Tata Steel’s bids for Bhushan a déjà vu moment for investors

Fears that Tata Steel Ltd may be biting off more than it can chew have made investors skittish as news reports say the company is in the lead to acquire Bhushan Steel Ltd, and Bhushan Power and Steel Ltd.

The last time Tata Steel stretched its balance sheet to grow in size, it was to acquire Corus Plc. It took a hard fall on that one. Several restructuring attempts and asset impairment write-offs later, the European operations are set to move into a joint venture with Thyssenkrupp AG. If Tata Steel’s investors were settling in for a more normal ride from here on, the stressed assets’ bidding changes that.

News reports indicate Tata Steel is offering an upfront payment of Rs35,000crore for Bhushan Steel for its financial creditors and Rs17,000 crore for Bhushan Power. This adds up to Rs52,000 crore, but after paying operational creditors and funding working capital, the amount may increase to Rs69,000 crore. At the financial creditors’ level, it translates to a haircut for the lenders of 38% for Bhushan Steel and 63% for Bhushan Power. The haircut in Bhushan Steel’s case seems to be less, which may be worrying investors.

The upfront payment is only one aspect and the full transaction structure will give a better picture of what Tata Steel has offered, and what it is asking for in return. For instance, favourable debt refinancing terms could be one concession sought. Therefore, any premature reaction—celebratory or funereal—may be jumping the gun.

What is behind Tata Steel’s interest in both companies? Bhushan Steel’s steel capacity is 5.6 million tonnes (mt), while that of Bhushan Power is 2.3mt, based on available information (Bhushan Power is unlisted). Both companies are also implementing expansion plans (including allied activities such as increasing captive power capacity) for their steel operations.

The existing capacity of 7.9mt itself is substantial, considering that Tata Steel recently announced plans to expand its Odisha steel capacity by 5mt over four years, which will add to the company’s total steel capacity of 13mt.

The location is another positive. Both the Bhushan plants are in Odisha, where Tata Steel’s new steel plant is also located. That should throw up opportunities of rationalizing costs across functions, and even higher operating efficiencies if possible, because of proximity of the plants. Saving costs on the corporate function is a given, as that function will become redundant and so will all the taxation-related concessions to make these stressed assets more attractive to bidders.

What’s more, both companies are making profits at the Ebitda (earnings before interest, tax, depreciation and amortization) level, with fiscal year 2017 numbers showing Bhushan Steel turned in an Ebitda margin of 17.6% at the consolidated level while Bhushan Power’s stand-alone margin was 14%. High depreciation and interest costs pushed them into losses, implying underutilization of capacity and an unfavourable capital structure.

A new owner would first focus on cutting costs, improving efficiency and utilization, and then completing those half-done projects that can improve profitability in the near run. Refinancing the debt at a lower cost will also be a priority to improve the net earnings from the acquired businesses.

Tata Steel’s capital structure is set to change, which should help ease the burden of this transaction. A rights issue is under way to raise Rs12,800 crore and once the European steel business moves to a joint venture with Thyssenkrupp, the debt related to this business will also be lower. That should give Tata Steel breathing room for the increase in debt because of these acquisitions.

Still, if not for these acquisitions, Tata Steel would have been left with a much lighter balance sheet and investors could have looked to a simpler life ahead. Now, the balance sheet will be weighed down by these acquisitions, and the additional investments needed to extract their full value. Invariably, such acquisitions are also a strain on profitability in the near-to-medium term.

The longer run may see it all turn out well. But the longer run is also unpredictable, especially if the steel cycle goes against Tata Steel. Investors may have to reconcile having a new monkey on their backs.livemint