Q.1.What are the benefits of the TATA-CORUS merger deal to the stakeholders of TATA Steel and the stakeholders of CORUS? Evaluate the post-merger security with the help of CAPM Model.
A.1.On January 31st, 2007 India’s Tata Steel acquired Corus, the erstwhile British Steel Major at a price of 608 pence per Corus share totaling $12.1 billion/ Rs 54,000 crore/ £6.1 bn, which was five pence per share higher than the offer of Brazil’s CSN (Companhia Siderugica Nacional). The deal is the largest Indian takeover of a foreign company, and creates the world's fifth-biggest steel company from the present 56th rank.
Benefits of TATA-CORUS merger deal to the stakeholders of TATA Steel
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:
1)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. 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 GDR’s (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-million-tone Greenfield ventures in Orissa, its debt levels may raise sharply in the medium term. 2)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. 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 bottom-line 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. 3)The steel cycle: While the industry expects steel prices to remain firm in the next...