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Krishnan Thiagarajan

Essar Global's definitive agreement to acquired Canadian steel major Algoma Steel Inc for $1.63 billion appears to be a favourable deal for the Indian company.

Essar Global holds 88 per cent of the equity in Essar Steel. At 5.5 times the 2006 EBITDA (earnings before interest, taxes, depreciation and amortisation) and an enterprise value (EV) of $660 per tonne, Essar Global appears to have struck a good bargain.

Though this deal is not comparable to the Tata Corus one or Arcelor-Mittal in terms of size, scale or strategic intent, on valuation yardsticks such as EV/EBITDA and EV/tonne criteria, the Essar deal scores quite favourably.

Competitive bid

This valuation is subject, however, to the deal going through without any competitive bid from another global steel major. Since the start of the negotiations to sell Algoma Steel in February, at least ten global steel majors or private equity players were said to have been interested. In mid-March, German steel major, Salzgitter AG announced that it had terminated discussions with Algoma as its stock price had risen sharply in the bidding process.

While the sales of Algoma have been on a rising trend for the past three years, its post tax earnings have declined over this period. Compared to post tax earnings of Canadian $344 million, recorded in calendar year 2004, the earnings had declined to Canadian $222 million in 2006.

However, the steel shipments over this period have improved from 2.19 million tonnes (mt) in 2004 to 2.42 mt in 2006. Though the operating margins have been on a declining trend at 20 per cent in 2006 compared to 33 per cent in 2004, it still is fairly high compared to steel majors in the developed markets. Algoma also has a good balance sheet with Canadian $860 million in free cash flows generated between 2004 and 2006, and an average return on equity of 33 per cent over this period.

Global steel price

Timed to a probable recovery in the global steel price cycle, Essar Steel may be able to gain from improved price realisations. Algoma's hot and cold rolled sheets are supplied to the automobile industry, mainly General Motors and Ford, and plates to the construction and mining industry. It's proportion of steel shipments flowing from sheets stood at 80 per cent, with the balance from plates.

Essar Steel, with a capacity of 3 mt per annum, manufactures flat products catering to the engineering and automobile industries.

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