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S. Muralidhar

Jindal Iron: Sell JVSL: Hold

THE proposed merger of Jindal Iron and Steel Company and Jindal Vijayanagar Steel (JVSL) seems to be a marriage of convenience which had been on the cards for quite some time now. The merged entity will be called JISCO. From an investment perspective, the current valuation of JISCO's share at about Rs 730 is clearly not sustainable in the long run. Post-merger, the JISCO stock may trade more in line with the valuations of other integrated steel manufacturers such as Tata Steel. JISCO shareholders can, thus, use the current high price of the stock to book profits.

The JVSL share now trades at about Rs 11.3. In the light of the capital reorganisation which proposes to bring down the number of shares in JVSL by nearly 95 per cent and the merger to follow, JVSL shareholders can consider holding on to their shares and wait for the merger exercise to be completed.

Marriage of convenience

Among the benefits arising from the merger of the two steel companies, the most obvious is that of size. Also, what the companies hope to take advantage of, post-merger, is the Rs 2,500-crore-plus tax benefit that could accrue to the merged entity due to the accumulated losses of JVSL. Set over the next two-three years, this could leave JISCO tax-free. In addition to this income tax benefit, the companies also hope to save on sales tax paid on inter-company sales.

Merger milestones

The swap ratio for the purposes of the merger has been fixed at 1:16, which means that one share in the merged entity will be allotted for every 16 shares held in JVSL. The swap ratio has been calculated from the weighted average of the four valuation methods — break-up value, market price, discounted cash flow and earnings capacity.

The merger is to be preceded by a number of equity and debt restructuring initiatives within the two merging companies.

First, the plan envisages the demerger of the investment business of Jindal Iron, a portfolio of over Rs 620 crore, into a new company to be listed in the name of Jindal South West Holdings Ltd.

Shareholders are expected to be allotted one share in the new investment company for every four shares held in Jindal Iron.

In the meanwhile, another tranche of restructuring of JVSL's equity is also in the pipeline. The scheme of arrangement involves a reduction of capital step-by-step from Rs 1,291 crore to Rs 96.56 crore.

The corporate debt restructuring package will enable the conversion of four equity shares out of every ten held, into four low interest, 0.01 per cent cumulative redeemable preference shares (CRPS) of Rs 10 each.

These CRPS are to be converted into equity shares of Rs 10 each in the ratio of one equity share for every four CRPS held by the shareholders resulting in the allotment of 12.91 crore shares.

In addition to this, JVSL will allot one warrant for every seven shares held by its shareholders. The warrant holder will have a right to apply and be allotted one equity share on or before April 1, 2006.

As per the debt restructuring package, Rs 456.88 crore in debt is set to be converted into 45.68 crore shares of Rs 10 each in JVSL. The merged JISCO will have an equity base of about Rs 140 crore.

Merged strengths and opportunities

What does all these capital reduction measures mean to the JVSL shareholder? A JVSL shareholder holding 100 shares currently will end up with about 84 shares after the CRPS and warrants are converted. After this when the merger is given effect to at a 1:16 swap ratio, the JVSL shareholder will end up with about five shares in the merged JISCO.

The merged JISCO will be involved in every stage of the steel value chain starting from iron ore mining to the manufacture of special and value-added galvanized products. While the economic rationale and the obvious benefits of size and the accompanying economies of scale from the company's perspective do not require any elaboration, two issues will nag the shareholders of both the companies.

Between the two companies, Jindal Iron is the manufacturer of value-added steel products, and as such is less vulnerable to the steel price swings.

However, JVSL is probably bringing much more to the table in this merger than Jindal Iron. The merged entity will be a complete, integrated steel manufacturer only due to the addition of JVSL's facilities. Further, JVSL, which is the producer of steel slabs and hot rolled (HR) steel, is better poised to leverage the current buoyancy in HR prices. During the last six quarters, margins have generally been higher for hot rolled coils compared to cold rolled steel, due to the relatively higher prices for HR in the international markets.

If and when the merger is put through, JVSL shareholders may wonder if there is a case here of a missed opportunity. JVSL has just started making money at the operational level and looks set to post a full turnaround if the current buoyancy in steel prices continue. The merger may thus disallow the company and its shareholders the possibility of realising its full potential. However, the merger could also potentially help JVSL tackle the vagaries of fluctuating steel prices better, because of the addition of higher value-added products in the portfolio of the merged entity.

But the new company will have to aggressively market its products and make further progress on the branding front to be able to realise full potential.

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