In the event of a serious challenge to the Tata bid for Corus, to what extent should Tata Steel pursue the bid? Sandeep Bhatia, head of research at UBS and Neil Buxton, managing director of GFMS share their views on the recent developments over the Tata-Corus deal. CNBC-TV18 shares with domain-b its exclusive interviews with Bhatia and Buxton
With increasingly speculation over the possibility of Brazil's largest steel maker, Companhia Siderugica Nacional (CSN), preparing to challenge Tata Steel's bid for Corus with its own counter-bid, will the Tata Group be forced in to offering a premium to its bid? To what extent should the Tatas raise their offer? (See: Brazils' CSN the only likely challenger for Tata's Corus bid)
Sandeep Bhatia, head of research at UBS and Neil Buxton, managing director of GFMS share their views on the recent developments over the Tata-Corus deal.
Bhatia says that Corus is worth 335 pence a share as a standalone entity, and the maximum price should not exceed 525 pence per share. He adds that synergies between the two companies would become negative if the price went beyond 525 pence per share.
He analyses the risks including integration, financials and operations as a result of the deal going through. Bhatia says that there is a 60 per cent to 70 per cent chance of the Tata-Corus deal going through.
Neil Buxton says that he won't be surprised to see more bids for Corus coming in by the weekend. He further adds that SeverStal, CSN and ThyssenKrupp may be likely bidders.
He says that as a result of the deal, however, steel prices may soften further, but won't crash. CNBC-TV18 shares with domain-b its exclusive interviews with Bhatia and Buxton:
Looking at the price at which the bid has come in, how would you rate the chances of a counter offer coming in and where do you see the story going from here?
Bhatia: I think the bid is fair in our opinion. If there was no bid, the price of Corus would have clearly fallen below 400 pence. I think without a bid, as a standalone entity, in our view Corus is worth 335 pence.
In the next two-three days, if these news reports have any credibility, I would think that a counter bid would be coming through. I do not think the Tatas should be in a hurry to raise their offers until we see any real competition coming through. As I have said, at current valuations, it is fair because without the deal stock, it is worth much less.
What is your sense looking at the whole picture globally- would you expect other rival bids to come in to match Tata's or better it?
Buxton: I think many of the other steel companies, which have been mentioned have the same thinking behind such a deal. It would not surprise me to see further bids nurture later this week.
Looking at what Corus does, as a business, and its financials, when does it become a stretch for Tata Steel in terms of what it offers?
Bhatia: We think that this deal adds value up to 525 pence for the Tatas. We feel that the value of synergies that we expect from this deal will become negative if it bids above that.
So the highest price should be 525 pence. But that does not mean that you should bid at that price because there are risks involved always, and a lot of hard work has to go through if those synergies have to come through.
So it is not necessary that you have to pay off all the synergies in the bid price. So let's wait and see, but we feel the answer is 525 pence.
Does it strike you as a fair enough enterprise value that Tata Steel has put to Corus? Do you think, going by what you are seeing at this point in terms of counter bids, that this might go the Mittal-Arcelor way?
Buxton: I think ThyssenKrupp and particularly Severstal are the other companies involved. Certainly, there is the potential for a higher bid to come in from our perspective.
Which of the global companies do you think might throw their hat in the ring over the next one-week or so?
Buxton: The most obvious one is SeverStal and CSN of Brazil. But you cannot rule out ThyssenKrupp. ThyssenKrupp would probably just be interested in the flat product operations of Corus and would probably sell the long products division.
In the past, we have seen a lot of Indian companies adding a lot of capacity when the cycle was good only to ruin their balance sheets and get into trouble when the cycle turned. Is there a significant risk to this acquisition if the steel cycle were to go a bit soft over the next two-three years?
Bhatia: One has to realise that all bids of any kind, and especially on the scale of merger that has now been attempted by Tata Steel, have various risks involved. There is risk of integration, there is operating risk, there is a steel cycle risk and a financial risk.
So clearly it is a huge challenge and that's why I have highlighted that you do not need to pay the maximum price because that means that you paying away all the hard work you need to do to realise those synergies.
I think the risks are definitely very much there, the leverage on the balance sheet rises upto 2.95 times just after the merger. Of course, the cash flows will ensure that it falls sharply after that to 1.7 times in two years, but in the near-term the financial risk will rise.
These valuations and these prices that we are looking at are coming at current steel prices and as I have highlighted that if the steel price goes soft, then the valuations look even richer. This is an all-cash bid, and not partly shares and partly cash, which we had in the Arcelor-Mittal case.
So if you have shares, then shares of both the entities will fall in value, but cash is cash, and the sellers walk away with cash forever.
So they do not have any risk left once they get the cash. So that is why from Tata Steel's point of view, this is a sensible price that allows them some synergies, which they will get on the balance sheet. Otherwise it's just maxing out on the price.
Aside from the financial concerns, do you foresee any problems for this combination in terms of backward integration?
Bhatia: I do not think that there should be a concern. I wouldn't be surprised if they turnaround and say, that we are going now increase a capacity higher than what we talked about.
On Friday, at the analyst meet, Tata Steel said that they would raise the Jamshedpur capacity from seven million tonnes to 10 million tonne. I wouldn't be surprised if they go out and ask for mines and other assets, which will allow them to expedite their greenfield plants.
But I don't think there will be a bottleneck. After doing the kind of deal that they have done, which puts them in the top five, I am sure that there would be enough support coming through and they will be able to execute their plans. But of course, there are always other operating and steel price risks that they may have to encounter.
As you look out in the next 12-18 months what do you see for steel prices?
Buxton: In terms of prices going forward, it's more likely that the recent trend of prices softening may continue. We are not projecting any sharp decline in prices, but I think that the market is moving into lighter supply, which is going to preclude any significant gains from current levels.
So the price environment going forward is probably going to be steady to slightly downward, rather than an increase from current levels.
What are the chances that this deal does not go through? So far, the implicit assumption is that the deal is done. What is the likelihood that we get a bid, which the Tata's do not want to match or do not want to overstretch themselves and they walk away from this deal?
Bhatia: We should all know that no one should be under any pressure to do a deal for the sake of doing a deal. The deal has to be done only if it makes financial sense for the buyer. Based on current information, we cannot assume that this is really a fantastic bid coming from the other side.
We have to remember that since August 2005, Corus has made it known that its looking out for a partner and we have not seen anything come through.
Now of course, we have a bid from the Tatas, which will make everyone think about whether they want to step-in at this moment. So at this moment, there is a fair chance, over 60 per cent to 70 per cent, that this will happen.
Clearly, the management and the unions are on board and the Tata's have taken a lot of pains to ensure that the pensions of the Corus workers are also protected. So there are lots of other issues that need to be considered.
As long as we do not have a counter bid of any significant premium over the current bid, I would think that there is a fair chance that this will happen. But I would emphasise that it is not necessary that someone should chase a target for the sake of chasing a target if it doesn't make any financial sense.
also see : Brazils'
CSN the only likely challenger for Tata's Corus bid