Tata Steel Corus buy – What went wrong…

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After Struggling for nearly nine years with Corus, Tata Steel has finally called it quits. A sad event for sure, to end the audacious attempt by Mr Ratan Tata to take Tata Steel global.Right from the beginning the going was tough for the company. In the first year itself after integration, company’s EBITDA margin fell from about 31% to 14.1%, whereas pre-tax return on capital employed fell from 42% to 19.1% (Annual report, FY08), even though it was expected to improve in the subsequent years.

So, what all went wrong.  A brief…

  • The deal seems to have been done on the best case scenario assumptions, based on the then prevailing growth rate. However, with the slump in global growth, the deal was in for serious trouble. The optimistic view was probably based on the result of its acquisitions/ international JVs in the preceding years where the company was doing reasonably well.
  • Most importantly, it was an all cash deal causing severe cash outflow for Tata steel on financing cost. Had it been a part cash, part share swap deal, the impact would have been much lesser. For instance, in case of ArcelorMittal, only about 30% of the deal value was paid in cash with the rest being paid in the form of shares of the new company.
  • To take the previous argument further ahead, Company faced an additional cash outgo on account of interest of as much as $ 900 mn in FY08 over FY07, which came down slightly in FY09. It can be safely assumed that most of it went towards financing of Corus. In contrast, the deal envisaged an annual saving of $ 450 mn only. At the original bid price, cash outgo for interest arising out of the deal would have been almost as much as the expected savings giving company a reasonable chance of succeeding.
  • The company had been a low cost producer with access to captive iron ore mines in domestic market. It hoped to repeat the feat by securing mining leases or fixed price contracts for iron ore needs of Corus also which would have resulted in significant saving. However, iron ore and coking coal prices surged beyond all projections very soon after the deal, putting to rest all its plans to achieve savings on this most important cost component.
  • The aggressive bidding due to the presence of another party made matter that much worse – A classic case of winner’s curse… Compare ArcelorMittal. That deal was also stuck at the peak of the cycle, yet it is managing to survive because of not-so-stretched valuation.

Yet, nothing takes away the courage shown by the Tata Management and the intangible gains that has come from the deal in terms of raising India’s stature in the world business map.

An afterthought… Can we imagine CSN purchasing Corus then and putting it up for sale after 3-4 years, to be purchased by Tata Steel at a much better valuation…!

(Image courtesy of Suat Eman at freedigitalphotos.net)

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