Now comes the hard part.
The morning after emerging victorious in an expensive four-month battle to acquire Corus Group Plc for $13.65 billion (Rs 60,333 crore) Tata Steel got an early taste of the challenge ahead as unhappy shareholders pushed its shares down by 10.7%, wiping out Rs3,000 crore in market capitalization.
A combative Ratan Tata, the 70-year-old chairman of Tata group, brushed aside concerns that Tata Steel had paid too dearly to beat out Brazil-based Companhia Siderurgica Nacional (CSN) to buy Corus in India’s single largest overseas acquisition.
“The market is frankly taking a short-term view and a harsh view,” said Tata. “We have satisfied ourselves that the company has in no way jeopardized the interest of shareholders.”
A chorus of Indian executives and politicians hailed the move as a sign of the growing confidence of India’s companies to compete aggressively in the global marketplace.
Meanwhile, analysts noted that Tata Steel had to pay through the nose—nine times trailing earnings—and is making a big bet that it would be able to use its potentially low-cost production to create significant synergies—up to $350 million annually in about three years time. The company is also much better at making profits in steel—its operating profit margins are 42% compared to the 9% or so at Corus.
The one catch and the reason why significant savings will take a few years to drop to the bottom line: Tata Steel hopes mainly to make the savings by shipping cheap slab steel to Corus, reducing the need for expensive production in the United Kingdom. But the company, which has ambitious growth plans inside India, currently doesn’t have the capacity to supply a lot of this steel.
Once approved by Corus shareholders, Tata Steel would jump from the 55th ranked steel company, in terms of output, to the fifth ranked, with an annual capacity of about 24 million tonnes, of which some 19 million comes from Corus. In addition to capacity, Corus also gives it a global footprint with a very strong brand in Europe.
Tata noted that while the proposed acquisition could be seen as “an audacious move for an Indian company, creating that kind of capacity would have taken “several years” to build. The company also noted that in terms of price per tonne, it was only paying about $710 compared to the $1,200 to $1,300 per tonne that it would cost to create such capacity.
While Tata Steel is cash rich—it is sitting on a cash pile of $1 billion—the company will end up having to raise billions through equity and long-term loans to pay for Corus.
Riding on the back of a booming stock market, Indian companies have typically used their more expensive shares to pay for part of their overseas acquisitions as they usually buy companies with lower valuations. But valuations on Corus are significantly higher than those of Tata Steel, another reason why the market reacted negatively to the deal. Tata Steel shares fell to Rs463.95 on the Bombay Stock Exchange, down Rs55.35.
An investment banker associated with the Tata-Corus deal said the company expects its credit ratings downgraded a notch but expected the rating agencies will leave it at investment grade status, which gives it more flexibility in terms of its ability to borrow.
Still, improving the business profile of Corus and integrating such a large company with Tata poses significant challenges, said S&P credit analysts Anshukant Taneja.
Analysts expect Tata Steel to puts its equity contribution into Tata Steel Asia which will use that money and some of its own debt to invest in Tata Steel UK. Tata’s UK subsidiary will then raise junk bonds to complete the complicated leveraged buy.
With a group revenue of about $22 billion—accounting for about 3% of India’s gross domestic product—and as India’s single biggest private employer with 222,000 people on its rolls, the Tata conglomerate and its senior executives are used to operating on a large scale.
Under Tata, the company, which makes everything from watches, tea, buses, cars and runs hotels as well as phone networks is also used to a steady diet of acquisitions, increasingly outside India.
While the Tatas have pulled off leveraged deals in the past, notably when they acquired Tetley Tea, the UK’s top tea brand, they are now betting they can do the same in steel, a notoriously cyclical commodity.
Tata, a low-profile bachelor with an MBA from Harvard University, has often maintained that the Tata group needed to “spread its wings far beyond India.” He called the proposed Corus deal a “very visionary move... Hopefully in future, people will look back and say that we did the right thing.”