Steelmakers' Megalomania Leads to Misery

Europe has taken a heavy toll on Tata and Mittal

Of the many lessons from Tata Steel's decision to sell its loss-making British operations, surely the biggest is this: If a steelmaker tells you he's embarking on a multi-billion dollar, cross-border, debt-funded expansion, run for the hills.

No doubt there will be much anguish in the coming days about the pernicious impact of China's cheap steel exports, which increased to more than 112 million tonnes last year (equivalent to about two-thirds of total EU production).

But in truth, Tata's U.K. business has been struggling ever since a bidding war tempted the Mumbai-based company to pay an eye-watering 6.2 billion pounds ($8.9 billion) for Corus Group in 2007 -- a one-third premium on its initial bid funded largely with debt.

European Blues

Tata Steel Europe was losing money even before China exports became a problem

Source: Company statements

At the time chairman Ratan Tata called the takeover a "defining moment" for the company. Indeed it was, only in all the wrong ways.

Granted, the financial crisis and Europe's protracted recession weren't foreseeable and that hit the company hard. Europe accounts for more than half of Tata's revenue but demand there hasn't recovered to pre-crisis levels. Yet, in spite of cost cuts and thousands of job losses, Tata hasn't been able to turn things around.

In today's money, Gadfly estimates the company's European operations have lost almost $5 billion since 2010. Asset impairments in the UK totaled more than two billion pounds ($2.9 billion) in that period, according to Tata. As a result, Tata Steel's net debt stood at some $11.3 billion at the end of December, or more than 10 times estimated 2016 Ebtida, according to Bloomberg data.

Pride Before a Fall

Tata Steel's shares have fallen since it paid 6.2 billion pounds for Corus in 2007.

Source: Bloomberg

Given that burden, Tata's decision to sell-up shouldn't come as a surprise. Arguably it should have recognized its mistake in buying Corus sooner. Doubtless, a big reason why Tata first did the deal was that Indian rival Lakshmi Mittal had completed a $38 billion takeover of Arcelor the previous year.

That hasn't turned out terribly well either. ArcelorMittal has also been forced to shutter European plants and it wrote down the value of its European steel business by $4.3 billion in 2012. Its huge debt forced it to announce a $3-billion rights issue in February.

Steel industry megalomania isn't a peculiarly Indian phenomenon, however, nor is organic growth necessarily better. ThyssenKrupp plowed billions of euros into a new Brazilian steel plant but lost more than 8 billion euros between 2011 and 2013 as construction problems and currency swings destroyed the original business case. The German steelmaker's balance sheet still bears the scars.

These deals demonstrate that while global steel prices sometimes move in sync, local market conditions remain hugely important. When it bought Corus, Tata didn't think enough about how the U.K.'s expensive electricity and swings in the pound could impact competitiveness.

While the decision to sell up is obviously distressing for its British workers, there is at least a silver lining for the industry. Would-be empire builders might now think twice before embarking on ill-considered and value-destroying deals.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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