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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 Short-Term Implications 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 highcost 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 2025 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 GDRs (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 sixmillion-tonne greenfield ventures in Orissa, its debt levels may rise 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 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. 3) 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 1012 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. 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:
1) 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 sixmillion-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. 2) 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. Benefits of the TATA-CORUS merger deal to the stakeholders of CORUS In order to survive, Corus needs to extend its global reach just as much as Tata does. A tie-up with Tata gives it, among other things, access to markets in India one of the fastest-growing economies in the world - as well as access to lowcost materials.
Shareholders in Corus gained from the acquisition as the premium offered much more price than the book value of shares. Both companies exhibit degrees of cooperative spirit despite competitiveness in providing rescues to each other from hostile takeovers and cultivate situations of collaborations sharing goodwill of each other to achieve performance heights through business combinations. The acquisition was pursued to obtain the desired level of integration between the two combining business houses. This integration was operational and financial. Some other benefits: 1. Corus shares rose 6.8% to 601.5 pence in intra day trading on the London stock exchange on January 31, 2007. 2. Corus' well known strength is the production of high-end steel-used in construction automobile and aircraft as well as its impressive research and development will complement Tata Steel. The merger will also give it access to the important markets of Europe. All that will benefit Corus is the management expertise of the Tatas and their cost advantage in producing steel. With their acumen they will bring down the production cost of Corus. 3. Corus have a much better R&D and Tata have also better R&D other than in India, so combine entity have very strong R&D Dept. that would enable them to create a better output and faces competitive majors successfully in future market. CAPM Model CAPM is a model that describes the relationship between risk and expected (required) return; in this model, a security’s expected (required) return is the risk-free rate plus a premium based on the systematic risk of the security CAPM assumptions 1. 2. 3. Capital markets are efficient. Homogeneous investor expectations over a given period. Risk-free asset return is certain (use short- to intermediate-term Treasuries as a proxy).
Market portfolio contains only systematic risk (use S&P 500 Index or similar as a proxy).
Post merger security through CAPM model According to CAPM model the purchase or sell of security can be undertaken in infinitely divisible units. Through this model Tata Steel has evaluated the prices of securities of Corus because the CAPM provides a framework for assessing whether a security is under priced, overpriced or correctly priced. The real rate of return can be calculated through following formulae Expected Security Return = Riskless Return + Beta x (Expected Market Risk Premium or: r = Rf + Beta x (RM - Rf)
Characteristic Line Characteristic Line
EXCESS RETURN Rise Run ON STOCK
Narrower spread is higher correlation
EXCESS RETURN ON MARKET PORTFOLIO
So by the CAPM model, we can say that TATA has taken a right path for the deal of merger and the risk valuation also low as the Corus is already a established industry captured European market, and the diversified asset of Tata through the merger deal would definitely gave the expected rate of return because the asset is to be added to an already well diversified portfolio and it support the theoretically value of the CAPM model. Further consolidation of the industries makes the market in a stabilized condition.
TATA has claimed some synergies during the takeover deal. Comment on the Takeover Tactics and the resulting synergies which shall benefit the organization. Under what circumstances will TATA and its stakeholders benefit in this merger?
A.2. Takeover tactics adopted by Tata Steel was purely friendly. The offered to takeover Corus. There were many synergies between the two companies which are mentioned below. Considering this synergies Corus directors and employees were in total agreement to be taken over by the Tata’s in comparison to the Brazilian CSN. Synergies from the TATA-CORUS Deal i. Tata Steel would get an access to the European market. Corus has already a well-defined network in European Market. If Tata Steel had independently entered the European market, it would have taken a considerable time to develop a well-established network. In the post deal scenario it will become a global player with the balanced presence in developed European market and fast growing Asian Market. Tata Steel will have a strong position in construction, automotive and packaging market sector. It will have a low cost position in Europe and South East Asia. It can double the size and profitability The deal has expanded scale from 7 MTPA to 25 MTPA and reaps significant economies of scale. The merged entity would become world’s 6th largest steel company with 25.6 MTPA of crude steel production. The combined entity will have more efficient operations through enhanced optionality to optimize asset base and material flow, including sourcing of raw materials, and semi-finished steel. Better equipped to race intensifying competition arising from consolidation in the industry globally. Both Tata Steel and Corus are a strong cultural fit. Tata Steel would benefit from Corus’s pan-European distribution network. The acquisition gets with Tata Steel’s stated objective of having a global distribution network. There a strong cultural fit both the two companies. -Both Tata Steel and Corus have strong commercial relationship. -Management of both companies are highly focused on improving efficiency and productivity -Tata’s continuous improvement programme “ASPIRE”, whereas Corus improvement programme – “The Corus Way” -World class governance
ii. iii. iv. v.
vii. viii. ix. x. xi.
Under the following circumstances TATA and its stakeholders will benefit from the merger: • Any advantage and profits from this deal will merge only when Tata Steel would be in a position to export low-cost slabs to Corus. There may be restraints to exports as Tata Steel will need to heed the requirements of its other acquired companies in South East Asia of NatSteel and Millennium Steel. This effect may change if the Tatas can acquire businesses in the low-cost regions such as Latin America, opening up an assured source of slab-making that can be exported to Corus’s plants in the UK. Iron ore policy in India undergoes a major change in the coming years. If global consolidation becomes possible with the merger of Thyssen Krupp with Nucor or Severstal with Gerdau or any the top five players. The possibility of pricing stability may ease the performance pressures on Tata-Corus and moderate the risks of restructuring at high cost plants in UK If Tatas considers global listing say in London it may help the group commands a much higher price-earning multiple and give it more flexibility in managing its finances.
What are the long-term implications of this deal on the global steel market? Justify your answer with strong reasoning and financial/technical analysis. Cite an example of another Indian company entering the global market and which has been successful.
A.3. There has been growing evidence of a shift in global business power, with foreign investment from developing countries now a major factor in the world economy. The Tata deal is a further sign that India's economy is a force to reckoned with. Analysts expect a wave of takeovers by Indian firms to ensue around the world. The long term implication of the deal for Tata Corus reflected in the corporate objectives. It has to decide the specific objectives to be achieved through acquisition. The basic purpose of this combination was to achieve faster growth of the corporate business. Faster growth may be had through product improvement and competitive position. Other possible purposes for the acquisition are short listed below: (a) Procurement of supplies:
To safeguard the source of supplies of raw materials to obtain economies of purchase in the form of discount, savings in transportation costs, overhead costs in buying department, etc.; to share the benefits of suppliers economies by standardizing the materials. (b) Revamping production facilities:
To achieve economies of scale by amalgamating production facilities through more intensive utilization of plant and resources; to standardize product specifications, improvement of quality of steel, expanding market and aiming at consumers satisfaction through strengthening after sale services; to obtain improved production technology and know-how from Corus. To reduce cost, improve quality and produce competitive products to retain and improve market share. (c) Market expansion and strategy: To eliminate competition and to obtain a new market outlets in possession of Corus; to obtain new product for diversification or substitution of existing products and to enhance the product range; strengthening retain outlets and sale the goods to rationalize distribution; to reduce advertising cost and improve public image of Corus; strategic control of patents and copyrights.
(d) Financial strength: To improve liquidity and have direct access to cash resource; to dispose of surplus and outdated assets for cash out of combined enterprise; to enhance gearing capacity, borrow on better strength and the greater assets backing; to avail tax benefits; to improve EPS (Earning Per Share). Current EBITDA of 13%; 25 million tons, ranked 6 By 2012 EBITDA of 25%; 40 million tons, ranked 2 (e) General gains: To attract superior managerial talents of Corus to manage its affairs; to offer better satisfaction to consumers or users of the product. (f) Own developmental plans: The purpose of acquisition is backed by the Tata Steel developmental plans. A company thinks in terms of acquiring the other company only when it has arrived at its own development plan to expand its operation having examined its own internal strength where it might not have any problem of taxation, accounting, valuation, etc. but might feel resource constraints with limitations of funds. It has to aim at suitable combination where it could have opportunities to supplement its funds by issuance of securities, secure additional financial facilities, eliminate competition and strengthen its market position. (g) Corporate friendliness: Both Tata Steel and Corus exhibit degrees of cooperative spirit despite competitiveness in providing rescues to each other from hostile takeovers and cultivate situations of collaborations sharing goodwill of each other to achieve performance heights through business combinations. Example Of Another Indian Company Entering The Global Market Previous Indian deals in Europe include the takeover of German group Betapharm by pharmaceutical firm Dr Reddy for $570m, as well as energy company Sulzon's acquisition of Belgian firm Eve Holding for $526m. Both companies were successful in these acquisitions.
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