With the virtually instant counter-offer from CSN to Tata Steel's raised bid, is it time for Bombay House, the HQ of the House of Tata, to turn its back on the deal?

Has Tata Steel lost the plot in its bid for Corus? Is it preparing to bow out of the race? Or does the company still have a chance to acquire Corus, without taking much higher financial risks by raising its offer yet again? Analyst opinions are still divided on the issue, but most believe that it would be very difficult now for Tata Steel to beat CSN.
(See: CSN goes for broke; offers $9.6 billion for Corus)

When CSN first announced its readiness to offer 475 pence per share of Corus, higher than Tata's first offer of 455 pence per share, most analysts expected Tata Steel to wait till CSN announced a formal offer. Tata Steel already had the first mover advantage and the backing of the Corus board. (See: Corus board approves Tatas' offer)

It could have afforded to wait till CSN came out with its firm 475 pence per share bid and then agree to match it. The Corus board would most likely have continued to back Tata Steel's bid, unless CSN offered some other strategic advantage like an assured supply of cheap iron ore.

In this scenario, CSN would have been forced to hike its offer while at the same time trying to pre-empt Tata Steel's next move. It is likely that the Brazilian company would then have made a 'make-or-break' final bid and Tata Steel could have walked away with Corus with a slightly higher bid – the position CSN is enjoying now.

But, instead of this safer approach, Tata Steel decided to risk dissuading CSN from making a firm bid with an even higher bid of its own, which it presumed would be enough to scare the Brazilians away. But CSN, without blinking, seized the initiative by topping Tata Steel's enhanced offer of 500 pence.

Why did Tata Steel opt for such a strategy? Some analysts believe Tata Steel was under the impression that CSN would not be able to gather enough financial resources to go over its 500 pence per share bid. After all, CSN already has some debt in its books and plans for additional debt would have faced some resistance from large institutional shareholders. Did Tata Steel discount the possibility of large international banks, which have more than enough funds at their disposal these days, backing a risky leveraged buy-out.

Corus' attraction for CSN
Another possibility is that Tata Steel may have believed that the Corus management would decide to back CSN, if both companies offered the same price, because of possible raw material supply assurances from CSN. Hence, presuming that a higher bid might help retain support from the Corus management, Tata Steel felt compelled to offer a higher price.

After all CSN has some very attractive advantages to offer.

It is the largest steel manufacturer in South America, and was a government-owned company till 1993, when it was privatised and acquired by a team led by local entrepreneur Benjamin Steinbruch, currently its chairman, for $800 million. The company, which had accumulated losses of over $6 billion till privatisation, was restructured and has become profitable.

Four years later, Steinbruch pulled off another big deal in 1997, when a consortium including CSN acquired a 42-per cent stake in Companhia Vale do Rio Doce (CVRD) – the largest global producer and supplier of iron ore and pellets – for over $3 billion. CVRD wields enormous influence in setting iron prices as it is the principal supplier to many large steel makers, including Corus.

CSN, which operates an integrated steel plant in Brazil, acquired US-based Heartland Steel in the US in 2001. The company also has a presence in Europe through its ownership of Lusosider in Portugal, which manufactures galvanised products. Interestingly, Lusosider was floated as an equal JV between Corus and CSN, but Corus sold-off its stake to CSN early this year.

However, the real attraction of CSN is its ready access to abundant raw material - a consortium led by CSN has a nearly 42-per cent stake in Companhia Vale do Rio Doce (CVRD) – the largest global producer and supplier of iron ore and pellets and a major gold miner in Brazil. The CVRD stake was acquired in a privatisation process for over $3 billion. CSN directly holds a 16.3 per cent stake in CVRD.

Now that it is unlikely that the Corus board would continue to back Tata Steel, what are its chances of still emerging the preferred suitor?

Support from pension funds
There is a very slim possibility that CSN may not get the approval of the Corus pension fund trustees. But that possibility is slim as CSN has offered a higher amount than Tata Steel to plug the pension fund deficit and has also agreed to increase pension fund contributions in future.

Apart from that, the only other option for Tata Steel is to hike the offer yet again. That would mean having to shell out in excess of $10 billion besides taking over the existing debt of Corus.

Is a further hike in the bid really worth it for Tata Steel?

As it would be a leveraged buy-out, the question is whether the future cash flows of Corus would suffice to service the debt. For that, Tata Steel has to take a call on when it expects the global steel cycle to head for a downturn. Most industry analysts believe that prices have steel already peaked. Though prices may sustain at these levels for the next year as well, they are likely to decline later as more capacity – especially from China - comes in to the market.

If that were to happen, Corus's profitability and cash flows would take a hit and it would be difficult to service the debt. Though Tata Steel and Tata Sons would not have to dip into their own resources as the credit facilities arranged for the Corus bid are on a non-recourse basis, the capital invested by them would erode substantially in value.

Such a scenario would seriously affect Tata Steel's fund raising abilities to finance its own greenfield expansion plans in India. These new domestic plants may be more profitable in the long run than the acquisition of Corus and hence cannot be sacrificed. But Corus would open up large markets and provide access to a sizeable customer base, particularly in the automotive sector.

It is a difficult choice to make and most industry observers expect the Tatas to walk out - richer by the $92 million Corus would have to pay as break-up fee.

A minority view still holds out hopes that the Tata Group may not give in so easily after spending so much time and effort on working through the deal and may come up with a final offer of up to even 550 pence per share before giving up. If that were to happen, Tata Steel's minority shareholders can write-off their expectations of some appreciation in their holdings even over the medium term.