinery portfolios. Makers of building
machinery are benefiting from the large-scale infrastructure
projects planned by the Indian government, while machine-
tool makers are being buoyed by the upturn in the
automobile and autoparts industries for example. Exports by
the Indian mechanical engineering industry rose recently by
nearly 30% to USD 10 bn. By comparison, German
mechanical engineering firms exported products worth close
to USD 117 bn, including machinery to the value of about
USD 1 bn to India. Germany claims a particularly large share
of Indian imports of woodworking machinery and machine
tools as well as pumps and compressors. The demand for
foreign machinery comes from customers requiring
especially high standards of performance and precision. The
Engineering Exports Promotion Council (EEPC) forecasts that
Indian exports will be worth USD 30 bn (+32% p.a.) by 2008;
nevertheless the volume is still very low by international
standards.

Booming Automobile Industry

The automotive industry may consume a relatively small
proportion of steel output, but its growth rate is the highest
of the most important clients for the steel industry. In India a
small but flourishing automobile industry has now developed
that sees its future primarily in the budget price segment
and views the domestic market and other emerging nations
as potential markets.7 Vehicle ownership (cars and trucks) in
India at 11 per 1,000 inhabitants is even less widespread
than in China with its very low figure of 21. The growth of
the Indian automobile industry is being driven by healthy
domestic demand. The consumption-minded, fast-growing
middle class is a major factor. The continuing increase in
incomes and low-cost financing facilities are boosting sales.
However, it is not uncommon for cars to be used for 20
years (Western Europe: 12 years), with vehicles that have
been taken off urban roads often being driven for longer in
rural areas.

The population’s steadily growing demand for mobility and

sharply rising traffic volumes will continue to generate
strong demand for cars in the future. At the same time
India’s automobile sector is establishing itself as an exporter
to international markets. Hyundai, for example, uses the
country as an export base for small cars, and Ford
manufactures vehicles there for South Africa and other
markets. However, competition between automakers has
intensified markedly. Whereas in 1995 there were just five
carmakers in India the figure has now reached 10. The
biggest are Maruti Udyog Ltd., Hyundai Motor India and Tata
Engineering (Telco). The Tata group is even trying to gain a
foothold in the European market with new models. India
currently produces a total of 711,000 cars each year
(Germany: 5.4 million).

While the automakers have been posting positive

performance, many parts suppliers have also been
flourishing. In India in the meantime a number of private,
independent companies have become established, some of
which have already made names for themselves
internationally (e.g. Tube Investments and Bharat
Forge).
Indian crude steel output forecasts up to 2015

All in all, the forecasted increase in Indian crude steel

production from 38 m tonnes in 2005 to 68 m tonnes (+6%
p.a.) in 2015. The increase in Indian crude steel production
of around 30 million tones during the 10-year period ending
in 2015 is roughly equivalent to the current annual crude
steel output of Italy. It should however be noted that annual
steel consumption in India currently amounts to just 35 kg
per capita compared with the EU-25 average of 400 kg.

The main reason for such high growth is the good

performance of domestic customer industries, especially the
construction, auto and mechanical engineering sectors.
Overall, industrial production in India should undergo
double-digit growth over the coming years. Additional
stimulus will come from private consumption. The ongoing
outsourcing of IT-based business processes to India will
provide good earnings prospects for the middle class living
there.

The Indian government wants a modern and efficient steel

industry. The strategic objective is no longer simply to
supply the domestic market. India is also trying to position
itself more emphatically as an exporter of steel products
over the medium term. According to government plans the
export share is to be grown from 14% at present to 24% in
the medium-term. The announcement of an aggressive
export strategy in conjunction with the planned capacity
increases is bound to have some impact on the global steel
market. Stiffer competition can be expected in the
commodities segment in particular. The Indian steel ministry
has set a figure of some 90 million tonnes as the supply
volume by 2020 – compared with just under 38 million
tonnes in 2005. This would mean growth of around 6% p.a.
over the coming years. The expansion of the industrial
sector and thus also of steel consumption is absolutely
essential to alleviate the poverty affecting broad sections of
the population.

By contrast, crude steel output in the EU-25 will probably

rise by just 0.5% p.a. to 196 million tonnes; nevertheless,
even in ten years’ time it would still be almost three times as
high as in India. Global crude steel output should increase by
around 5% p.a. between 2005 and factor in the sharp
expansion of the global market is the strong demand in India
and China. 2015 to 1,844 million tonnes. One instrumental
factor in the sharp expansion of the global market is the
strong demand in India and China.

There are a few factors that are hampering the growth of

TATA steel; and if not attended to soon will cause a lot of
opportunity loses in the days to come. Let us have a look at
the problems faced by the company in the country that
could be resolved after the merger, as it will let TATA steel
have access to international avenues for sourcing know how
& capital goods.

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.8 Investment in infrastructure is rising
appreciably but remains well below the target levels set by
the government due to financing problems.

Energy Supply

Power shortages hamper production at many locations.

Since 2001 the Indian government has been endeavouring
to ensure that power is available nationwide by 2012. The
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
tonnes. Almost half of this is coking coal (the remainder is
power station coal). India is the world’s sixth biggest coal
importer. The rising output of electric steel is also leading to
a sharp increase in demand for steel scrap. Some 3.5 million
tonnes of scrap have already been imported in 2006,
compared with just 1 million tones 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 are becoming
increasingly serious impediments to economic 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 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.

Consolidation in Steel Industry

In the medium term the global steel industry is likely to

undergo a more extensive process of consolidation 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
Mittal Steel (Netherlands) and Arcelor (Luxembourg) will
create an 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. In India the three biggest
steelmakers, whose combined output is almost 20 million
tonnes, have a market share of 51%. Their domestic
competitors are numerous mediumsized and smallish
companies. One of these, for example, is Ispat with an
output of 2 million tonnes. 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. Going forward, India’s lower wages and
favorable energy prices will continue to promise substantial
cost advantages compared to production facilities in
(Western) Europe or the US. The growth prospects of the
client industries are also very good. The deployment of
modern production systems is increasingly enabling India to
improve the quality of its steel products and thus to enhance
its export prospects.
In the last two years the above mentioned figure have
witnessed a sea change Mittal steel has acquired Arcelor to
increase the gap from its second in the industry. TATA Steel
which on 55th position has moved to 5th place after the
acquisition.
TATA-CORUS Merger :Positive Aspects

Tata Group is convinced of the long-term synergies in

manufacturing, access to global customers, opening India to
Corus or leveraging research and development for Tata
Steel’s greenfield projects. It hopes these will save costs up
to $350 million per year. The combined entity could also
scout for more acquisitions together effectively — it is
eyeing more buyouts in finished steel and iron ore.

But tying up the funding is the immediate priority. The Corus

acquisition is being routed through a special purpose vehicle
(SPV) called Tata Steel, UK. (A similar structure was used for
the Tetley buy in 2000.) So far, the Tatas have indicated that
group holding company Tata Sons will pump in $4.1 billion
as equity into the SPV. The balance $8 billion will be raised
by junk bonds and senior term loans (part of it has been tied
up with banks like ABN Amro, Deutsche Bank and CSFB).
These loans will be serviced out of Corus’s profits; Tata Steel
need not repay this. This has effectively ring-fenced Tata
Steel shareholders.

Of the $4.1-billion equity component, analysts say that $2.3

billion-2.4 billion could be tapped from Tata Steel’s cash
reserves. This leaves another $1.7 billion-1.8 billion that is
yet to be raised. There are three routes through which this
could be mobilised.

First, if Tata Sons pumps in this amount as equity into the

SPV, there will be a minimal impact on Tata Steel’s balance
sheet. This will be good for Tata Steel shareholders (see
‘How Tata Sons Could Further Protect Tata Steel
Shareholders’). Tata Sons has the resources to do so. Its
78.3 per cent holding in TCS is worth Rs 99,700 crore, and it
generates over Rs 3,250 crore in cash profit every year.
In the second scenario, Tata Steel could borrow $1.7 billion-
1.8 billion; analysis done by brokerage firm CLSA shows that
the interest on this borrowing could dilute earnings per
share (EPS) by 1.4 per cent in FY08. But such a borrowing
may be difficult as Tata Steel may need to raise more debt
in the next 18-24 months for its greenfield projects in Orissa,
Chhattisgarh and Jharkhand.

The third option is that Tata Steel could dilute equity,

possibly through a preferential issue to Tata Sons. This will
hurt Tata Steel’s EPS even more. CLSA predicts a 13.1 per
cent decline in EPS in FY08 if this option is exercised (see
‘EPS Unfriendly?’).

The financial strength of the Tata Group is not in doubt. But

the funding puzzle is yet to be solved. The $4.1-billion equity
component is the first bit of the jigsaw. The second piece in
the puzzle is the $8 billion-debt being raised by the SPV.

This debt has to be serviced out of Corus’s profits. This is a

short-term concern. Given Corus’s EBITDA margins of only 8
per cent, compared to Tata Steel’s 30 per cent, the UK-
based firm’s ability to service the additional debt of $8
billion is under scrutiny.

Analysts say that the new debt of $8 billion, which will be

serviced through Corus’s cash flow, will roughly bear an
interest cost of 8 per cent. In other words, the annual
interest cost would be as much as $640 million. Based on
results for the 12 months ended September 2006, Corus
already has an interest outgo of $400 million, which means
the total interest outgo could be over a billion dollars after
the acquisition. However, after factoring in a tax break of 30
per cent on the interest paid, (interest cost on funds used for
acquisitions are an allowable expense in the UK), the net
interest outflow may be about $725 million.

Corus’s current EBITDA of $1.45 billion covers the interest

outgo more than comfortably, but a significant drop in steel
prices would adversely impact it and its ability to service
debt.

Brokerage house First Global estimates that a $50 fall in

global steel prices could lead to a $414-million loss from the
acquisition in FY08 (see ‘Price Impact’). If there is a $75 fall,
the losses could climb to $846 million. This does not seem to
be just a street view. “The world steel consumption growth is
expected to slow down from 8.9 per cent in 2006 to 5.2 per
cent in 2007 and 4.2 per cent in 2010,” an ICRA industry
monitor said.

However, in terms of leverage, Corus currently has a

relatively low net debt-equity ratio of 0.25 times. So, while
Corus has room on its balance sheet to take on more debt, it
may come under pressure on debt servicing, if steel prices
head in the wrong direction.

1 Short term aspect

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 working on the
deal. In our view, three elements are stacked against this
deal in the short run:
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 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. Despite that, on the basis of conventional metrics
such as EV/EBITDA 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.

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 replaced by `The
Corus Way', the scope for Tata Steel to bring about short-
term 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. As outlined by Mr B. Muthuraman, Managing
Director of Tata Steel, synergies are expected in the
procurement of material, in the marketplace, in 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 clear indications that steel imports
into the EU and the US have been rising 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.

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
stable in this fragmented industry. The top five players, even
after this round of consolidation, will control only about 25
per cent of global capacities. Hence, the steel cycle may
stabilise only if the latest deal triggers a further round of
consolidation among the top ten producers.

2 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.

Over a long time-frame, the management of the combined

entity has far greater room to manoeuvre, 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 is unlikely to be a short-term outcome as neither Tata

Steel's six-million-tonne 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 requirements of NatSteel,
Singapore, and Millennium Steel, Thailand, its two 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 Corus' high-cost plants at
Port Talbot, Scunthorpe and the 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.

In our view, two factors may soften the risks of dramatic

restructuring at the high-cost plants in UK. If global
consolidation gathers momentum with, say, the 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.
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.

Corus buy will impact Chinese steel market

Analysts from Steel Biz Briefing (SBB) say the Corus deal will
help Tata catapult itself into the global industry.

They also say that the Chinese steel industry will continue to
grow, and that China, not being a low-cost producer, will not
flood market with cheap steel. They believe that steel prices
will be positive in 2007.

TATA-CORUS Merger: The Negative Aspects

An Expensive Deal

To begin with the acquisition has not come cheap. On an

EV/EBITDA (enterprise value/earnings before interest,
depreciation and tax) basis for CY2006 estimated earnings,
the multiple is 6.2 times. That’s more or less similar to the
Mittal-Arcelor deal. But, the big difference is that the deal is
being paid for entirely in cash, while the Arcelor deal
involved a share-swap along with cash. So, it is more
expensive since it will mean a cash outflow from Tata Steel
of £1.84 billion (Rs 15,000 crore or $3.3 billion).On an
EV/tonne basis, Mittal paid $586 a tonne for Arcelor, while
Tata Steel will get Corus at $537 a tonne. But that’s because
Arcelor is more profitable than Corus. A glance at the share
prices of steel stocks shows that they have moved up
sharply and had Tata Steel been a little more nimble, it could
perhaps have got itself a better price. The implied EV/tonne
valuation of $537 for Corus is higher than that of $374 paid
for NatSteel and $333 for Millennium Steel, which Tata Steel
acquired in 2004 and 2005 respectively.

Apart from the timing, Tata Steel would definitely have had
to pay a premium for Corus because of the much larger
operations of Corus–second largest rolling capacity in Europe
of 18 million tonne–and access to better technology.

Tata Steel’s cash flows at the end of March 2006 were Rs

4,281 crore and it should generate around Rs 5,700 crore in
FY07 and Rs 6,000 crore in FY08. However, it may need to
dilute its equity to keep the leverage–its debt-equity is at
0.26– under check given that it has $4-6 billion worth of
projects in the pipeline.

Corus vulnerable to falling steel prices

The borrowings in Tata Steel UK, of £3.3 billion ($6.3 billion),

will be repaid through the cash flows of Corus. According to
analysts’ projections, the topline growth could slide to £9.53
billion in 2007 and further to £9.37 billion in 2008. Corus is
expected to turn in earnings before interest and tax (EBIT) of
around £520 million in CY06 on net sales of around £9.6
billion.
In fact, analysts believe the EBIT will go up only marginally
in CY07 to between £550-570 million and could even dip to
£500 million in CY08.
Thus, if steel prices slip even marginally, they could stretch
Corus’ finances with an adverse impact on its topline and
consequently its ability to repay the debt–annual interest
outflow estimated at around £300-350 million on the new
debt–because there’s little room for cutting costs.
But access to slabs can change things should Corus have
access to low-cost slabs, the deal begins to look better.
Corus is Europe’s second largest steelmaker with crude steel
capacity of 18.2 million tonne in the Netherlands and the
UK.
But it is far less efficient than Tata Steel which, thanks in
part, to its access to iron ore and coal mines, is one of the
world’s lowest cost producers with operating profits of $1.5
billion from 5.3 million tonne. Corus has an EBITDA/tonne of
$97 compared with Tata Steel’s $300.

As some of Corus’ plants suffer from high slab cost

production (estimated at around $330-340 per tonne), the
company needs to be supplied with slabs, at a competitive
price. Tata Steel, whose slab cost is close to $180-190 per
tonne, could be aiming to ship out slabs to Corus, and in the
process saving around $100 per tonne, after incurring
freight costs.
However, Tata Steel is not saying that slabs will be exported
to Corus. While Tata steel agrees that the supply of slabs to
Corus is core to the strategy, it is unwilling to disclose where
the slabs are going to come from.” We have several
options,” is all the CEO will say, adding that, “the slabs will
be sent at the appropriate time from India or elsewhere.”
Since there is still time to go–three to four years–before Tata
Steel’s slab capacity is commissioned, the answer could lie
in an acquisition of a company that makes slabs cheap
located either in Russia or in Latin America, since that’s
where the low-cost slab makers are to be found.