The Hindu Business Line : The battle for Corus

It is anybody's guess how far and how long the bidding war will continue. But research reports indicate that any price beyond 525 pence per share may take the entire deal into dangerous "winner's curse" territory, with the winning bidder paying too high a price.

The tussle for control over Corus. (Clockwise from top left) The bidders, Ratan Tata and B. Muthuraman, Chairman and MD respectively of Tata Steel, and Benjamin Steinbruch, CEO of CSN. And the target Corus' Philippe Varin, CEO, and Jim Leng, Chairman.

Will the bidding war between India 's Tata Steel and Brazil's CSN aimed at controlling Anglo-Dutch steel-maker Corus escalate in the coming weeks? CSN has trumped Tata Steel's 500 pence per share offer with a 515-pence offer, throwing the ball back into the Tata court. Asked to comment on the battle, Lord Swraj Paul, founder of Caparo Steel, told a newspaper from London: "Now, it's purely a price issue. Management has no say in such matters. In this case, the shareholder who is selling wants more money." And, as things stand today, it is anybody's guess how far and how long this bidding war will continue.

However, any lay observer of this battle may well wonder why two emerging market steel players are locked in such a bruising battle and why Corus is such a prize catch for them to be willing to pay such a heavy price. There appear to be four elements that have made this pursuit of Corus inevitable:

It will transform the winner into one of the top five global producers with a combined capacity of about 24 million tonnes (see Box);

It will offer access to the European market. Europe and the US are the high-growth steel markets ripe for consolidation. For instance, in Europe, of the top five steel-makers after the Arcelor-Mittal combination, Corus, with its scale and distribution gateway, offers the best opportunity for entry. Other players, such as Riva or ThyssenKrupp, may not be open to consolidation at this point.

The US and Europe are expected to be heavy users of steel, at least over the next five years, Asian markets, where the demand remains strong, will take a while to catch up with European markets. The demand potential in the growth markets in the intermediate period hold out a lucrative opportunity for steel-makers from the BRIC countries.

Tata Steel's push for Corus

The acquisition of Corus is likely to confer three principal benefits on Tata Steel: Larger scale, strong downstream business operations, and scope for cross-fertilisation of R&D capabilities (through value-added products in packaging, auto and construction).

Access to European markets, however, remains the larger attraction. Corus, which controls about 50 per cent of the UK steel market (in volume terms), is likely to offer Tata Steel a direct gateway into the European markets, where it does not have a presence now.

The move also fits well with its de-integration strategy (making primary metal in low-cost countries and having finishing facilities in end-user markets). Its earlier two acquisitions, of NatSteel and Millennium Steel, were also carried out with a similar intent.

For Corus, the high operating cost has been the principal factor affecting its profitability. This, perhaps, explains the reason for its low EBITDA (earnings before interest, taxes, depreciation and amortisation) margin at about 8 per cent vis-à-vis 14 per cent for its European peers. This is in stark contrast to Tata Steel's margins of over 30 per cent and its low-cost manufacturing base.

CSN's chase for Corus

From a strategic perspective, CSN's bid for Corus enjoys the following key advantages:

Offers access to iron ore: For Corus, which sources a substantial portion of its iron ore requirements, its key raw material (estimated at 20-25 million tonnes) from third-party sources, CSN can immediately supply high-quality and low-cost iron ore from the Casa de Pedra mine in Brazil, one of the largest captive iron-ore projects worldwide, owned by CSN. Since this iron ore will be utilised in Corus' upstream operations in the UK and the Netherlands, CSN claims it will lead to "incremental annual cash-flow in Corus of approximately $450 million (pre-tax) by 2009," apart from providing a good hedge against input price volatility.

Scope for slab production: The slab market is said to be notoriously fickle, largely on account on its small scale relative to finished steel. If CSN can establish a regular supply flow of slabs to Corus, it will be able to consider expansion projects for slabs that it has put on the backburner.

Both Brazilian and Indian steel-makers enjoy over 20 per cent cost advantage in slab-making over their European counterparts.

According to the information document submitted by CSN, "... (it) is one of the lowest-cost steel producers in the world and has announced plans for a greenfield slab project at Itaguai (in Brazil) to expand production by 4.5 million tonnes annually by 2011. Over time, Corus would gain a sustainable cost advantage from increased supply of low-cost intermediate steel products."

Shift from high- to low-cost regions: In certain product categories, Brazil enjoys a huge cost advantage over some of the European producers such as Corus, especially where the company carries high legacy costs as in the case of Corus' plants at Port Talbot or Scunthorpe in the UK. Moreover, Teesside also has a high-cost slab facility in the UK, which can also be shifted once the combination stabilises.

Considering the high cost structure of Corus (despite its restructuring programme of the past few years), its EBITDA per tonne is considerably lower than global average. Hence, the scope for moving production to low-cost regions will be a compelling proposition in the medium term.

Anyway, this will only complement the immediate advantage of CSN cross-selling to Corus' customer base, improving its product mix and using the Corus distribution gateway into Europe.

Financing structure and valuation

Though both CSN and Tata Steel have gone for a leveraged buy-out route to bid for Corus, Tata Steel appears better placed in terms of servicing the debt.

The combined leverage of CSN and Corus will be three times its EBITDA, which may be pegged higher if the bidding war continues. This is likely to expose CSN to debt servicing risks, if it fails to generate the kind of cash flows through cost synergies and by closing down and moving the high-cost mills in the UK to low-cost locations in the medium term. It does not have the kind of backing of a cash-rich group such as the Tatas to tide over a difficult situation.

Importantly, all the debt contracted by Tata Steel is without recourse, unlike for CSN, where parts of its credit facilities are with recourse. This offers greater protection to the former's balance-sheet.

Tata Steel's revised offer, at 500 pence per share, values Corus at about eight times its EBITDA, which appears stiff, compared to the multiple of 5.4 times that Mittal Steel paid to buy out Arcelor. CSN's bid valuation is obviously higher, at 515 pence per share. While valuation does hold significance, it is the desire to gain pricing power and calibrate supply to global demand that appears to be the key driver in the battle for Corus.

Endgame for Corus

On balance, CSN's bid for Corus appears stronger on operational rationale, while the Tatas' is stronger on financing structure.

As mentioned earlier, it is anybody's guess how far and how long this bidding war will continue. But research reports are veering around to the view that any price beyond 525 pence per share may take the entire deal into the dangerous "winner's curse" territory (with the winning bidder paying an overvalued price).

However, unlike 2002, when an attempted merger between CSN and Corus failed on uncertainties in the global business environment, this time around, a call on the steel cycle will play a crucial role in this bidding war.

Steel prices are expected to remain at higher levels on an average, driven by strong demand, particularly in the emerging markets, led by China.

With consolidation set to gather momentum and greenfield capacity additions unlikely to be commissioned before 2010, the bargaining power is expected to switch back to steel-makers from suppliers, lending a firm outlook to pricing.

Finally, there is also some speculation whether a three-way merger between Corus, Tata Steel and CSN may be a good choice. For instance, Arcelor was created through a merger of French, Spain and Luxembourg steel producers, in the first wave of regional steel consolidation in 2001.

As the steel sector enters a global consolidation wave, such a three-way merger may not be such an outlandish proposition.

Though this is still in the realms of speculation, considering the immediate synergies offered by CSN and the long-term benefits and financial strength from the Tatas, it may well turn out to be a desirable idea.

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