Hindalco Novelis.. contd.

Hindalco Novelis Merger: Previous Article

Financial numbers show that novelis is not a good choice by Hindalco at least at the price that they paid for the company. The imediate effect of the merger is that Hindalco would achieve its target of doubling its turnover to $ 20 billion three years in advance. Novelis fits well in the long term strategy of Hindalco. Novelis is not a dying company looking for a savior, Hindalco approached Novelis because they believed that Novelis can give them some business advantage.

Natural Hedge

All raw aluminium is processed so that it can be used in products. Fourty percent of the products are rolled products and Novelis is in leader in rolling business with a market share of 20%. Any change in the raw material price is directly passed on to the customers who range from coca cola to automobile companies like aston martin. The current revenue of hindalco is very much dependent on the aluminium prices and when the prices are high they make a larger margin, this not the case with rolling business which usually has a constant margin.

Technology

Novelis being market leader in the rolling business, has invested heavily in developing various production technology. One of such technology is a fusion technology that increases the formability of aluminium. This means that it can be better used formed into the design requirement by the car companies. For Hindalco to develop such technology will take a lot of time. According to Standard and Poors it would take 10 years and $ 12 billion to build the 29 plants that Novelis has with capacity of close to 3 million tonnes.

Future Synergy

Currently Hindalco's production is tied up with clients. Also Novelis has similar contracts with its suppliers. But after 3-4 years it would start the operation of new plants. Then it can source excess capacity to the Novelis plants located in south east asian countries.

The merger looks not bad if the current financial valuations are ignored. Also we need to keep in mind that Hindalco is a very aggressively growing company, for it to build infrastructure that can match Novelis is very difficult.

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Hindialco Novelis Merger

The recent bid made by Hindalco of $6billion for Novelis is very much sidelined by the Tata Corus deal of close to $13 billion. Tata tried to gain more synergy by the deal and more importantly trying to gain access to high margin markets of Europe. This is a very good risk mitigation ploy, isolating Tata from the adverse movements in global steel prices.

Birla with Hindalco is trying a similar hedging strategy by taking over the aluminium rolling business of Novelis. It a market leader with a share of 20%. The rolling business is very less risky because any price change is passed on directly to the clients.

Financial Troubles

The financial trouble for Novelis began with wrongly speculating that the prices for Aluminium (raw mat) would stay soft. It entered into contracts (sept 06) with four major customers (accounting for 20% of the revenue) to keep the prices constant even in case of increase in input costs. Within few months the prices for aluminium increased by close to 40% resulting in the company selling below material costs. They made a loss of 170 million last year.

Valuations

This makes the valuation of the company really interesting. Birlas are paying close to $46 per share for this company even though the maximum price quoted by the company when it was doing well was below 30. If you compare this with Corus Aluminium and Aleris merger, where Corus Aluminium a smaller company was valued at only 18 times (market cap/PBT) compared to double (36) for Novelis. Also the company has accumulated a total of $2.33 billion of debt with a net worth of only $322 million. This gives a highly levered debt-equity ratio of 7.23/1.

All this casts a serious doubt on why Birlas are ready to buy such sick and overvalued company. The answer lies in "long term strategy"

Keep watching this space for the other half of the article...

Corus Welcomes TATA

Finally TATA Steel ends up as the winner in the poker match between TATA Steel and CSN (Companhia Siderurgica Nacional)for Corus. It was very clear that TATA would bid aggresively and in the end they ended up paying 508 pence a share for Corus. Translating into 6.2 billion pounds or $ 12 billion. 30 percent higher than the initial offer made by TATA. For CSN it was second time in five years that it has failed to acquire Corus.

Valuation

The bid made by TATA Steel values the firm at 7.6 times the EBITDA of Corus. If the merger is compared to the $32 billion deal of Arcelor Mittal then the valuations seem overpriced. Arcelor was valued at 4.6 times its EBITDA. But if you look at valuation per mt then this deal could be considered a good bargain. According to TATA it would take arround 80% more capital to build up capacity and quality similar to Corus.

For two days after the merger TATA Steel shares were trading 12% lower. Now on 2nd feb it gained 1%. It shows that eventhough valuation for the merger was overvalued, tata did the right thing at the right time to acquire Corus(their bid was only 5 pence higher than CSN). In the short term TATA may face financial troubles due to overvaluations, but in long term this deal puts up the foundations which will make the company a 90 mt Steel company from the current post merger 28 mt. TATA would also have to overcome the task of integating close to 50,000 worker of the company spread accross UK and Neatherland.

Inefficiency of Indian Companies !

The Net profit of Indian companies is lower 40% as compared to other MNC companies

43%. The figures were of top 100 Indian and MNC companies. This might only look like

a marginal thing. But it is important to keep in mind that the aggregate turnover of

an sample MNC company has increased 22.9% as compared to 34.5% for Indian companies.

This could be attributed to inefficiency of the Indian companies. Mainly the input

costs of the companies have gone up. For Reliance the growth in profits was limited

to only 10% dispite of a 38% increase in turnover. High crude oil price was the main

cause, the aggregate costs have risen by 42%.

Tata steel also showed similar performance with 14.5% increase in the expenditure

and only 4.4% increase in the net profits. The MNC's have fine tuned their cost

management. Their turnover has not inceased that much compared to the indian

companies. This could be signs of inefficiency of the Indian companies. The interest

liability of Indian companies has declined compared to last year.

It important to notice that Indian companies are taking more debt to finance their

activites. TATA steel for example is planning to finance its Corus deal using debt and Reliance also trying to raise money

through foriegn debt market. In future rising interest costs on borrowings would

bring down the net profit growth even more. With Sensex now at all time high and valuations on stretch it is

very important to pick companies with steady growth in future.

C

Tata, buy buy

Tata steel is continuing its buying spree after it announced its plans to buy the world’s eighth largest steel maker Corus for close to $ 8billion. We had earlier seen Lakshmi Mittal creating its steel emprire by aggressively taking over other companies. In the last two years Tata steel made its expansion plans clear by acquiring companies like Singapore’s Natsteel and Thailand’s Millinium Steel.

Tata Steel is the second largest steel company in India with production of 5 mt (million tonnes) next to SAIL (12 mt). With the asian acquisitions it nearly doubled its steel capacity. Corus is British based company with capacity of close to 18.2 mt. After the merger the combined entity would be the sixth largest steel company in the world Tata is currently 55th.

The Synergy

Tata is one of the most efficient produces of semi finished steel (a low margin player). Corus on the other hand produces higher value specialized steel mainly for auto companies; with operations mainly focused in the high margin European market. The plans are to produce semi finished steel at low cost in India and then supply it to Corus which will increase the margin of Corus.

Valuations Comparison

Tata is paying Corus close to 5.5 pound per share in cash to Corus, while the share price of Corus was around 4.80 to 3.90 range in last one year. The recent Arcelor Bid by Mittal steel valued the company at 5 times EBITDA while the valuations for Corus is around 8 times EBDITA. But on per ton production basis the valuation for Corus is $610 compared to $785 of Arcelor (20% lower). It is clear that Corus is less profitable compared to Arcelor; Tata believes profitability for the combined entity would improve.

The cash for the acquisition would be raised mainly from debt. Corus and Tata Steel have low debt to net-worth ratio of 20% and 30%. Main concern here would be repayment because Corus is only starting to be profitable; between 2000 and 2003 it made losses close to $ 4 billion. And the synergy that Tata is looking for from its new plant its Orisa and Jharkhand won’t start operation till 2010.