Case Study

Tata Steel Ltd:

Convertible Alternative Reference Securities

Submitted by –
Kshitij Srivastava ( G19070)
Abhishek Kumar ( G19053)
Rushal Shah (19089)
 Case Summary

Tata Steel was originally incorporated as “The Tata Iron and Steel company Limited”, as a public
limited company under the provisions of the Indian Companies Act 1882. The company
manufactured a diversified portfolio of steel products, including flat and long products, as well as
non-steel products like ferro alloys and minerals, tubes and bearings. The main markets included
Indian construction and automotive industry.

Corus was formed by the merger of British Steel plc N.V. The company prior to its acquisition
was listed on the London Stock Exchange, New York Stock exchange. It had four operating
systems; strip products, long products, distribution and building systems and aluminium. It had
good distribution network in North America and Europe. It was the second largest steel producer
in Europe and the ninth largest steel company in the world. The steel division of the company
accounted for 91of the total turnover of the company.

The UK panel on mergers announced the winning bid of Tata Steel of 608 pence per share of
Corus. The total consideration for the acquisition worked out to around 6000 million Euros.
Following the auction, Corus board unanimously recommended the offer of Tata Steel to the
shareholders who gave their approval.
Convertible Alternative Reference Security (CARS)

The issue of US$ 725,000,000 in aggregate principal amount of one percent letter of credit backed
Convertible Alternative Reference Security (CARS), due 2012, which would include any CARS
issued pursuant to an option to increase the principal amount of the CARS up to an additional
US$150,000,000 was authorised by a resolution passed by the BoD of Tata Steel. CARS was a
variant of a standard International Convertible bond; among the typical features missing (from an
Indian FCCB) was the call option to the issuer linked to the market price performance of the
convert (the issuer did not have the right to call the bond under defined circumstances and
effectively force conversion). The CARS issue was backed by an irrevocable letter of credit under
a credit agreement entered between Standard Chartered and Tata Steel. It was issued in favour of
the trustees for the benefit of the holders of the CARS.

CARS was required by Tata Steel to defer cash flows and also the fact that the rating agencies did
not consider this instrument as a plain debt as these were convertible to shares at a later stage. It
was therefore considered to be a Quassi equity instrument and the ratings of the company didn’t
fall because of this.

Some of the features of CARS were:

1. Provided coupon rate of 1%

2. The bond would be redeemed at 23% premium
3. Effective Yield was 5.15%
4. The provision of convertibility came into picture after 4 years and was open for only one
year. This was different from the normal FCCB wherein call option was there with the firm
(it could call back the instrument and convert it into shares and issue them or pay back cash
to the investor). In this case one needed to wait for 4 years and only if the share prices were
high and rising at that time would convert the bond into shares. At the time of purchasing
CARs the market was bullish and people thought prices would continue to rise even after
4 years hence they purchased the bond.
5. The instrument was supported by Letter Credit and this attracted foreign lenders easily as
backing an instrument by LC grades the instrument at A or AA.
6. Tata Steel being a Capex heavy company had a lot of operating leverage. When market
goes into recession it becomes difficult to manage the operating leverage. With this
instrument the company had the lenders also to partner with them and share the risk.
7. On conversion, voting rights were not given to the shareholders.
Valuation of the instrument: -

Convertible bonds have two parts in value:

 Value of plain bond+ value of convertible part

 Value of plain bond comes out to be Rs 97,425

Convertibility gets estimated assuming call option. Convertible price quoted was Rs 876 i.e when
the stock price increase beyond Rs 876 the lender will exercise conversion.

Convertibility gets estimated assuming call option. Convertible price quoted was Rs 876 i.e when
the stock price increase beyond Rs 876 the lender will exercise conversion.

Value of underlying 21
Strike price 22
Option price per CAR 4,591
Option value (derived using Black Scholes 10
model)
Option value of CARs 43,898
Value of plain bond 97,425
Value of CARs 1,41,323

Since it is a case of deferred conversion, option value will not vary linearly with the underlying
price.

The above calculations show that CARs was trading at a discount then and with a few more
incentives interested the buyers to purchase the bond.

Post Acquisition

Then, the 2008 subprime crisis happened. With the collapse of marquee names such as Bear
Stearns and Lehman Brothers, the Western world went into a tailspin. Automobile companies and
construction companies, the main sectors affected in the financial crisis, were key customers of
Corus. The company recorded a 23 per cent decline in Ebitda for 2008-09, followed by a $303 mn
(Rs 1,361 crore) operating loss in 2009-10.

Tata steel thought Corus would do well and stock prices would go and they would not have
to redeem debt. The investors would convert the bond into shares. Exactly the opposite happened
and Tata Steel was asked for redemption of debt. The company already in a lot of cash crunch
decided to postpone the date of payment of principal amount. This made the investors ask for more
interest that previously decided.
Conclusion

The indenture provisions on a convertible bond are generally much more stringent than they are
either in a short-term credit agreement or for common or preferred stock. Hence, the company may
be subject to much more disturbing restrictions under a long-term debt arrangement than would be
the case if it had borrowed on a short-term basis, or if it had issued common or preferred stock.
Firms issue such financially engineered instruments keeping a rosy picture of the future economy
in mind or considering that a period of recession will not arise soon. As we have seen in this case,
such plans generally go for a toss leaving the firm with a lot of liquidity crunch and also bringing
bad name to it.

Moreover sometimes the complexity of the instrument (or in other words when the buyers are not
able to understand the clauses of the instrument completely) either he will refrain from buying the
instrument or buy it at a higher coupon rate.