Tata steel
emerged victorious after series of heated bidding rounds (final bid (the first
bid was made by Tata steel at 455pence/share) from Tata was 608 Pence / share, against
Brazilian rival CSN’s bid of 603 Pence/share) for acquiring Corus Plc for around
$12 Billion, only to see that after some 9 years it has to start disinvesting Tata Steel UK in whole or in part. One of the key plants (Scunthorpe
steel plant) is sold to Greybull Capital Llp for nominal value of £1 which
includes investment commitment of £ 400 Million and financial packages from Greybull. Undertone
has changed in last nine years, from everyone was being so euphoric talking
about advent of new era where Indian company was (Tata Steel) taking over
global giant (Corus Plc) and becoming hot topic for every other research
article and case study, to critically appraising bad acquisition and being
pragmatic by cutting the loss and adding yet another story piece to library/case
study/research article on how acquisitions go wrong. Let’s try to do quick
anatomy of this acquisition deal. The idea is not at all to criticize or
disparage this deal because that’s easy & so many mindless (and few genuine)
are doing it (I admit honestly it’s very easy to comment or to do post-event
analysis of anything and being Indian we love to be judgmental about
everything!) but just to touch upon few points which may be interesting to
explore further.
Though the
potential benefits of the Corus deal were widely appreciated at the time of
deal, but I’ll be focusing on few downsides.
1. Biting off more than one can chew
– Competency to manage larger & diversified organization: It is always enchanting to see David
taking on Goliath in business world. In world of acquisitions unfortunately
just winning over Goliath (by exorbitant premium payout) is not the end of the
story, here David (Acquirer) has to actually manage the Goliath(Target) profitably
over longer time frame to be considered it as true victory. Imagine one company
is trying to acquire another company which itself is the product of two
companies merged eight years back and trying to settle down. Well, this is the real story of Tata steel acquiring Corus Group Plc which
was new entity coming into force in 1999 as merger of British steel and Koninklijke Hoogovens. One of the very reasons of this
merger was to put life into dying British steel which was incurring losses. After the merger of two entities,
Corus Group Plc was consisting of huge diversified product portfolio (Diversified
product portfolio is considered to be one of the foremost reasons for acquisition, but what acquirers
forget is whether they can manage effectively this diversified product
portfolio or not especially when they are lacking expertise of this, based on
no such experience in the past) having four divisions and the core business
comprised of manufacturing, development and allocation of steel and aluminum
products, variety of services like; design, consultancy, technology etc. Corus
Group was 2nd largest steel maker in Europe having revenue of £ 9.2 Billion, having 42,600 employees spread across 40 countries before
acquisition. Tata group might have got too much of confidence & guts from group
company Tata tea’s successful acquisition of giant Tetley- four times bigger
company in the year of 2000. But it seems Tata steel never got the competency
and expertise of managing huge, diversified, and culturally complex (within Corus Group there was internal
conflict going on between British arm and Dutch arm) organization, this kind of
organization itself reduces probability of success in the long run. It would be
interesting to see and explore why Tata Tea -Tetley was successful as compared
to Tata steel – Corus Group, specifically from perspective of managing larger
organizations after acquisition.
2. Mountain of Debt: Intolerable burden of debt is capable
enough to break backbone of the business. Let me dramatize this whole high
premium pay out eventually leading to high debt scenario for Tata Steel.
Imagine with aim of satisfying the hunger need you entered in Pizza outlet,
here Pizza outlet which was big but having really tough times, seeing you and
another few fellows entering the outlet the seller suddenly created big hype
and said, “I have only one Pizza left which is of the finest quality and having
it will give you some super natural powers and you will be the greatest!”
“Whoever bids highest will get this last on earth Pizza”. You started bidding
at Rs. 100 for this Pizza, another person also starting bidding up over and
above Rs. 100. Meanwhile, some shrewd
fellows understood the whole gimmick and left the outlet. Furious bidding was
going on between you and another person in run up to have this miraculous pizza
and in hope of converting yourself from Bollywood Krrish to Hollywood Iron Man(Many
companies go through this notion of becoming larger than life entities by
making grand acquisitions).So much blinded by this elusion highest bid was made
by you at Rs. 133.60 which is 33.6% higher than first bid made by you. Only to
realize that you have won the so called miraculous pizza but you have only Rs.44(roughly
33%) in your pocket and for the rest Rs.89.60(67%), you have to take loan from
the banks at interest rate of around 8% p.a. Just to add more spice, imagine
the similar pizza you bought was sold at around Rs.89 previously. So, actually
you have paid roughly 49 %( From Rs.89 to Rs.133.6) premium over the previous
price of the Pizza. Now just take a pause and think, take yourself out from the
above drama & put Tata Steel in your place (Where Pizza is Corus Group). Tata
Steel paid 33.6% premium per share for Corus over first bid. The final bid of
608 pence/share was around 49% higher than the Corus share price as on 4th/Oct./2006.And
the fun part is almost 67% of total $12 billion of acquisition amount has to be
funded through external debt. Around $725 Million (including $400 million of
Corus’s existing interest burden) was projected to be paid as interest obligation
after acquisition. Funding larger part of the
acquisition through external debt (Fancy name is Leverage Buy Out – LBO) has
caught up the fancy of every another company but it is forgotten that it is double edged sword
which can kill/ severely damage the company and same has happened with Tata
Steel. One can see Quick financial data
charts comparison.
3. Curse of buying commodity business
at peak of commodity cycle:
If we
observe the global commodity cycle for steel, it picked up at all time high
during 2007-08(Steel, other metals and materials were huge in demand thanks to
Global economy on its pick and 2008 Beijing Olympics) where steel price was recorded $1265/MT in June of
2008. From this pick
due to demand of steel waning off (Due to prime reason of late 2008 financial
crisis of unprecedented scale - nobody could have got this right so no fault of
Tata Steel) price has been falling to as low as $ 90/MT in March of 2016. Tata Steel bought Corus Group in year 2007 where steel pricing was
sky rocketing thanks to mammoth demand from China and other parts of the world.
Entire demand projection for steel based on this 2007-08 pick (which was
important ingredient for projected revenue calculation for acquisition) went
for a toss due to huge crackdown in demand as aftermath of financial crisis. Problem
of buying commodity business at the pick of the cycle is that Acquirer Company
must have while deciding valuation of the Target Company incorporated this pick
demand & high price in future projection of revenue which leads to higher
valuation of the Target Company & easy justification to pay premium over
and above existing market price of the share. It is important to build
valuation on worst-case scenario projection basis or mixed of different
scenarios based average valuation. Buying commodity business at the pick was
never a good idea as once commodity cycle turns down, falling
prices create huge pressure on profit margin & sustainability of business.
Especially when it is known fact that commodity prices move through different
phases of super cycle it becomes very imperative to see that as acquirer you
are not caught at the wrong end of the cycle.
4. What’s true goal? Larger than
life/Ego-feeding V/S Long term profitable sustainability: HP’s $11 billion acquisition of Autonomy Inc., Google’s
acquisition of Motorola for $12.5 billion, Alcatel-Lucent deal and many more
have one thing in common these deals failed massively. There is constant tug of
war between whether merger/acquisition fits into long term profitable
sustainability of the firm as objective or over-inflated egos (of CEO/Top Mgt.) which compel to do
merger/acquisition so that they can have even bigger companies to manage, even
larger role to play and justified in front of the BOD that they are doing this
for better future growth of the company, and being covered and discussed by
every other top media houses & intelligentsia. Many
important and eye-opening articles/researches are done on the matter of how
over-inflated ego of CEO/Top mgt. has created nasty failures in M&A world
and wasted billions not millions of wealth of shareholders. The crux is till
what point shareholders are ready to allow their acting agents to go for
M&A as per their whims and fancies, how BOD can put control over this. It
has been seen that in the heat of limelight and ever increasing expectations
from all stakeholders for higher growth even genuine/rational CEOs tend to go
down the path of going for disastrous M&A deals in this case strong BOD
guidance and control should be in place. Perhaps, Tata Steel also went down
this same path where Tata Group’s hunger to be in top ten players by
acquisition route in steel industry and setting the benchmark of a sort that
how small company from developing nation can still go for giant from developed
nation, played big role.
To sum up, it is very paradoxical to observe
that in M&A world which has seen so many failed mergers and acquisitions
and relatively very less successful deals in long term, still companies and
high profile CEOs get tempted by this mirage and record M&A deals are
created. Interested reader can explore this book on failure of M&A.
It is high
time to device proper control system for vigilance over decision makers where
deal value is huge from stock holders’ perspective.
