An acquisition will be EPS-accretive

Exponentially higher scale could lead to re-rating of price-earnings

MUMBAI: The countdown to the acquisition of the world’s 9th-largest steel maker by the 56th has begun.

But, does the bid give any kind of certainty about Corus landing up in the Tata fold? Not really, as the bid is only indicative and non-binding. A Tata Steel statement itself says there is no certainty that a final offer would be made.

The question now is, why such an offer?
Says an analyst: “Since there is no single promoter with a controlling stake in Corus, the offer is being made to the board, which will have to consider it and, if they are comfortable with it, they will put it before the shareholders for approval.”

Secondly, currently, the due diligence by Tata Steel is on, which is why it is an indicative non-binding offer. This offer only indicates the buyer’s seriousness to the seller and facilitates access to the books of the latter. Hence, after the two parties find comfort, the deal may be taken forward.

So, will it clear the finishing line?
Unlikely, at least in its current form! Considering that the offer price of 455 pence per share is well below Corus’ Tuesday market price of about 479 pence, the offer may not get a favourable response from Corus shareholders.

Says another analyst: “It may not get an enthusiastic response from shareholders. There is a high probability of Tata’s revising the bid-price upwards. Once done, then it should find acceptance with the shareholders, including the institutional shareholders.”

The Tata bid, unlike Mittal Steel’s bid for Arcelor, is a friendly one and not a hostile takeover attempt. The Corus board, too, seems to be supportive of the Tata’s bid.

“It should finally pass muster. Tatas have been working closely with Corus. And both managements seem to have consulted each other. We also need to see how the deal is structured. There are various alternatives here viz., complete cash, cash plus share, and so on.”

Lastly, but not the least, the deal will go through only if there are no other bids from competitors.

Analysts believe that Severstal is readying itself to make a bid for Corus at a premium to Tata Steel’s price. But, assuming if that doesn’t happen, will Tata Steel finally benefit from the acquisition?

It certainly should, as far as scale, geographical presence and market share is concerned.

How profitable it works out over the long-term will depend on Tata Steel’s ability to extract operational synergies (improve profitability) between the two companies.

Says Chirag Shah, analyst, SSKI: “Prima facie it appears that this is a case of Tata Steel acquiring scale, improving operational efficiency and creating value in Corus over the long run. In the immediate term, the acquisition is unlikely to be value accretive. The merger does not appear be as good a strategic fit as the Arcelor / Mittal merger, where there were complementarities in products, geography and mining & manufacturing operations.”

The arithmetic
Assuming that other companies will be vying to buy Corus, the buzz is that the buyer, in this case Tata Steel, will have to folk out a premium over current price to buy the stake. At 500 pence a share, the enterprise value of Corus works out to $10 billion (including debt of about $2.5 billion), indicating that about $8-9 billion will be required for a 100% buyout?

It would certainly be a highly leveraged deal. For Tata Steel though, it had consolidated debt of Rs 3,377 crore as on March 2006, translating into a debt: equity ratio of just 0.3 times.

Additionally, the company board has already intimated that Tata Sons will be allotted 2.7 crore equity share at Rs 516 each (on preferential basis, and also 2.85 crore shares to be issued against warrants after April 2007-pricing based on the Sebi formula), aggregating about Rs 2,900 crore. This in effect leaves scope for the company to raise debt (up to Rs 10,000 crore; taking its debt: equity to 1:1), for which it has already taken approval of shareholders (up to Rs 20,000 crore) at the time of its annual general meeting in July 2006.

The company can also raise another Rs 5,000 crore through dilution of investments. It had Rs 2,026 crore investments in debt-oriented mutual fund schemes as on March 2006.

Likewise, it held 3.24 crore equity shares of Tata Motors (cost Rs 147.03 crore; market value Rs 2,881 crore), which if need be, it can offload to the promoter-group Tata Sons. Put together, the amount works out to $4 billion.

For the time being though, the group is reported to have arranged a loan facility for $5.5-6 billion, which should most likely be secured against a part of their stake and future profits of Corus.

Based on these calculations, the net outflow of interest (assuming debt of Rs 13,000 crore for Tata Steel and Rs 18,000 crore for Corus -- in worst-case scenario -- at 7% per annum) works out to Rs 2,170 crore. Adjusting for this, the net profit addition (Corus’ Rs 3,000 crore minus Rs 2,170 crore) works out to Rs 830 crore. Considering the 10% equity dilution due to the preferential offer, the deal would still be earnings accretive. However, the actual impact would differ based on how the deal is really financed and the debt-equity mix.

But Chirag Shah of SSKI begs to differ on the EPS analytics. He says even if the entire merger is financed through debt (which looks unlikely) the deal would at best be EPS-neutral.

“However, there may be a case for earnings multiple re-rating of Tata Steel, purely on the back of scale,” he said.

Clearly, lot of action is pending.