The signals from Tata Steel’s fundraising plans
Inorganic” is the one word from Tata Steel Ltd’s statement that will catch investor attention. They may also wonder why it took the board a little under 10 hours spread over two days to approve an expansion at an existing location and a rights issue. Their curiosity may be stoked by Tata Steel reportedly being interested in bidding for distressed steel assets.
The expansion plan itself is fairly straightforward. The company is already operating at 98% utilization and wants to add 5 million tonnes or 38% to its existing capacity of 13 million tonnes. This will cost it Rs23,500crore spread over four years and it will focus on producing automotive, general engineering and other value-added steels.
This is a forward-looking investment. On paper, India is an attractive market for steel but domestic consumption has been sluggish and firms are forced to export. Still, adding to capacity is one way to grow sales and Tata Steel will benefit from economies of scale as this expansion is as at an existing site.
Since the investment is spread over four years and the company’s cash flows have improved, it could have funded this investment through debt and internal accruals. In fact, if its European steel business moves into a joint venture with Thyssenkrupp AG, then its group-level indebtedness should ease too.
So why does Tata Steel need to raise Rs12,800 crore from a rights issue? It’s a significant dilution considering the value represents 19% of its current market capitalization. After all, between FY12 and FY17, the company’s stand-alone gross block increased by Rs58,338 crore, shows Capitaline, but its equity capital remained constant. Is something else being on the agenda a reasonable question to ask?
That’s where distressed steel assets come into the picture. Bidding interest is strong for some of the large steel assets, such as Essar Steel Ltd or Bhushan Steel Ltd, according to reports, with funds and even global companies such as ArcelorMittal showing interest. Domestic firms such as Tata Steel and JSW Steel Ltd too are reported to be keen. If Tata Steel stays away, it runs the risk of a smaller domestic rival becoming bigger or a large foreign rival getting a ready-made stronghold in the market. These assets come attached with captive mining assets, which can be valuable if utilized well.
The decision to bid cannot be an easy one. While Tata Steel knows the industry like the back of its hand, the process itself is new and can have surprising twists. The move to keep defaulting promoters out of the process, for example, was one. Of course, this is advantageous to Tata Steel but some other twists may lie ahead that may not be.
Secondly, while it may have market intelligence on the assets it is bidding for and also access to bid-related data, the real test will come when it is in the driver’s seat. Take United Spirits Ltd. After Diageo Plc acquired it, questionable transactions were uncovered which led to United Spirits taking write-offs. Some may however say that Diageo still became the market leader in a large liquor market.
A similar attraction is what may be driving large steel producers to rescue these assets in distress. Once the deal is done, it will become the responsibility of the acquirer to meet the commitments made in the resolution plan. The risk is of skeletons tumbling out of the closet or market conditions taking a turn for the worse, making the acquisition a pain in the acquirer’s balance sheet.
The memory of Tata Steel’s European acquisition must still be fresh which may be a reason why the board deliberated for so long or it could be a totally unconnected reason. Whatever it is, what is evident is that Tata Steel is lining up big bucks, possibly for an acquisition. If the rights issue is priced well, then shareholders may not fret and also if the acquisition seems a worthwhile one.
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