Graphic: Mint
Graphic: Mint

Thyssenkrupp’s split could give Tata Steel an advantage

Tata Steel investors' concerns proved true in that Thyssenkrupp is indeed being split into two entities, but their worst fears appear unfounded

Calls for splitting up Thyssenkrupp AG, which also led to two top executives departing, had caused some anxiety among Tata Steel Ltd’s investors. Their concerns proved true in that Thyssenkrupp is indeed being split into two entities, but their worst fears appear unfounded. The joint venture (JV) with Tata Steel is still on track.

Thyssenkrupp announced a spin-off into two companies. One will house industrials, with categories such as elevators, components technology and industrial solutions. Another will house the materials business, which includes material services, industries, marine systems and the steel JV with Tata Steel. The new industrials company will be more profitable (see chart) and likely to trade at higher market valuations.

Thyssenkrupp said it expects to get shareholder approval in a time frame of 12-18 months. It said another priority is to get European Commission approval for the steel JV. This means the JV remains very much on track though some delays could take place in closing.

The JV is very important for Tata Steel, as it will help lower debt on its books and improve profitability.

The spin-off could yield another advantage. In Thyssenkrupp’s current structure, the steel business was less important in size and profitability. That will change once the industrials business is spun off.

Thyssenkrupp said the residual materials’ business earned pro forma revenue of €18 billion and adjusted Ebit (earnings before interest and tax) of €550 million in 2016-17, resulting in a margin of 3.1%.

Thyssenkrupp said these numbers don’t include its steel business’ contribution since the JV is not formal. But we can estimate it. The steel JV had estimated annual revenues of €18 billion as of March 2018. If we assume a moderately conservative Ebit margin of 5% (the Thyssenkrupp steel business earned a margin of 6.1% in 2016-17), it translates to an Ebit of €900 million. At half, Thyssenkrupp’s share will be €450 million, substantial compared to the €550 million figure of the non-steel business.

The steel JV’s contribution to Ebit is therefore likely to play a significant part in the industrial entity’s market valuation. Why does this matter? Earlier, the two companies had modified their JV agreement, stating that Thyssenkrupp would have a 55% economic interest in the proceeds of an initial public offering (IPO), with Tata Steel getting 45%. This concession was given to compensate for a decline in Tata Steel’s UK profit margins from the time the JV was planned.

While that arrangement will stay in place, Thyssenkrupp may not feel the need for an IPO under the new structure. That would work to Tata Steel’s advantage.