Financing Strategy at Tata Steel

Group C2|Case Study Solution

Q1. Why does TSL need to raise capital? Explain.

TSL had an extremely low debt ratio in the early 2000s, which was unusual in the industry. Prior to the Corus
acquisition, the debt ratio was only 0.3.

• It has stuck to this strategy throughout the years.

• Even while the debt capacity has deteriorated, particularly since the $12 billion acquisition of Corus, it
remains relatively high.
• TSL has been seen over the years, after Corus, to be constantly seizing opportunities for a joint venture,
a share acquisition, or a strategic collaboration with other companies around the world.
• In addition, in order to maintain a steady financial position, the corporation prepaid a portion of the
debt in 2009-10 debt in 2009-2010.
• Keeping in mind the CFO's comments, TSL intends to raise funds through a variety of equity and debt
sources in order to maintain a stronger position in negotiations.
• To deduce the statement, TSL wishes to have money in its bank account whenever and in whatever way
feasible to ensure that any opportunity for a company acquisition/stake in a firm, a JV, or even a
contract is not missed due to a lack of funds.
• The financial statements also show how the corporation has evolved into a cash-hungry diversified
behemoth.

The following are the key causes for obtaining the current debt of INR 10 billion:

➢ Debt reduction.
➢ Expansion of the Jamshedpur plant.
➢ To redeem some nonconvertible debentures issued on a private placement basis by the firm.
➢ Projects involving raw materials in Canada and Mozambique (Africa).

Q2. What securities make sense for TSL in early 2011? Why?
TSL, as a cash-strapped diversified behemoth, needs to raise funds through several securities choices.
They've already started issuing stock, so choosing the best form is vital.

• They may issue long-term securities with no or very low coupon rates, which are paid at the
discretion of the issuing company.
• To avoid dilution, issue long-to-medium-term securities that may not offer voting power.
• The issuance of preference shares and debentures may also assist in raising additional funds,
although this will include a certain amount of risk.

To get the most out of any security, it should have the following terms/elements:

• It should be long-term. Medium-term plans may also be viable, but only if they can be extended.
• Source of a huge sum of money
 • A coupon rate may or may not exist. Those who do not have a coupon rate should be given priority.
• Also, historical data can be used to determine if a coupon rate should relate to a security and
whether it should be fixed or floating.
• To define the rationale behind the issue, the coupon rate should be better than (cheaper) than the
bank loan rate.
• There is no maturity date (Not possible for some debentures)

Q3. How has TSL performed in the recent past?

TSL had a low debt ratio and was one of the few companies in the industry with a positive EVA prior to the
Corus acquisition. After the acquisition, however, the amount of debt used to finance the transaction had an
influence on the company's performance. TSL's performance statistics are listed below.

Performance in terms of strategy

• They have successfully expanded operations in Asia, Europe, and Southeast Asia, and the Corus deal
has catapulted them from 60th to 6th largest company in the world.
• TSL has been able to maintain a consistent supply of raw materials at low costs thanks to its
ownership of captive mines in India leased from the government.
• Following Corus, TSL formed several joint ventures, alliances, and purchase deals in Mozambique,
Canada, and Australia, as well as beginning to build the port in Orissa.
• TSL now has greater control over the global steel market, allowing it to pursue a variety of other
opportunities around the world.
• TSL's financial connections, such as Export Credit, also help to raise finances and loans with a
strong financial backing.
• Through the Corus transaction, economies of scale, low cost benefit, and technology transfer were
achieved.

Financial Achievements

• Looking at some basic financial measures, we can see that TSL has had consistent growth in Net
Sales after a decline in 2010.
• The net profit has recovered after a loss in 2010, going from -2009.2M in 2010 to 6479.2M in 2012.
• TSL has reduced interest expense through its prepayment strategies, which has helped to increase
profit. The decrease was from 4183 million in 2008 to 2992.3 million in 2012.
• There was an increase in free cash flow after the dip in 2010, from 1819 million in 2010 to an
estimate of 68789 million in 2013.
• The company's debt capacity has also been increased by the repayment and payback of various
debts. In 2010, there was a significant payment streak. Between 2009 and 2010, the debt was
reduced by nearly half.

Q4. How would you explain the company’s choice of securities in the recent years?
TSL has taken the following steps in order to increase the repayment time and cut the interest rates because
it has taken a large amount of debt for the Corus acquisition.

2010-2011:

• TSL issued $500 million in Global Depository Receipts in July 2010.

 • In December 2010 and January 2011, the business raised $30 billion through the issuing of 20-year
nonconvertible debentures, with no interest payments for the first three years.

2009-2010:

• In November 2009, the firm offered to exchange Cumulative Alternative Reference Securities (CARS)
it had issued in 2007 for foreign currency convertible bonds in order to lengthen its debt maturity
profile, lower costs, and perhaps reduce future payback obligations.
• The business completed financial close on its 2.9 million tpa expansion in Jamshedpur, for which it
negotiated long-term rupee borrowing in TSL and its subsidiary totalling 93.39 billion rupees, to be
borrowed over the next three years and repaid over a seven-year period.
• The company chose a 264 million euro long-term buyers credit that can be taken over two years and
repaid over ten years, extending the loan period.
• It raised $21.5 billion in non-convertible debentures with a 10-year maturity in May 2009. It also
secured a 6.5 billion ten-year term loan and a 1.99 billion seven-year term loan.

2007-2009:

• The company raised $20 billion in May 2008 through a private sale of three classes of redeemable
nonconvertible rupee debentures with interest rates ranging from 10.2% to 12.5 percent.

Q5. In light of the facts presented in the case would you invest in the company? Why or why not?

We would not invest in the company for the following reasons:

➢ The steel industry is evolving at a quick pace, and TSL is striving to keep up with the changes. As a
result, forecasting demand is extremely difficult and impossible.
➢ TSL's future is in doubt because there are other companies across the world that can produce steel
in far larger quantities and at higher economies of scale than TSL.
➢ There are just a few iron ore mines left on the planet. TSL is buying these mines in order to take
advantage of its cost advantage. However, in the long run, it will be bad.
➢ TSL believes that after acquiring Corus, their operational efficiency would improve and their costs
will decrease, but we cannot guarantee this.
➢ Because China is consolidating and expanding its capacity at a considerably faster rate than TSL, it
could become one of TSL's major competitors.
➢ TSL is unable to lower costs despite acquiring Corus and making several efforts in the years after the
acquisition.
➢ Following the transaction, the interest coverage ratio dropped from 31.03 in 2007 to roughly 4.42 in
2010. (See Exhibit 2.5 for more information.)
➢ TSL's debt/equity ratio went from 0.31 in 2006 to 0.78 in 2010, indicating that the company is
heavily indebted and that investors are unlikely to be interested in it. (See Exhibit 2.5 for more
information.)

Q6. As Anuj, what recommendation would you give? Why?

We agree with Anuj and suggest that new shares be avoided in favor of long-term bonds with no coupon
payments.

➢ TSL might save money on these bonds by deducting the interest.

➢ The bondholders are not the company's owners, although the shareholders are.

As a result, by issuing bonds, we can avoid the dilution that would occur if new owners/shareholders were
added. Existing stockholders will see their gains increase, while bondholders will only receive interest.
Because there are no coupons, bond payments will be made only when the bonds mature, reducing the cash
outflow in the early years.

Q7. Undertake a multiples valuation of the company’s shares using the data in the case. What does
analysis suggest?

As per the Exhibit 2.4 described in the case

Analysis based on P/E Ratio:

Considering for the year 2009

Now, multiplying the EPS of TATA with the P/E average for the industry which is 10.9 (as depicted
from the Exhibit 2.9a), we get

Price per share = 10.9 * EPS

= 10.9 *67.80

= 739.02

However, the market price for TATA shares during 2009 was 625.12.

Hence, this indicates that the share price of TATA were slightly undervalued since after the Corus deal i.e.
during 2007.

We are not taking into account the calculations for the year 2010, due to the financial crisis.
For the year 2011

Price per share = 10.9 * EPS

= 10.9 *47.4

=516.66

However, the market price is 602.99.

Therefore, this states that the TATA’s share price continued to be slightly undervalued for the year
2011, and this trend continued for the year 2012.

Moreover, from the Exhibit 2.9a which indicates the domestic peer comparison for the year 2009-10, as
per below;

Industry Composite Average: 10.9

This again shows that the share price of TATA Steel are trading at a lower P/E ratio compared to its
competitors, indicating that they are undervalued.

Valuation based on EV/EBITDA Ratio :

The EV/EBITDA ratio for the year 2009 is 4.80 (Exhibit 2.4), we would use this to calculate the enterprise
value of the combined entity TATA Steel and Corus.

The EBITDA for the year 2009 is 18,127.7 million (Exhibit 2.1)

Using this and the EBITDA multiple to calculate the Enterprise value of TATA we get,

Enterprise Value = EVITDA X Ratio

= 18,127.7 X 4.80

=87012.96

Removing the book value of debt from this EV (2009) i.e.

Secured loans (34,329.3)+ Unsecured loan (25,571.2) = 59,900.5 (Exhibit 2.2) we get

Value of Equity = Enterprise Value – Book Value of Debt

= 87012.96 – 59,900.5

= 27112.46 M

Analysis based on Price-Book Value Ratio:

As it is clearly evident from the above table , the Price/Book Value ratio has been continuously dropping
through the years after 2007, i.e. 2008-10; which clearly indicates that the investors are losing trust in the
company.

Q8. Value the company’s equity by the sum-of-the-parts valuation methodology. Assume the following for
your analysis:

For calculating the equity, we require the EV/EBITDA ratio of the entities.

Since, the ratio is not given for the separate parts, we will consider the average EV/EBITDA ratio of TATA
steel from the exhibit 2.4 till 2009 for calculating the EV of all the 3 parts.

EV/EBITDA ratio = (4.7 + 4.8 + 4.8) / 3

= 4.8 (approx.)

In sum-of-the-parts valuation methodology, we calculate the enterprise value for each of the parts and then
subtract the book value of debt from it to obtain the value of equity.

Calculating the enterprise value of TATA Steel:

EBITDA (TATA Steel) : Rs. 125,626M

EV/EBITDA = 4.8

EV = 125,626 X 4.8

= Rs. 603,004.8 M

Calculating the enterprise value of Corus:

EBITDA (Corus) : Rs. 41,231M

EV/EBITDA = 4.8

EV = 41,231 X 4.8

= Rs. 197,908.8 M
Calculating the enterprise value of Asian Subsidiaries:

EBITDA (Asian Subsidiaries): Rs. 3,842M

EV/EBITDA = 4.8

EV = 3,842 X 4.8

= 18,441.6 M

Total EV = EV of TATA Steel + EV of Corus + EV of Asian Subsidiaries

= 603,004.8 + 197,908.8 + 18,441.6

= Rs. 819,355M

Value of Equity = Enterprise Value – Value of Debt

= 819,355 - 416,029

= Rs. 403,326.2 M

No. of Shares Outstanding = 914.85 M

Value of each share = Value of Equity / Shares Outstanding

= 403,326.2M/ 914.85M

= Rs. 440 per share

Q9. Value the company by the free cash flow valuation methodology. Assume the following:
Risk Free Rate = 7%
Market Risk Premium = 9%
Beta = 1.12
Cost of Debt = 11%
Tax Rate = 30%

We calculate the following using data from Exhibit 2.1 Income Statement for 2009.
EBITDA – 18127.7, Depreciation – 4265.4, Amortization – 0, Capex – 0

Formula EBITDA – Depreciation – Amortization = EBIT

EBIT(1-Tax) + Depreciation + Amortization – Capex = Free Cash Flow to firm

EBITDA 18127.7
(Depreciation) 4265.4
EBIT 13862.3
(Tax 30%) 4158.69
Net income 9703.61
Depreciation 4265.4
Free Cash Flow 13969.01

Cost of Equity: Rm = Rf +  (Rm – Rf)

Rm = 0.07 +1.12(0.09)
Rm = 17.08%
PV = Free Cash Flow/Cost of Equity PV = 13969.01/0.1708
PV =INR 81785.78