It’s never a steel

These fears are unfounded. As on March 2006, Tata Steel’s long-term borrowings stood at Rs 2,460 crore ($0.54 billion), having halved over the past seven years. During the same period, its net worth has jumped 2.7 times and operating profits 6.6 times. This has resulted in its interest cover — operating profits over interest payments — rising sharply from 1.5 to 31.6 times and its debt-equity ratio falling from 1.5 to 0.26. To reach 1999 levels, the company can raise $2.5 billion.

Again, during the same period (1999-2006), Tata Steel’s equity has risen 1.5 times, even as its net profits have jumped 23.7 times. This has resulted in its per share earnings rising 15.8 times to Rs 62.32. What we have as a result is a company with a very high capital as well as operational efficiency — return on capital employed has risen from 6.6 per cent to 50 per cent, net margins have soared form 2.4 per cent to 22.9 per cent.

What the company really needs at this stage is higher operating capacity, which Corus should give, and a higher topline growth which can only get better if global commodity cycles remain in a secular upturn. Given a long-term perspective, the company is well positioned to repeat its performance and protect its return on equity, the risk being a turn in the commodity cycle, which today looks unlikely. At this stage of the company’s sustainable growth path, asset capacity and growth matter more than leverage and margin.

Halfway across the globe, CSN, a company with $3.59 billion in sales, has seen its share price fall just 5 per cent. It’s difficult and ambitious to read too much into the fall, but looking at this company with a market capitalisation of $7.5 billion, what the market seems to be saying is that perhaps — just perhaps — CSN is a better suitor. Or let’s just say that investors have more confidence in CSN being able to leverage the advantages of Corus than in Tata Steel. Is that really so?

It could be too early to say, but it’s worth noting that CSN’s long-term debt stands at $2.94 billion, five times more than Tata Steel’s. On shareholders’ funds worth $1 billion, CSN’s debt equity ratio stands at 2.9, compared to Tata Steel’s 0.26. CSN’s net profits stood at $0.9 billion against Tata Steel’s $0.7 billion. To CSN, therefore, the sensitivity of EPS to global steel demand and prices is much higher, lacking as it does the cushions from lower leverage that Tata Steel has. To shareholders in Corus, the call is about the asset utilisation capabilities of Tata and leverage benefits of CSN.

The one winner in this game so far has been Corus, which is showing more steel than either of its two suitors. Barring 2000, when globally all stocks in general rode a tech tide — Corus’s share price was close to $30 on NYSE — the scrip has not seen its current perch of $20.88. Less than 12 months ago, about the time when the Tata offer may have strengthened, the share price was below $10. Between October 20 and yesterday, the share price rose 16.5 per cent.

The Tatas going after Corus is in tune with the group’s global plans — not merely seeing the world as a market to sell its products but leverage the best talent, resources, finance from across the world to deliver value. In 2000, Tata Tea acquired the UK-based Tetley for $407 million; four years later Tata Steel bought out the Singapore-based Natsteel for $484 million; earlier in the year, Tata Tea acquired 30 per cent in the US-based Glaceau for $677 million.

In terms of scale the Tata Group may be the largest, but when you study the global business arena, you’ll see many more Indian companies playing gladiator. The past three years have seen India Inc go out and grab companies as if they’re disappearing tomorrow. Suzlon acquired Belgium-based Hansen for $565 million; Dr Reddy’s bought Germany-based Betapharm for $572 million. And we are not even counting the hundreds of smaller $10-50 million deals that hit us through pink papers every day. Add the $10 billion Corus acquisition and India would have bought companies worth $16 billion in 2006.

But take a deep breath. History has repeatedly shown us that while companies finally have to deliver value in order to derive it from stock markets, what works for one company need not work for the next. In the short term, perhaps, the market may be blind and give PE points to acts mundane. But in the long term, fads have come and disappeared, taking companies with them.

The late 1980s to mid-1990s saw joint ventures as a means to increase stock price. Companies in any sector making any product sought the benefits of technology transfer through joint ventures. Hundreds of joint ventures followed; the markets bet on most of them; but few exist today in any serious form or sustained wealth creation. In late 1999 early-2000, companies brought the word ‘Tech’ into their names. Mid-2000 saw ‘Tech’ morph into ‘Media’. Today, it’s ‘Infrastructure’. All benefited from short-term rerating but once the truth was out, the companies disappeared from investor mindspace.

Are we seeing the same phenomenon recur in the global acquisition space? Yes and no. I believe serious and long-term players like the Tata Group will look beyond rerating and PE behaviour, and seek out companies based on strategic advantages and long-term returns. But at a point when there is what Raghuram Rajan terms a financing glut in the world markets, and money is easily raised in the form of debt, private equity and IPOs, in the currency of choice, there will soon be a commodification of the business of increasing valuation via raising money and buying companies abroad. At which point, patriotism and exuberance will give way to wealth destruction.