Mumbai: A day after getting 97% of Corus shareholders to approve the company’s acquisition by Tata Steel, Ratan Tata, the chairman of Tata Sons, and his team have to get their investment to pay for itself. Corus will now effectively take on $6.37 billion of debt to pay for the takeover, and it has to generate enough money to pay for the interest.
That may not be easy. Corus may be profitable, but it had a net negative operating cash flow of £105 million on a turnover of £7.18 billion for the nine months ended September 2006.
Although the debt will be taken on by the special purpose vehicles floated by Tata Steel, it will be guaranteed by Corus; the SPVs have no independent source of income to pay interest or repay loans. In any leveraged buy-out like the one Tata is attempting, the acquirer uses the cash flows of the company being purchased to secure loans that are used to purchase the company.
Mumbai-based brokerage First Global estimates that a $50-75 per tonne reduction in steel prices will wipe out all of Corus’s profits. “Even if the gamble does pay, there’s no jackpot at the end of it…..just mere survival,” says a report from the brokerage. Leading global credit rating agency Standard & Poor’s too says that Corus’ ability to generate positive free operating cash flows is highly cyclical. “These cash flows are only likely to be a source of financing in the current favourable pricing environment,” it says.
Ironically, a fall in prices would, according to Emma Tovey, director, investor relations, Corus, see it generate more cash. “When prices fall, the group tends to generate cash and vice versa.” She also expects that unwinding of inventories built up ahead of a plant shutdown to “correct an abnormal £400 million working capital outflow (£332 million of this was on account of build-up of inventories).”
But the Tata group will still have to look at generating some cash from the sale of assets such as Corus’s aluminium smelters in the Netherlands and Germany, cut costs to improve operating cash flow, draw on the cash balance of £702 million as of September 2006 and, use another £700 million in sanctioned bank borrowings that have yet to be utilized.
Last year the steel industry saw 349 mergers and acquisitions totalling $106 billion, up from 270 deals valued at $33 billion the year before, according to data compiled by Bloomberg.