Dr Narender Lal Ahuja

ecch: 310-277-1 London Business School REF: CS-10-001 Date: 2008

The Tata Corus Merger A Visionary Deal or a Winners Curse?

Tata Steel had been declared the winner in a heated battle for the Corus Group, topping an offer from CSN (Companhia Siderurgica Nacional) group of Brazil. The final price paid for the company was 30% more than the initial bid which led to financial analysts being unanimously negative about the deal. As a result Tata Steel share prices plunged as much as 9% after the deal. The Corus acquisition by Tata Steel was India's biggest foreign takeover ever. Winning the bid however was just the beginning of the real challenge to make the marriage work. Would the acquisition of Corus create more wealth for the Tata shareholders? Was it a visionary deal or merely destined to prove the Winners Curse?

Background

The Tata Iron and Steel Company (name later changed to Tata Steel) was established by Sir Jamsetji Tata in 1907. By 2006 it was India's largest integrated private sector steel company. Though domestically the company had seen significant growth in the 100 years, it ranked a poor number 56 globally in terms of steel output. In order to enhance its market share in the global market TATA steel made several smaller foreign acquisitions, including Singapore's NatSteel and Thailand's Millennium Steel.

This case was prepared by Dr Narender L Ahuja, Professor, International Management Institute, New Delhi, India as a basis for classroom discussion rather than to illustrate either effective or ineffective handling of a management situation. The case study was supported by the Aditya Birla India Centre at London Business School.

Copyright 2008 London Business School. All rights reserved. No part of this case study may be reproduced, stored in a retrieval system, or transmitted in any form or by any means electronic, photocopying, recording or otherwise without written permission of London Business school.

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After Mittal Steel (owned by another Indian group based in the UK) acquired steel major Arcelor in 2004 for $38.3 billion to become the world's biggest steel maker, Tata Steel decided to make some more strategic acquisitions to meet global competition. In 2006, Tata Steel had a capacity of only 8.1 MTPA, including 4.4 MTPA at its Jamshedpur plant, 2 MTPA at NatSteels plants and 1.7 MTPA at Millennium Steel. The company announced plans to raise domestic production capacity to 30 MTPA by 2010, and was understood to have an ambitious target of reaching 50 MTPA globally in the foreseeable future. A major global acquisition would obviously be one of the possible ways to fill the capacity gap quickly, because the organic route of building new plants to add capacity would be time consuming and more expensive. Tata Steels overseas acquisition plans were bolstered by favourable Government policy. Since year 2000, the Government of India had liberalized the policy towards overseas investments with the objective of promoting Indian investment abroad and to enable Indian companies to reap benefits of globalization. Also in 2005, the Reserve Bank of India raised the limit of overseas investment from 100 per cent net worth to 200 per cent net worth of the Indian investing company. The limit of allowable overseas investment could be further enhanced in deserving cases. Additionally several other rules concerning overseas investments had also been simplified. CSN (Companhia Siderurgica Nacional), had been formed over 65 years ago, and was Brazil's fourth largest steel producer. Apart from producing steel for the automotive and construction sectors, it was also heavily involved in food and can packaging for the food industry. CSN had production facilities in Panama and the Cayman Islands as well as Brazil. In 2002, there had been speculation about a possible merger with Corus, but the merger did not materialize. When the opportunity came revisiting in 2006, CSN was determined to win over Corus. There were many synergies between the two companies, and to the CSN management, a merger between the two seemed the most perfect thing to happen. Corus was formed in 1999 by merging British Steel, for long a symbol of British industrial power, and the Dutch Koninklijke Hoogovens. Corus was then the worlds third largest and Europes largest steel maker. However, the Dutch and British sides did not g et along well, and the company faced management and financial problems which resulted in an operating loss of 1.152 billion for the 15 months period ending March 2001. When Phillippe Varin took charge of Corus as its CEO in 2003, Corus shares traded at a market price of 40 pence and annual losses amounted to over 450 million in 2002. Varin was ruthless in slashing costs, and by end 2005, Corus had affected savings worth over 550 million. Apart from cost savings, the rising steel prices also helped in turning the company around. Since he took over in 2003, the Corus share price started moving up and was about 390 pence before Tata Steel made its initial offer of 455 pence per share.

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Rationale

Tata Steel was India's largest integrated private sector steel company but globally ranked number 56 in terms of steel output. The company was aware of the consolidation taking place in the global industry and desperately needed Corus to enhance its global competitiveness. The Corus buy would instantly catapult Tata Steel to the position of 5th largest steel producer in the world, and provide access to the latest technology and strategic European markets as Corus had plants in Britain, Germany, France, the Netherlands and Belgium. Tata also expected to benefit from reduced production costs due to large volume, combined R&D operations and broader product range. Corus buy would also dovetail with Tata Steels efforts to move up the value chain, as the former had built a reputation as an established supplier to the aviation and auto industries. Brazils CSN and other suitors were also trying hard to acquire Corus which meant that acquisition was the only alternative. On 17th October 2006 Tata Steel declared that it had made a non-binding offer to acquire 100% stake in UK-based Corus Group at a bid price of 455 pence a share, valuing Corus equity at $8 billion. At that time, nearly 49% of Corus was owned by British shareholders, 11% by North American shareholders, 10% by Dutch shareholders and another 30% by shareholders in Germany, France, Belgium and other countries. At first, it had appeared that Tata would get Corus unopposed as the bid had received favourable initial response from the Corus Board. The Corus board had unanimously accepted Tata Steel's takeover proposal and had even recommended it for shareholders' approval. However, things changed soon after CSN entered the fray, making a more competitive offer than Tata. The bidding process continued for three months with CSN countering each successive move by Tata with a higher bid for the equity of Corus. For example, when Tata raised their bid to $9.2 billion for Corus equity in early December 2006, CSN countered it with $9.6 billion within hours of the Tatas offer. When months of takeover battle could not determine the winner, UKs Takeover Panel announced that it would hold an auction with a maximum of nine rounds to decide the winner. The auction took place on 30th January 2007. The relevant excerpts of the Takeover Panels statement on auction procedure are given in Exhibit-1. On the auction eve, Ratan Tata along with Tata Steel managing director B Muthuraman were monitoring the Corus auction taking place thousands of miles away in London. The Tata Sons director Arun Gandhi, their investment bankers and advisers were in London representing Tata Steel.

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The nine-round auction called by the UK Takeover Panel to decide the winner between the two contestants began at 1630 hrs GMT (2200 hrs IST) on 30th January 2007 in London. Both companies were asked to send bids through email or fax by 0230 hrs GMT next day. CSN was bidding from its adviser Lazard's office in London while the Tata Steel team was housed in and bidding from the offices of its lawyers Herbert Smith. Reportedly, Herbert Smith's London office had been video-linked to the Tata headquarters in Mumbai. The nine-round bidding began at 1630 hrs and initially neither party seemed to be in a rush to come up with a bid. It seemed the two suitors Tata and CSN were delaying their bids to give minimum possible response time to the other, and to keep the price as low as possible. As per the guidelines issued by the UK Takeover Panel, each contestants bid had to be higher than the other bidder by at least 5 pence. As a result, more the number of bidding rounds, the higher the price they would have to quote. However the bidding gradually warmed up and by 1900 hrs GMT three rounds of auction process had been completed, and neither party was willing to withdraw. The two contestants were required not to publicly announce the increased bids lodged during the auction procedure. After several hours and rounds of auction, Tata was declared the winner when CSN reportedly backed out. Tata agreed to pay $12.9 billion for Corus. The relevant excerpts of the Takeover Panels announcement on the outcome of the auction process are given in Exhibit-2.

Valuation & Due Diligence

Tatas original bid for Corus had been at 455 pence a share in mid-October 2006, valuing Coruss equity at $8 billion. But as a result of the bitter fight with CSN of Brazil, Tata finally paid a price of $12.9 billion in an all-cash deal, raising doubts that the acquisition would likely turn out to be a winners curse. Within weeks of the acquisition announcement, Tata Steel had lost over $1 billion in market capitalization, as the market reacted negatively to the high price paid. The wealth-accretion advantages of the deal, if any, would accrue in the long term. Immediately, it meant raising huge amounts of debt and equity to finance the deal. Both Moodys Investors Service and Standard & Poors said they might lower Tatas debt rating which meant that debt financing would likely neither be easy nor cheap. To finance the Corus buy, Tata Steel embarked upon what was perhaps the biggest fundraising exercise by an Indian company. It raised funds through a number of sources.

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These included a rights issue of equity shares, rights issue of convertible preference shares and long-term debt including foreign currency structured issues. Tata Steel and its fully owned subsidiaries Tata Steel UK and Tata Steel Asia Singapore were involved in the unprecedented fund raising exercise by an Indian company. Tata Steel UK was also the SPV for the Corus takeover. The whopping about $13 billion was planned to have been raised as shown in Table-1.
Company Source Amount $ Million 700 500 640 862 1,000 500 6,140

Tata Steel Tata Steel Tata Steel Tata Steel Tata Steel Tata Steel Tata Steel UK

Internal generation External commercial borrowings Preferential issue of equity shares to Tata Sons @ Rs 499.7 per share Rights issue of equity shares to its shareholders @ Rs 300 per share Rights issue of convertible preference shares ADR/GDR EQUITY ISSUE Non-recourse debt raised from a consortium of banks Asia Bridge finance

Tata Steel Singapore Total

2,660 13,002

Source: Table developed on the basis of information from Business Line dated April 18, 2007.

Convertible preference shares were planned to have a coupon rate of 2 per cent with conversion into equity shares after two years at a price of about Rs 550 per share. Tata Steel had to make several changes in the original financing plan in view of the changing capital market conditions. The size of Rights issue of convertible preference shares was enhanced to Rs. 6,000 crore instead of previous Rs. 4,350 crore. The size of ADR/GDR EQUITY ISSUE (CARS issue as detailed below) was raised to $875 million instead of $500 million planned earlier to exploit the favourable market response. Tata Sons (Tata Steels holding/parent company) played a crucial role in ensuring the success of both the Rights issues of equity shares and the Convertible preference shares by agreeing to take up any unsubscribed portion of the issues. To part-finance the Corus acquisition, Tata Steel Ltd made a Foreign Currency Convertible Alternative Reference Securities (CARS) issue worth $725-million in August 2007, along with a green shoe option $150-million. The issue had been reportedly subscribed by over two times and the company raised a total of $875 million through the CARS issue including the green shoe option. CARS was a convertible security which would be convertible into either ordinary shares or other Qualifying Securities (such as depositary receipts) representing underlying ordinary

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shares with differential voting rights. CARS, which would be listed on an overseas stock exchange, carried a one per cent coupon interest with the effective YTM (yield to maturity) of 5.15 per cent. CARS were convertible at a conversion price of Rs 876.62 per share, which would be at a premium of 35 per cent to the companys closing share price on the National Stock Exchange on August 6, 2007. The outstanding CARS at maturity, if any, would be redeemed at a premium of 23.34 per cent of the principal amount. [Business Line, Aug 8, 2007] By early April 2007, Tata Steel had completed the $12.9 billion (Rs 52,700 crore) acquisition of Corus Group plc at a price of 608 pence per ordinary share in cash. The enlarged company would have a crude steel production of 27 million tonnes in 2007 and would be the world's fifth largest steel producer with 84,000 employees across four continents.

Post Merger Integration

Soon after completing the Corus acquisition in April 2007, Tata Steel formed a high-power seven-member Strategy & Integration committee, headed by Chairman Ratan Tata himself, to spearhead the Tata-Corus union. In addition to Ratan Tata, the committee had three senior leaders from each of the two uniting companies. Working at full swing and using a combination of top-down and bottom-up approach, the committee identified a number of projects to achieve the objectives and manage the cultural and organizational differences. By May 2007, a roadmap had been drawn up and the overall synergy charter was ready. Tata decided that the Corus' top management would continue with the enlarged Group and the Corus Board of Directors was reconstituted to include representatives of Tata Steel. At the same time, in a spirit of partnership, an invitation was extended to some senior members of Corus to join the Tata Steel board, making the exchange mutual to further augment the integration process. There were concerns also that Tata Steel could have problems in the power sharing process at the senior and mid-level managements due to cultural differences between the two companies. However, Tata management believed that Corus was a company which shared their values and management systems. Tata Steel did not want to engage in any hostile takeover bid. Ratan Tata had categorically declared that he would not go in for acquisitions or partnerships if the value system of the target company or its management grossly differed from that of the Tata group.

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Deriving Synergies

Tata Steel management emphasized many advantages of the deal such as a combined capacity of 27 million tonnes per annum, catapulting it to the position of 5th largest steel producer in the world from number 56 earlier. Also there were other synergies between the two companies; Corus was a large player in value-added services while Tata Steel was one of the lowest cost producers of steel in the world. Tata Steel also had a relative cost advantage because it owned iron-ore mines which Corus did not. A merger would complement their respective strengths. According to Tata Steel Annual Report of 2007-08 the expected synergies and efficiencies had already started flowing in and would bring in annual benefits of USD 450 million per annum by year 2010. Importantly, cultural differences between the two companies had been taken care of and the two merged entities were working under their joint management. Tata Steels earnings per share had improved after the merger. There were some concerns over the lower return of capital employed and EBIDTA margins in 2007-08 which seemed to have declined. As debt would be repaid over the years, the EBIDTA margin as well as return of capital employed were likely to improve, but would need to be carefully watched. According to Ratan Tata, post-merger the immediate focus would be on extracting synergies from Corus. He felt that there was scope to make Corus a competitive steel company by inculcating the creativity and cost-consciousness in Corus as had been generated in Tata Steel.

Reaction of the Stock Markets after the Acquisition

Analysts were quick to point out that the average overall return on equity for the combined entity would take a severe beating due to the negative impact of the high price paid for the Corus shares. Before the acquisition, Tata Steel had planned and announced several Greenfield and Brownfield projects in India to expand domestic production capacity. Investors also feared that the acquisition could adversely affect such already announced projects due to stressed financial position as a result of the diversion of resources to pay for the acquisition. Further, there was concern about the increasing financial risk, as Tata Steel went on a debt-raising spree to finance a major part of the cost of acquisition. It had earlier

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announced a long-term plan of keeping its debt-equity ratio at 1:1, which would now escalate at least in the immediate future. But the company was confident that the debtequity ratio would be brought down to the target levels within two years of consolidation.

Postscript

"The Tata-Corus on-going merger will provide $130 million savings this year till March 2008. After three years, the integration will lead to $400 million yearly savings to the company," Muthuraman, Tata Steel MD. [http://www.tata.com/company/Media] Post-merger the Tata-Corus combined entity emerged as the second-most geographically diversified steel company by revenues. Both Ratan Tata and Muthuraman had been confident that demand for steel products would continue to witness a strong growth for several years post merger. Ratan Tata summed up his justification for the merger when he said, "We believe history will say we did the right thing."

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Exhibit-1
THE PANEL ON TAKEOVERS AND MERGERS
10 PATERNOSTER SQUARE LONDON Statement 2007/3 dated 26 Jan 2007 OFFERS BY TATA STEEL UK LIMITED (TATA) AND CSN ACQUISITIONS LIMITED (CSN) FOR CORUS GROUP PLC (CORUS) On 20 October 2006, Tata announced a cash offer of 455p per share for Corus, such offer to be implemented by way of a scheme of arrangement. The Tata scheme document was posted on 10 November. On 10 December, Tata announced a revised offer for Corus of 500p per share. On 11 December, CSN announced a firm intention to make a cash offer for Corus of 515p per share and that it proposed that, subject to the satisfaction of a pre-condition, its offer should also be implemented by way of a scheme of arrangement. On 19 December, the Panel Executive announced that it had ruled that the last date for Tata and CSN to announce revised offers for Corus was 30 January 2007. On the basis that neither bidder has declared its offer final, such that either offer may be increased or otherwise revised, a competitive situation continues to exist for the purposes of Rule 32.5 of the Takeover Code (the Code). In order to provide an orderly framework for the resolution of this competitive situation, and in accordance with Rule 32.5, the Panel Executive has, after discussions with the parties, established an auction procedure which, assuming a competitive situation continues to exist is expected to commence at 4.30pm (London time) on 30 January. The auction procedure will consist of a maximum of nine rounds, comprising up to eight rounds in which each bidder is able to lodge a fixed price bid in cash followed by, if the auction procedure has not by then concluded, a final round. In the final round each bidder is able to lodge either a fixed price bid in cash or a cash bid calculated by reference to a formula pursuant to which an bidder can lodge a bid at a specified amount in cash more than the other bidder. It is expected that the increased bids (if any) lodged during the auction procedure will not be publicly announced by any of the parties. Assuming, as is currently expected, that the auction procedure has completed by 2.30am (London time) on 31 January, the Panel Executive expects to make an announcement by no later than 3.00am (London time) on 31 January setting out the prices of the offers to be announced by each bidder following the conclusion of the auction procedure. Each of the parties has agreed to the terms of the auction procedure and this announcement.

26 January 2007 Source: http://www.thetakeoverpanel.org.uk/new/

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Exhibit-2
THE PANEL ON TAKEOVERS AND MERGERS
10 PATERNOSTER SQUARE LONDON Statement 2007/4 dated 31 Jan 2007

OFFERS BY TATA STEEL UK LIMITED (TATA) AND CSN ACQUISITIONS LIMITED (CSN) FOR CORUS GROUP PLC (CORUS) On 26 January, the Panel Executive announced that it had established an auction procedure which commenced at 4.30pm (London time) on 30 January. This auction procedure has now completed and the prices of the revised offers which the bidders are required to announce under Rule 2.5 of the Code are as follows: (a) Tata 608p in cash for each ordinary share of 50p each in the capital of Corus; and (b) CSN 603p in cash for each ordinary share of 50p each in the capital of Corus. 31 January 2007
Source: http://www.thetakeoverpanel.org.uk/new/

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Appendix: Excerpts from Tata Steel Annual Report 2007-08

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Bibliography

Apte, PG, International Finance: A Business Perspective, New Delhi: Tata McGraw-Hill. Business Line, The Hindu, Aug 2007, various issues. Business World, Feb. 2007. Eiteman, D, Stonehill, A and Moffet M, Multinational Business Finance, Addison Wesley Publishing. Financial Times, British daily web edition, January 31, 2007. http://www.indiaonestop.com/economy. http://www.managementparadise.com/forums/articles/14071. http://www.rbi.org. http://www.tata.com/company/Media. http://www.thetakeoverpanel.org.uk/new/. Madura, Jeff, International Financial Management, South-Western College Publishing, U.S.A. Press Trust of India, Mumbai January 31, 2007. Tata Steel Annual Reports, 2006-07 & 2007-08. The Financial Express, Mumbai, October 18, 2006. Weston, J Fred, Mergers and Takeovers - Theory and Practice, McGraw-Hill.

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