The fierce battle over Corus (CGA) was recently decided when Tata, the Indian steelmaker, beat CSN, the Brazilian rival, in a final face-off. The price was 608 pence per share, which translates to a total purchase price of $12 billion. Tata thus agreed to pay approximately nine times EBITDA (earning before interest, taxes, depreciation, and amortization) for what many industry observers regard as a troubled steel company. Why? What's next for the steel industry? And how will this deal affect the industry's ongoing consolidation efforts?
Corus was formed via the merger of Hoogovens, a Dutch steel company, and the former British Steel. Between the two sets of assets, everyone in the industry regards the Dutch assets as the crown jewel. The British assets are older, less productive, and less profitable. They have union issues and are burdened with more than $13 billion of pension liabilities. On the other hand, Corus represents about 20 million tons of annual steel production, which is a very large amount of additional capacity for a growth-oriented steel company to add. Indeed, with this acquisition, Tata will catapult from being outside the 30 largest steel companies to No. 5 on a capacity basis.
Corus had been on the market for at least the last two years. Several major steel companies looked seriously at Corus and kicked the tires. They ultimately decided, however, that Corus was not worth the effort or the price, even when the price was around $5 billion. The big question everyone in the steel business is asking: What does Tata (and CSN) see in Corus that would make it pay $12 billion for a company that many other strategic players passed on at $5 billion?
Feeding Frenzy or Light Lunch?
One theory is that Tata violated the "in-too-far" rule, meaning that Tata simply got caught up in a kind of deal frenzy, convincing themselves that the acquisition would be good at almost any price, and they just could not back down. Certainly, Tata's shareholders thought that the company had caught a bad case of irrational exuberance, since each time Tata raised or threatened to raise the price for Corus, its own share price fell significantly. Tata's shares lost 11% on the day after its winning bid was announced, while CSN's stock price jumped more than 7% after it lost the auction.
Another theory is that, despite the enormous price tag for Corus, the purchase price per ton amounts to about half of what it would cost today to build those same assets from scratch. This theory maintains that there are also big synergies available by combining the two companies which will boost earnings. A third theory is that, like Mittal's purchase of the U.S. steel company ISG in 2004—which sold for a then-unheard-of $230 per ton—over time the Corus price will be viewed as just another speed bump in steel's global consolidation.
Certainly, steel's global consolidation played a major role in the contest over Corus. Mittal set the standard with its acquisition of Arcelor (MTTFF), creating a global superpower at over 120 million tons per annum of production. By comparison, the next largest steel company, Japan's Nippon, has a mere 35 million tons. Putting Tata and Corus together will create a company with about 29 million tons of production—a giant leap for Tata, which now produces some 9 million tons, but still light years from Mittal.
Reading the Future
Yet there is simply no other steel company the size of Corus available on the market, so if a smaller player like Tata had aspirations to become a large player, this was perhaps the only one-stop move that Tata could make to do so.
Which brings me to the price. As noted above, Tata agreed to pay about nine times Corus's EBITDA. This is an astronomical price in the steel business, where all other major steelmakers trade at roughly five to seven times EBITDA. Indeed, Arcelor Mittal, the industry leader, trades at 6.5 times EBITDA.
Should Corus be valued at a multiple that is more than 30% greater than that of Arcelor Mittal? I don't think anyone believes so, except maybe Tata and CSN.
Perhaps the most important question coming out of the Corus/Tata deal, however, is what does this transaction presage for the steel industry? Certainly, the age of consolidation is upon us. Consolidation is intended to bring price stability to an industry that has historically suffered through constant feast-or-famine pricing cycles. In the period from the late 1990s through 2003 alone, more than 50 U.S. independent steel companies were forced into bankruptcy due to pricing swings, legacy liabilities, dumping, and other forms of economic misery.
Hoping for Sustainable Earnings
However, in the last year, Arcelor Mittal has led the charge to bring stability to the industry. Thus, in 2006, amid generally falling steel prices, Arcelor Mittal and other major producers cut production rather than prices—a move that benefited them and all other participants up and down the steel food chain.
Industry leaders are hoping that price stability combined with various shareholder-friendly actions, such as transparent corporate governance and a formal dividend policy, will result in sustainable earnings for the industry and lead to a rerating of the industry by the financial markets. The steel industry has historically been valued by the markets at significantly less than other industrial sectors such as oil and gas, mining, cement, and chemicals.
Certainly, more blockbuster deals will be necessary to further consolidate and stabilize the industry. Where will these deals come from? That is the harder question, because the steel industry is populated by public and private companies that are run by "kings," each of whom wants to run the show. Getting two kings to agree to a mega-merger is a tough assignment, given all the personal, business, and cultural issues.
So, the bottom line on the Corus-Tata deal is that it is part of the new continuum in the steel business, one that has seen the industry consolidate as never before and which augurs well for the future. It will be interesting to see whether, say five years from now, the industry looks back on Corus-Tata deal wistfully, remembering fondly the time when a major steel company sold for "only" nine times EBITDA.