Analysis of corus acquisition by tata steel

Financial Statement
Analysis and
Valuation Project

Analysis of Corus Acquisition by Tata Steel

Submitted on: 18-Oct-2010

Akash Deep Batra (2008004)
Amit Bhalotia (2008007)
Naufal A. Kukkady (2008039)
Naveen Kumar (2008040)
Shantanu Gudihal (2008050)


Declaration

This is to declare that the report represents original work of the team undersigned and does not
contain any material that has been taken from any source, except as acknowledged.

Signed-
Akash Deep Batra (2008004)
Amit Bhalotia (2008007)
Naufal A. Kukkady (2008039)
Naveen Kumar (2008040)
Shantanu Gudihal (2008050)

Dated: 18th October 2010

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Table of Contents
1. Executive Summary .............................................................................................................................. 3
2. Introduction ........................................................................................................................................... 4
3. Background to the Acquisition ............................................................................................................. 4
3.1. Tata Steel – A Background ........................................................................................................... 4
3.2. Corus Plc Ltd– A Background ...................................................................................................... 4
3.3. Tata-Corus “Synergy” ................................................................................................................... 5
3.4. Final Price - The Bidding War ...................................................................................................... 6
4. Deal Financing ...................................................................................................................................... 7
5. Corus Reformulation ............................................................................................................................. 8
6. Corus Valuation & Sensitivity Analysis ............................................................................................... 9
7. Tata Steel Reformulation .................................................................................................................... 10
8. Tata Steel Valuation ............................................................................................................................ 11
9. Ratio Analysis ..................................................................................................................................... 12
10. Conclusion ...................................................................................................................................... 13
11. References ....................................................................................................................................... 14
12. Exhibits ........................................................................................................................................... 14

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1. Executive Summary
Tata acquired Corus on the 2nd of April 2007 for a price of $12.1 billion making the Indian
company the world‟s fifth largest steel producer. This acquisition process has started long
back in the year 2005. This process started in the year 2000 and with Tata it came to an end.
In 2005, when the deal was started the price per share was 455 pence. But during the time of
acquisition held in 2007, the price per share was 608 pence, which is 33.6% higher than the
first offer.

The high cost of acquisition posed several risks for Tata Steel
 Demand will reduce in case of global recession.
 High cost of acquisition may result in significant financial constraints which may
adversely affect Tata Steel‟s capital expenditure.
 Corus has experienced losses. To obtain any synergy plus benefits of acquisition, Tata
Steel had to turn around the company drastically to make it profitable.

Considering the risks mentioned, we have tried to analyse how Tata Steel has done post
acquisition and if the acquisition of Corus has actually added value to the firm or reduced the
overall value. However, the annual report in Tata Steel mentions clearly that they expect to
capture around $450 million worth of synergy between Tata Steel and Corus operations.

Analysts mention that Tata has a great history of making deals work and hence the Corus
acquisition will be successful. However, we have taken a neutral stance on the Corus
acquisition by Tata Steel and have done a thorough financial statement analysis to justify if
Tata Steel has overpaid for the acquisition or not.

To achieve our objective, we did reformulation of Tata Steel and Corus balance sheet and
income statement to calculate the intrinsic value of Tata Steel and Corus pre and post
acquisition. We have also done some key ratio analysis to find out how the deal has affected
operations of the firm and the return on capital employed for the shareholders before and
after the acquisition.

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2. Introduction
Tata Steel (part of the Tata Group) acquired the Anglo-Dutch steel firm Corus after a four
month bidding war with Brazil‟s CSN (Companhia Siderurgica Nacional) for US $13.75
billion (Rs. 52,000 crores) - this was the biggest acquisition by an Indian firm. Tata‟s
acquisition of Corus made it the fifth largest global steel producer with an annual capacity to
produce 25 million tons of steel. The acquisition was intended to give Tata Steel access to
European markets and to achieve potential synergies in the areas of manufacturing,
procurement, R&D, logistics, and back office operations. Analysts claimed that the
acquisition price at 608 pence per share was substantially higher than an earlier offer of 455
pence per share. Additionally, analysts felt that it would take several years for potential
production and operational synergies to materialize that would yield significant cost savings.
Following the acquisition, Tata Steel‟s stock suffered a significant decline in price causing
Standard & Poor‟s to place it on a credit watch list with negative implications.

By analysing the financial statements of both Tata Steel (before and after the acquisition) and
Corus (before the acquisition), the question that we are trying to answer is what was Corus‟s
intrinsic value at the time of acquisition and therefore conclude whether Tata Steel overpaid
(or underpaid) for this acquisition. In the process we also intend to analyse the impact on the
intrinsic value of Tata Steel due to Corus‟s acquisition.

3. Background to the Acquisition

3.1. Tata Steel – A Background
Tata Steel Limited, the flagship company of Tata Group, is the largest manufacturer of
steel in India with 25.6 million tonnes of steel capacity. The company produce HR and
CR coils and sheets, galvanized sheets, tubes, wire rods, construction rebars, rings and
bearings.

3.2. Corus Plc Ltd– A Background
Corus (as of 2007) was Europe‟s second largest steel producer with annual revenues of
Rs. 82,674 crores (£9.7 billion) and crude steel production of 18.3 million tonnes in
2006. Corus had a presence in nearly 50 countries, including its global network of

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offices and service centers. Corus was formed on October 6, 1999 following the merger
of Koninklijke Hoogovens and British Steel. Corus‟ main steelmaking operations were
located in the UK and the Netherlands with other plants located in Germany, France,
Norway and Belgium.

As of 30 December 2006, Corus was the ninth largest steel producer in the world and
produced 18.3 mt of crude steel in 2006 (equivalent to 18.8 mt of liquid steel). Corus had
four main operating divisions - Strip Products, Long Products, Distribution & Building
Systems and Aluminum. Corus had sales offices, stockholders, service centers and joint
venture or associate arrangements in a number of markets for distribution and further
processing of steel products. These were supported by various agency agreements. There
was an extensive network in the EU while outside the EU Corus has sales offices in
around 30 countries, supported by a worldwide trading

Corus delivered innovative solutions, differentiated products, reliable service and sound
technical advice to its customers around the world. Principal end markets for Corus‟
steel products are the construction, automotive, packaging, mechanical and electrical
engineering, metal goods, and oil and gas industries.

Construction was the largest market sector for Corus, with a strong position in
commercial and industrial construction. Corus was a leading supplier to the automotive
sector and was the third largest supplier to this sector in Europe. Europe, principally the
EU, was the most important market for Corus, accounting for 80% of total turnover in
2006.

3.3. Tata-Corus “Synergy”
The leveraging of low cost intermediate products from India with further processing at
Corus to produce high-end finished products, along with several operation-related
initiatives will improve the competitiveness of Corus in the European markets while
India will benefit from high-value, sophisticated finished products developed in Corus‟
R&D facilities. Further, the combined entity will foster cross fertilization of Research &
Development personnel, and domain expertise in the automotive, packaging and

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construction sectors, in addition to the exchange of technology, best practices and
expertise. The combination of Tata Steel (world‟s lowest cost producer of steel) and
Corus will move towards the next level of strategic transformation through access to low
cost steel production and high growth markets globally.

3.4. Final Price - The Bidding War
On 20th October 2006, the Boards of Tata Steel, Tata Steel UK and Corus reached an
agreement on the terms of a recommended acquisition of the entire issued and to be
issued share capital of Corus, at a price of 455p in cash for each Corus share.

Subsequently, a competitive situation emerged when CSN subsequently approached
Corus with a proposal to make a cash offer. While Tata Steel revised its offer to 500p
per share, CSN made a binding offer at 515p per share in December 2006. The Board of
Corus recommended CNS‟s offer to the shareholders.

As the process got extended, the Panel on Takeovers and Mergers in the UK set a
deadline of 30th January, 2007 as the final date by which Tata Steel and CSN could
revise their offers for Corus Group plc. The Panel subsequently announced in January
2007 that in order to provide an orderly resolution to this competitive situation, an
auction process would be held on 30th January, 2007 to establish final bids from both
Tata Steel and CSN. This auction process began in the evening of 30th January and
ended in the early hours of 31st January, 2007 when the Panel announced that Tata Steel
has won the auction to acquire Corus at a price of 608p per share.

The Board of Corus subsequently recommended the Tata Steel offer to its shareholders
who voted to approve Tata Steel‟s Scheme of Arrangement, at an Extra-Ordinary
General Meeting held on 7th March, 2007. Corus‟ shares were subsequently suspended
from trading on each of the London, New York and Amsterdam Stock Exchanges and
the Scheme became effective on 2nd April, 2007.

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4. Deal Financing
Total enterprise value of Corus is USD 13,751 million. Tata Steel would contribute USD
4,100 million as equity to its wholly owned Deal Structure

subsidiary Tata Steel Asia Holding Tata Steel Limted (India)

(Singapore) Limited, which would in turn 100%
invest the same in Tata Steel UK, which has Tata Steel Asia Holdings Pte. Limited
acquired Corus plc. U.K. Singapore

 Internal Generation: USD 1,267
million Tulip UK Holdings
UK
 External Commercial Borrowings: 100%
USD 500 million
Tata Steel UK Limited
 Proceed from Right Issue: USD UK

1,888 million 100%
 Foreign Equity Offering: USD 445 Corus Group Plc
UK
million
The company has arranged USD 6,143 million non-recourse debt financing by a consortium
of bank directly at Tata Steel UK. This refinancing provides significant benefits and
flexibility over the term of financing to the group. The refinancing facility comprises a five-
year USD 3,236 million amortizing loan and a seven-year minimally amortizing term loan of
USD 2,907 million. Corus net debt amounting to USD 846 million has been taken over by
the company. The balance amount of USD 2,662 million has presently been raised in the
form of bridge finance in Tata Steel Asia Singapore as quasi equity. Tata Steel would be
raising additional equity share capital (face value) in the range of about Rs. 2500 – 2800
million, depending on the final pricing of the various issues. This increase in equity capital
will come into effect only in stages during the three financial years FY2008-FY2010,
therefore easing the burden of servicing. The refinancing of debt will enable the company to
save around USD 100 million per annum and USD 1,000 million over the life of the loan
purely on interest cost.

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5. Corus Reformulation
For this reformulation, we referred to the Corus Annual reports for 2006 and 2005, which
gave us complete financial data for 3 years – 2004-2006. Here are some significant notes
during the process of reformulation:
 Financial year for Corus was 1st January to 31st December
 All numbers are in million pounds, unless stated
 All page number references are from „Corus Report & Accounts 2006‟
 For the income statement „Group Turnover‟ is consider „Revenues from Sales‟ as
Note 1 (pg 89) shows income from each of the four divisions. Restructuring charge,
disposal of assets, income from joint ventures & associates, other operating income
are all separate line items that is normally adjusted to obtain Revenue from Sales.
 The Costs for Sales is arrived at by adjusting the „Total operating Cost‟ figure by
removing restricting charges, profits from disposal of PPE and profit from disposal of
group undertakings (Note 2, Table 2, pg 95).
 Tax on operating income is arrived at using the normal adjustments of impact of tax
on other operating income and finance costs (Notes 2, 5 and 6).
 Other operating income is calculated from Notes 1 and 2. All items under
Restructuring & Impairment costs are clubbed together.
 Tax Rate is assumed at 35%, as the marginal rate is not mentioned in the notes to
financial statements. The effective tax rate as a weighted average tax rate for the
group undertakings is given in Note 6, Table 2, pg 99 but it is not helpful for
adjustments in reformulation.
 Financial Costs and Financial Income are taken as is, since all items in Note 5 are
financial items, so there was no need to take each line item separately for
reformulation.
 Minority Interest was deducted to obtain the net profit available for common
shareholders.
 The final figure for Net profit available to common was matched against the figures
in Income statement and found to be correct.

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 Most of the balance sheet items were easily classified as operating or financial. Only
items that required consideration from notes are mentioned below.
 Trade & other receivables contain a small component that is financial derivative
instruments. According to Note 17 and 24, it is clear that this is a very small number
and it is hedge for operating transactions and future cash flow. Hence we chose to
classify it as operating assets.
 Similarly, Trade & other payables has a component for financial derivative
instruments as a hedge for operating activities. So considering Notes 20 & 24, we
classified these as operating liabilities.
 Cash and short-term deposits were split as follows – all cash was considered
operating and short-term deposits were considered financial (note 18).
 The Consolidated Statement for Shareholders Equity was not reported in the Annual
report, and reconciliation data was available in Note 30. We did not recreate the SSE
as we didn‟t find the relevant information. The number of outstanding shares was
obtained from Note 9 for per share computations.

6. Corus Valuation & Sensitivity Analysis
We attempted both SF2 and SF3 valuation models to find the value of equity for Corus, using
the reformulated financial statements. The weighted average cost of capital is taken as 9.5%,
as given in the annual report.

Using SF2 valuation model, we get the equity value as 2473 million pounds, which is 276
pence per share. We compare this value with the price offered by Tata Steel to acquire Corus
and see that both the initial and final offers are more than the intrinsic value.

Using SF3 valuation model, we get a negative intrinsic value as the Core RNOA is only 6%,
whereas cost of capital is 9.5%. So why did Tata pay for a Corus if it has negative intrinsic
value?

While a simple forecast model like SF3, does not capture all the fundamental aspects of
equity valuation, we can still do a sensitivity analysis and see where the deal may make sense

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for Tata. Corus was in a bad shape as it has both RNOA and Core RNO lower than required
rate of return, but Tata Steel has been the lowest cost producer globally and it‟s management
has the skills and experience to manage costs. So, if Tata Steel can decrease costs, thereby
increasing RNOA and Core RNOA, plus manage growth in ReOI, the price paid (5441
million pounds) can make sense for them. From the Valuation Grid, we can see that if any of
the combination of growth in ReOI and core RNOA in green is achieved, the price paid by
Tata can be justified.

Sensitivity Analysis - Valuation Grid
Core RNOA
-8495.47 8% 9% 10% 11% 12% 13%
0% 3,188.4 3,682.8 4,177.2 4,671.6 5,166.1 5,660.5
2% 2,990.6 3,616.9 4,243.1 4,869.4 5,495.7 6,121.9
growth (g)

4% 2,649.0 3,503.0 4,357.0 5,211.0 6,065.0 6,919.0
6% 1,917.0 3,259.0 4,601.0 5,943.0 7,285.0 8,627.0
7% 1,111.8 2,990.6 4,869.4 6,748.2 8,627.0 10,505.8
8% -767.0 2,364.3 5,495.7 8,627.0 11,758.3 14,889.7
9% -10,161.0 -767.0 8,627.0 18,021.0 27,415.0 36,809.0

7. Tata Steel Reformulation
For this reformulation, we referred to the Tata Steel Annual reports for 2007-08 and 2006-07,
which gave us complete financial data for 3 years – 2005-2007. Here are some significant
notes during the process of reformulation:
 Financial year for Tata Steel was 1st April to 31st March
 All numbers are in Crore Rupees
 Cash including checks in hand and remittance in transit were considered as operating
asset[schedule I Pg 236]
 All balances in Current and Deposit accounts have been assumed to be financial
assets
 The assets miscellaneous expense corresponds to part of the Employee separation
scheme which has not been expensed in the current year1
 Unpaid and Proposed dividend have been added as part of Shareholders equity

1
Schedule M pg 235

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 Interest accrued but not due which was part of current liabilities has been assumed to
be due to outstanding financial liabilities
 Tax rate assumed to be 36%
 Sports infrastructure expenditure added this year is a part of Corus‟s corporate Social
responsibility
 Minority Interest was deducted to obtain the net profit available for common
shareholders.
 The final figure for Net profit available to common was matched against the figures
in Income statement and found to be correct.
 Tax on operating income is arrived at using the normal adjustments of impact of tax
on other operating income and finance costs

8. Tata Steel Valuation
Here are some significant notes during the process of valuation:

 Risk Free Rate has been obtained from the 91-day Treasury Bill rate as of Jan'07 and Jan'08.
 Market Rate of Return has been taken from the Sensex 5-year return as of Dec'06 and Dec'07.
The 5 year market rate of return has been taken since the value of synergy was assumed by 2010.
 Since the long term borrowing rate was not mentioned in the annual report, we have assumed it
to be 12%
 Beta values have been fetched for Tata Steel from Capitaline database as of Jan 31st'07 and Jan
31st'08.
 Growth rate has been taken as 6% as it was mentioned in Tata Steel annual report 2006-07.
 Share prices are being taken as of 31st Jan'07 - the day of agreement of deal between Tata Steel
and Corus.

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9. Ratio Analysis
Looking at the Ratios for Tata Steel and Corus, some insights can be found:
 For Corus, RNOA is 7.48% that is less than NBC 12.65% and WACC 9.5%, hence
we see that ROCE 6.12% is lower than RNOA as the SPREAD become negative.
 In 2006, RNOA has fallen from 12% to 7.48%, hence the company was struggling
and an acquisition target in a consolidating steel industry.
 A low RNOA indicates that traditional valuation methods may give very low or
negative value as the company is losing value. We see that in SF3 valuation, when we
get negative value.
 For Tata Steel, we see the impact of external financing for the acquisition as the
FLEV jumps to 79.25% and CSE increases by 123.78%.
 The SPREAD decreases as the analysts downgrade Tata Steel, and its net borrowing
cost goes up to 23.5% from 8.6%.
 The core RNOA decreases slightly from 22.22% to 21.47%, but the RNOA increases
from 26.19% to 32.7%. This could be due to other adjustments and increased effects
of operating liability leverage. OLLEV increases from 38.04% to 55.88%.
 Overall ROCE for Tata Steel jumps from 30.55% to 47.08% after the merger. This is
mostly due to financial and operating leverage, as the operations are merged. But
since the fall in Core RNOA is very small, we can conclude that the first year of
consolidation has not eroded value for the shareholders.

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10.Conclusion

From the analysis of Corus and Tata Steel financial statements, we can conclude that Tata Steel
paid more than 120% premium over the intrinsic value (using SF2 model). The model can
refined by forecasting ReOI considering the steel industry data and outlook. But there will still
be a significant premium over intrinsic value. From the sensitivity analysis, we can assume that
Tata is relying on it‟s competence to manage costs and access to low cost raw materials.
Increasing Core RNOA is the shortest path to increasing the value of Corus operations.

Also looking at the Tata Steel valuations, we can see that there is a jump in value from Rs 12,399
crores to Rs 51,893 crores from consolidated statements analysis. Tata paid 42,444 crores for
Corus a year before, so reconciling we get (51893-12399) = 39494 crores difference is
approximately from Corus which cost shareholders 42,444 crores in an all cash deal. So approx.
2950 crores is value lost for shareholders in first year of integration of Corus with Tata Steel. As
we didn‟t value effect of other components of Tata Steel (only looked at consolidated statements)
we cannot attribute the loss to Corus operations.

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11.References
 Corus Annual Report 2005
(http://www.tatasteeleurope.com/file_source/StaticFiles/Functions/Financial/2005_Re
portAccounts_20-F.pdf)
 Corus Annual Report 2006
(http://www.tatasteeleurope.com/file_source/StaticFiles/Functions/Financial/2006_A
nnual_Report.pdf)
 Tata Annual Report 2007
(http://www.tatasteel.com/investors/pdf/100-Annualreport.pdf)
 Tata Annual Report 2008
(http://www.tatasteel.com/investors/annual-report-07-08/annual-report-07-08.pdf)
 Tata Prevails in the Corus Battle. Dated: 31st January 2007
http://www.forbes.com/2007/01/31/corus-tata-steel-update-markets-equity-
cx_cn_rd_0131markets12.html
 S&P downgrades Tata Steel on Corus Debt. Dated: 12th July 2007
http://www.forbes.com/2007/07/12/tata-corus-downgrade-markets-equity-
cx_rd_0712markets3.html
 The Tata-Corus Saga
http://www.rediff.com/money/tatacorus.html
 Tata Steel Company Profile
http://www.tata.com/company/profile.aspx?sectid=jsA69xFbDUA=

12.Exhibits
Excel spreadsheet tables attached.

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