Corus Plc Acquisition leaving bad taste in the mouth of Tata Steel

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 2^nd 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 4^th/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. 

Truth is more dramatic and thrilling than Fiction (James Bond movies): The inside story of Mossad - Book Review

Book review:

Book:  Mossad the greatest missions of the Israeli secret service

Authors: Michael Bar-Zohar, Nissim Mishal

Publication: ECCO Publication,2012.

I confess the moment I finished reading up this book, I am no longer a fan of James bond like movies. If I was not cognizant of the fact that, this book is collection of daring & most dangerous missions (at the heart is unbelievable plot-lines of the missions) by the Mossad- Israel Secret service, the book could have easily been considered as one of the superb spy novels.

Consider this, on shores of Gaza suddenly boat appeared which was carrying Palestinians and they were followed by Israeli soldiers in torpedo boat. Eventually, Palestinians managed to escape from the shore with some help from local Gazan youngsters. Rescued Palestinians who claimed to be members of the Popular Front for the Liberation of Palestine, coming from Tyre refugee camp in Labanon. Leader of rescued Palestinians requested to the local Gazan if they can arrange meeting with Popular front commanders of “Beth Lahia”(Terrorist organization) in Gaza, as they have weapons & other vital information to share. Very next day, Rescued Palestinians were called in isolated house, where they met with Popular front commanders of “Beth Lahia”. The moment they sat facing one another, Leader of rescued Palestinians raised his hand and looked at watch. It was signal. All rescued Palestinians pulled out handguns and opened fire, all commanders of “Beth Lahia” in that room were killed. The entire rescued Palestinians team escaped, only thing was they were not Palestinians (members of the Popular Front for the Liberation of Palestine). The Leader was Captain Meir Dagan, Commander of the IDF’s(Israeli Defense Forces) secret Rimmon Commando unit and others were his team. Adding more spice, now imagine this seemingly “movie thriller” plot was not played out in today’s ultra-modern spy world but in the year of 1971. That’s true.

Many other missions like above is the soul of this book. My favorite parts are Ch.1(King of Shadows),Ch. 6 (Bring Eichmann Dead or alive), Ch. 10 (“I want MiG-21!”),Ch.11 (Those who will never forget), Ch.12 (The quest for the red prince) and so on, actually all of the chapters.

One of the most famous missions, the hunt for the terrorists who were responsible for attack on Israel athletes during Munich Olympic in 1972, on German soil is covered in this book. Similarly one of the most secretes and covert operations of bringing “Adolf Eichmann” the cruelest face of Nazi and the leader who orchestrated the holocaust, is simply breathtaking as it unfolds. Eichmann was considered to be responsible for extermination of 6 million Jews.

The chapters in the book are very much detail-oriented yet crafted like script to keep you on your toes all the time. Michael Bar-Zohar and Nissim Mishal have taken a great care by providing sources of information for every chapter, to make it as nearer to the reality as possible. But in my personal opinion reader is advised to take content of the book with grain of salt, as veracity of every content in no way can be validated. Certainly as it happens, there could also be hidden propaganda of putting Israel into “right frame” in world’s eye, so reader should be wary of that too.

In my personal opinion…. (Sorry if it sounds like too patriotic, but then that’s what it is !):

Informative & daring stories of Mossad and Israel, has certainly one thing to teach our country India (and Indians, especially those pseudo secularists) that country itself is responsible for its fate. India should stop begging and crying for help from other nations when dealing with enemies-terrorists. (as every nation has its own political agenda and such help is not free of cost). Every Indian should read this book at least just to understand to what extent the county and its people goes to stand, fight and defend its sovereign and its people no matter wherever they are in the world.

We the people of India: suffering from high inflationary fever!

 To the fellow victims of high-inflation,

 When foreigners in past used to call India -the country of “snake-charmers”, we hardly knew that even today the word snake can be used in bit different context. Since 2010-11 we (especially middle class & lower and retirees) have been bitten by the snake called high inflation.

Inflation can be understood( I am just taking one perspective to inflation, there are many dynamics, perspectives to inflation) as lets say you used to buy pizza at Rs.100 a year back, now after one year everything is same but when you go to buy pizza the price is Rs.110. So, The price of the product has moved up but the product we get is the same product-everything is same for the product. (There is no value addition for that extra Rs.10 you pay).

So, in the simplest way if we say when everything is same or all other factors are same about the product (quantity, quality etc) but over a period of time you have to shell out or pay more money for buying same product that can be termed inflation (General increase in the price).

Now-a-days as many of you must be knowing, the famous gimmick played by producers to tackle inflation is instead of increasing the price of the product (in highly competitive environment producers may not be able to increase price frequently but still smartly they have to adjust for inflation to protect their profit margin); they decrease the quantity or change in quality & sell the product at the same price.

But the thing to understand is that, this is still inflation friends! Keep always in mind that inflation does not mean here that the price increase has to happen. When you can still give Rs.100 for buying that pizza after year & due to competition that Pizza Company has not increased the price, but now when you buy that pizza may be the size is decreased or change in quality. So for same amount of money (Rs.100) you got less of quantity or quality as compared to what you bought one year back, so inflation still hurt you. If nothing is changed for product & price is still same in inflationary scenario, the company or some entity in chain must have taken profit margin hit. (Decrease in profit margin)

So, in true sense we can say inflation reduces the worth of money (or as they say “real purchasing power of money”). Means either you will have to shell out more money to buy same product or with the same money you will get less of product.

The way we can see it…..

For salaried persons: for year 2011 & 2012 average annual inflation was between 8% to 9.30% & lets say you as salaried person got annual increment of average 5% only in you salary(so, products prices increased by generally 8% to 9.30% but your salary increased by 5% only in those years), you actually made loss or to say when you have to spend extra money on your many requirements due to inflation, against that what you received was not equal and in fact less. Difference between what you have to pay (due to high inflation) & what you received is you have to fill that difference from your savings or other monetary resources.

For retirees:  The high inflationary scenario is always toughest for retirees. In many of the cases where retires only have fixed pension cash inflows & they have to spend more due to inflation- increase in product prices-they face real trouble. For solution there should be inflation linked saving schemes which can provide inflation-hedge to savers.

For students : Imagine when you have lot many things to manage(birthday parties, night outs, movies & all) & your pocket money(provided your papa is not really in mood to increase your pocket money in line with inflation) remain same as compare to increase in prices of all the stuff due to inflation.  What a miserable life it becomes due to inflation…!

and so on for all the people... 

Friends!   inflation has always important (we like it or not!) role to play in our daily life. For any return calculation one should always take inflation rate into consideration. With the basic understanding we can also calculate inflation adjusted returns.

 For E.g. Lets say you earned lasted year 10 % on particular investment & in last year inflation rate was averaged at 8%. Now here if you forget inflation rate you will fell like you earned 10% return but see that in last year when you earned 10% return, in the same year general prices of goods & services also increased by around 8%. So to get inflation adjusted return;

 = (1 + nominal rate of return / 1+ inflation rate) – 1

= ( 1+ 0.1 / 1+ 0.08) -1

= 0.0185 *100(to convert into %)

= 1.85% (Real rate of return OR inflation-adjusted return)

So, we can say actually what you got is after inflation adjustment 1.85%.

 Same way you can also adjust your expenses in line with inflation. For E.g. lets say you are spending Rs.10, 000 for milk & stuff yearly & you feel that inflation is going to be averaged 7% yearly. So what would be my spending for milk & stuff after 10 years?

 = present expense * (1+ expected inflation rate) ^ no. of years

=10,000 *(1+0.07) ^10

=19671.51

 So you have to shell out Rs.19671.51 instead of Rs.10, 000 after 10 years for milk & stuff with expectation of inflation averaged at 7%.

So, next time friends! Whether you are doing financial planning for your family or for any particular occasion or calculating future increase in expenses due to high inflation or calculating rate of return on any investment…..think about inflation & then calculate after adjusting for inflation.

Note: The above write-up is just for very basic understanding of inflation from common man‘s perspective.  There are different types of inflations & components to inflations & different perspective to inflation from different fields and so on and so forth…which is beyond capacity here.

Calculating av. rate of return: Geometric mean is the king!

Hi friends!

Generally we have natural inclination towards arithmetic mean or simple average. Whenever we try to calculate (or we are asked to calculate) average or mean for any data, many of us with out second thought go for simple average. This is perfectly fine in cases like; av. marks of students, av. height of group etc. but generally in world of finance especially where return on investment is involved, calculating simple average of return on investment for some number of years is full of error and gives wrong perception about return rate on investment.

A good example will be worth thousand words!

You bought 1 share of ABC Ltd at Rs.100/- in year 2009. The share price for next 3 years;

Year          Price      Return(%)

2009           100           -

2010           115          15% = (115-100)/100 * 100

2011             69         -40% = (69-115)/115 * 100

2012          89.7           30% =( 89.7-69)/69  * 100

Now if your friend asked you, hey what’s average annual return rate on the above investment you made?  Without thinking, you say well average annual return on my investment is 1.66% due to simple average formula =(15 + (-40) + 30) /3.

Is this true average annual rate of return or is this correct methodology of calculating av. annual rate of return?

 Friends just pause & think….if you have invested Rs.100/- in 2009 & in 2012 you are getting only Rs.89.7, have you actually earned anything for last 3 years time period on your investment? Of course NOT, current price (Rs.89.7) is lower than what you invested (Rs.100) at the start. So how can you ever have positive av. annual rate of return on your investment?

That’s where the beauty of Geometric mean/average or compound average of return comes to mesmerize us into the world of finance.

If we calculate Geometric mean/average for the above example;

 Geometric mean = (1.15 * 0.6 * 1.3) ^1/3 , So by solving, geometric or compound average annual rate of return on your investment comes to negative 3.55% (-3.55%).

Note: Geometric mean takes only positive numbers for calculation purpose so, what we do generally is add 1 to every yearly return so that we get away with negative number & after calculating Geometric average deduct 1 from geometric average & multiply by 100 to get percentage(%).

The above geometric average rate is more realistic as it is negative (which it should be as you are down from what you invested at the start) & it takes into effect of compounding which is very crucial in world of finance & price volatility gets reflected in geometric average.

               

Geometric/compound average is better because;

1.       It reflects more economic reality in av. returns rate.

2.       Takes return volatility into consideration.

3.       It is compounding rate.

Always understand, whether you are finance/investment professional or just any one, it is always more truthful & realistic to present av. annual rate of return on investment to client or anyone in terms of geometric average

So next time when anybody says to you that this investment is good as it earned very good av. Rate of return & you should invest, ask if that is compounding average or just simple average (many  times even professional does not know & just blindly follows what is given) or better if you have the details calculate compounding rate yourself. When you are thinking to invent for more than one year & when your are looking for track record of some investment, av. rate of return will surely come into picture.

Friends! Just by slight change in our thinking & bit of better understanding you can see the change. Always go for (or ask for) compound average while calculating average rate of return on investment as it will not fool you like simple average.

Feel free to share any suggestion/question/doubt. Thanks! 

Return on Investment : Mistakes to avoid

Hi Folks !

I have come across many times that, lot of people (educated & uneducated and even people with finance back ground - this is the motivation behind writing this article) in society get so much awfully surprised by word “returns on investment” and completely get carried away with out putting return on investment in context. I have one real example to share with you; (many of you already do it in right way- Great! & help spread awareness to those who don’t)

One of my relative came to me one day & said, “you know what! I earned cool 30% on particular investment!”  Another cousin seating next to me was like wow! Tell me I also want to invest.

A classic example of taking return of investment without any context & jump into investing.

What is missing in above statement “I earned 30% on particular investment”? From my perspective two things at the least; (there can be many more specially inflation-adjusted returns but these two comparison bench marks are never going to go away) 1.Time period 2. Risk involved.

Let me just ask you one simple question if your friend comes to you & say, “ I earned 40% returns on asset-A & I earned just 14% on asset –B, isn’t asset-A great asset?”  What is your answer?

My answer is I can not say whether asset-A is better as compared to asset-B, before I know in what time period return is generated & what was risk involved. The key point is with out knowing how long (time period) the investment was made & what was the risk in it, no body can ever say it is good or bad investment.

 Next time whoever you are facing, be it elder person from your family, friend, investment/mutual fund professionals, your professor etc. with the above question or asking you to invest with high return on investment asset check out on Time period & Risk involved first.

 In general terms here, risk means volatility or movement in the price of asset in particular time frame. So, in simple words, higher the volatility higher the risk. (Risk/volatility stuff is ugly for getting into details so I am just sticking to basic understanding here)

Now let me add in the above statement, “I earned 40% returns on asset-A & I earned just 14% on asset –B. I got 40% on asset-A after 8 years with 56% annual volatility(risk), while I got 14% on asset-B in 2 years with 5% annual volatility(risk).” Now what is your answer- which asset is better?

Let’s do bit of Maths;

1. To compare different time period assets we have to calculate annualized rate of return. So that we can compare on same time-scale.
2. To compare different risk-involved assets, we divide time adjusted rate of returns by volatility (risk). So, that we can compare on same risk-scale.

Asset-A

Annualized rate of return for 40% return over 8 year is 4.3%.( {(1+0.4)^ (1/8)}-1*100=4.3%)

So, effective after risk-adjusted rate of return (for taking 1% of risk you get this much % of returns) = 4.3 % / 56% = 0.076%

Asset-B

Annualized rate of return for 14% return over 2 year is 6.77 %.( {(1+0.14)^ (1/2)}-1*100=6.77%)

So, effective after risk-adjusted rate of return (for taking 1 % of risk you get this much % of returns) =  6.77 % / 5% = 1.35%

So, now when you compare for time period adjusted (as time period is different in both assets) & risk adjusted returns of assets A & asset-B, certainly asset-B is better as you get 1.35% return with compare to 0.076% return of asset-A, in the above context.

Friends! You are the king now. Never take returns on investment in absolute way from any one. We all make investments in different ways & in different phases of life, so next time any one says this is cool investment due to whatever return on investment, straight away ask for time period & risk involved in it or better calculate yourself the time & risk adjusted return & then only decide or make comment.

Hope by better thinking/understanding on the above stuff we can make our day to day life bit better!

Feel free to share any suggestion/question/doubt. Thanks!