FUNDING OF THE CORUS–TATA DEAL

Total cash payment to shareholders of Corus at 608 pence per share

worked out to be US$12.90 billion. Additionally, debts outstanding in the
Corus balance sheet which amounted to a little over US$800 million were
required to be refinanced. Thus the total funds requirement was a
whopping US$13.70 billion. To mobilize these funds and acquire Corus,
Tata Steel followed the strategy of multiple leveraging through a chain of
holding and subsidiary companies. One reason of doing so was to keep a
minimum debt on the balance sheet of Tata Steel as also to minimize the
equity dilution of Tata Steel. The other reason was the RBI restriction of
200 per cent (now 400 per cent) of net worth on the investment by an
Indian company in joint venture or subsidiaries abroad in one financial
year. The corporate structure used for acquisition and fund mobilization
was as follows:

The funding arrangement is shown below in tabular form:

Tata Steel UK raised US$6.14 billion through a mix of high-yield
mezzanine and long-term debt funding. These non-recourse loans were
secured by the cash flows and assets of Corus. Tata Steel Asia—Tata
Steel’s Singapore special purpose vehicle (SPV)—raised US$2.66 billion
through bridge loans. Banks like ABN Amro (27.5 per cent), Deutsche
Bank (27.5 per cent) and Credit Suisse (45 per cent) extended the bridge
loans of US $2.16 billion. Payment for these bridge loans upon their
maturity was to be financed by way of non-recourse facilities which were
being arranged by a syndicate led by ABN Amro, Citigroup and Standard
Chartered Bank. The refinancing facility comprised of quasi-equity
instruments worth US$1.25 billion and long-term loans of US$1.41 billion.
These were probably secured by Tata Steel Asia’s equity holding in Tata
Steel UK. Tata Steel’s own contribution in the Corus deal amounted to
US$4.9 billion. This was raised by a combination of debt and equity such
that the debt burden on Tata Steel’s balance sheet was restricted to US$
500 million only. The company used its cash reserves of US$700 million
and external commercial borrowings of US$500 million.

A preferential issue of equity shares and warrants convertible into equity

shares of Tata Steel to Tata Sons fetched US$640 million. Remaining
US$3.06 billion was raised through two rights issues and a foreign
currency issue of equity related instruments. The first rights issue of Tata
Steel was in the ratio of 1:5 at a price of ₹300 per share. This issue
generated approximately US$860 million. Tata Steel also made a
simultaneous but unlinked rights issue of convertible preference shares in
the ratio of 9:10, convertible into equity shares in two years at a price of
₹600 per share. This issue had generated a total amount of US$1.300–
1.325 billion. Tata Steel also came out with an issue of equity-related
instrument called as Foreign Currency Convertible Alternative Reference
Securities to generate an amount of US$800 million.
RATIONALE BEHIND THE ACQUISITION

Apart from Tata Steel’s ambition of growth and globalization, there was a
compelling need for it to globalize and catapult itself in the league of the
top ten steel producers in the world. Indian steel industry, tiny by global
standards, is under threat of getting overcrowded with the Tata Steel,
Mittal, Posco and many others planning greenfield capacities, since the
domestic demand for steel is unlikely to grow so dramatically as to absorb
all the incremental capacities that might come up. Therefore, India has
been trying to increase exports to overcome the anticipated domestic
situation of excess supply. This has resulted in antidumping actions being
taken by developed countries like USA, EU and Canada. Hence, the
compelling logic for Tata Steel was to have production capacities in the
export markets and the acquisition of Corus fits in nicely with that game
plan. At the same time, the sheer size of the new entity will give Tata
Steel the leverage to take on multinational rivals and thwart a possible
hostile takeover threat. After successfully acquiring Corus, Tata Steel
became the fifth largest producer of steel in the world, up from the fifty-
sixth position. There were many likely synergies between Tata Steel and
Corus considering the fact that while Tata Steel is the lowest-cost
producer of steel in the world, Corus is a player with a large presence in
value added steel segment. Also, Corus has a strong distribution network
in Europe.

One of the benefits to Tata Steel was that post acquisition it would be
able to supply semi-finished steel to Corus for converting into high value
added products in its finishing plants, which are located in the European
markets. Another expected area of synergy was the synergies of joint
procurement. Combined entity would be able to negotiate much better
raw material prices on one hand, while on the other it would not be so
vulnerable to the pressure on prices of the end products. All these
synergies were expected to increase the merged entities profitability
further. Tata Steel’s optimism regarding the synergies that could be
generated after merger with Corus was strong. B. Muthuraman had said
‘We will benefit from the significant synergies although they will take
around three years to happen. We are looking looking at synergies of
$300–350 million per annum although it will start lower.’ (The Hindu, 1
February 2007). Tata Steel could now adopt one of the two alternate
strategies. The first one, which made more sense, was that two would
manufacture primary steel in India—close to its iron ore deposits and ship
the semi-finished steel to Corus’s finishing plants in developed markets.
Second one was to relocate some of the Corus’s capacity to India where a
massive expansion was any way planned. Also, Tata Steel could now
leverage upon Corus’s expertise in making high grade steel for supplies to
growing Indian automobile market. Corus had a much better R&D
capability than Tata Steel. It was planned to leverage on the same for the
benefit of both the companies. Post acquisition, acquisition, Mr
Muthuraman had said, ‘Corus has a highly developed R&D capability and
although Tata Steel has better R&D than other Indian players, this is
another strength Corus brings to Tata Steel.’ (The Hindu, 1 February
2007). THE FLIP SIDE Despite the potential benefits of the Corus deal,
there were concerns about the outcome and effects on Tata Steel’s
performance. It was felt that Corus EBITDA (earning before interest,
taxes, depreciation and amortization) at 8 per cent was much lower than
that of Tata Steel which was at 30 per cent in the financial year 2006–07.
There were also concerns about the valuation and funding of the deal. At
608 pence per share, Tata Steel paid a 68.7 per cent premium to average
mid-day stock price of Corus over preceding twelve months. Earnings per
share (EPS) for the nine months that ended in September 2006 was 37
pence per share. Considering this, the price of 608 pence meant a P/E of
approximately 16.5, which was much higher than industry average of 6–8.
At 13.7 billion, Corus’s EV (enterprise value) ended up being valued at
approximately 7.7 times the EBITDA, which was considered an
overvaluation, when compared with Arcelor–Mittal deal, where the EV to
EBITDA ratio is around 4.6. However, when we look at the EV/tonne, at
US$710 per tonne, it is slightly lower than Arcelor’s US$725 per tonne
and quite comparable with industry range of US$650–900 per tonne.
Analysts raised concerns that the Corus’s acquisition would result in a
significant equity dilution of Tata Steel. Though, there was hardly any
debt taken on Tata Steel balance sheet, the combined entity has become
highly leveraged due to the significant increase in debt in its capital
structure. With regard to the US$6.14 billion debt, that was mobilized to
finance the acquisition, based on the security of the assets of Corus and
which was planned to be serviced by the cash flows generated by Corus,
there was a danger of default if the business performance of Corus were
to go down on account of slowdown in the global economy in near future.
It was also felt that after the Corus deal, Tata Steel would no longer
remain as the lowest-cost producer of steel in the world. Tata Steel’s cost
advantage (production cost of US$160 per tonne as against industry
range of US$300–350 per tonne) stemmed from its access to raw
materials. Tata Steel’s captive iron reserves in India would last for about
fifty years if one were to consider the company’s pre-acquisition annual
production capacity of 5.3 million tonnes of steel. However, the iron
reserves would remain for much shorter period with the Tata-Corus
production capacity of 27 million tonnes of steel per annum. Furthur
more, Corus itself did not have access to any iron ore or coal reserves.
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, might be at lower levels in the first two years. A recent report in
The Financial Express says that the combined synergies achieved during
2007–08 were US$76 mn.

THE ROAD AHEAD

Before the acquisition, the major market for Tata Steel was India. The
Indian market accounted for 69 per cent of the company’s total sales.
Almost half of Corus’s production of steel was sold in Europe (excluding
UK). The UK consumed 29 per cent of its production. After the acquisition,
the European market (including UK) contribute to the sales of 59 per cent
of the merged entity’s total production. Tata Steel’s immediate plan after
completing the integration was to conduct a joint synergy analysis and
establish a plan or a timeline for delivery. Since Tata Steel had quite a few
brownfield and greenfield projects in the offing, they were to be pursued
further. The achievement of EBITDA of 25 per cent was also targeted.
Moreover, the company aimed at a robust capital structure and financial
flexibility. In mid-2007, Tata Steel formed eighteen teams, each consisting
of three to four members from both companies to work on various
potential synergy areas like iron and steel making, manufacturing,
marketing, logistics and procurement of consumables. These teams were
to come up with a report on synergy potential and priorities and it was
planned that by October 2007, detailed synergy targets would be set for
the combined entity. The objective was to develop efficient practices by
sharing information, know-how and best practices of both the companies
with the ultimate aim of cost reduction. As a result of Corus acquisition,
Tata steel got access to the developed markets of Europe. According to
Mr Muthuraman, ‘It gives us access to developed and mature markets of
Europe where we can go downstream much more than say in India or
China and where the quality of products and service is important.’ The
merged entity aimed at transferring European technology and the
expertise of the research and development wing of Corus to India to
develop new products and capture growth in India and other parts of
Asia. By the year 2015, Tata–Corus targeted that production should
increase to more than 50 million tonnes per annum (MTPA) in early 2007.

EPILOGUE

While only the time will tell whether Tata Steel’s acquisition of Corus was
a move in the right direction or not, on 11 May 2009, The Times of India,
Mumbai reported as follows: London: In a candid admission, perhaps for
the first time, Ratan Tata has said his two mega acquisitions—Anglo
Dutch steelmaker Corus and British marquee Jaguar Land Rover—were
done at an ‘inopportune time’ and his company might have gone ‘too far
too fast’. It further reported: In an interview published in The Sunday
Times, London, Tata admitted with hindsight that he might have gone too
far too fast, but said that nobody saw the economic recession coming.

Questions :

1. Explain the concept of Leveraged Buy out in the context of Tata

purchase of Corus
2. Explain Hostile takeover in the context of Tata acquisition
3. Whats the opinion in market about both Corus and jaguar purchase
and how the effect in both cases.
4. What are the various types of synergies and which synergies can be
witnessed in the above cases
5. Explain - brownfield and greenfield projects in the context of above
case study.