With thyssenkrupp no deal, Tata Steel back to Square One

Tata Steel’s stock fell over 6 per cent last Friday on news that the European Commission may not clear Tata Steel Europe’s (TSE) JV with the German giant thyssenkrupp AG. For the companies, the economic logic of the joint venture would get diluted if the deal happens with Commission-suggested remedies that include further sale of European assets.

This no-deal-TSE means continuance of high debt burden on the consolidated balance sheet, halt to restructuring of inefficient European operations and a long way to focus entirely on the healthy and profitable domestic business.

Background

The European steel industry has been severely hit after the recession in FY 2008-09. Weaker global conditions, increased competition within Europe and cheap imports from China had adversely hit the industry. Despite showing signs of recovery in the last two years, the demand for the metal has been lower than the pre-financial crisis levels.

In the case of Tata Steel, heavy debt taken to finance the $13.7-billion acquisition of Corus in 2007 followed by weakness in the European economy began to weigh on Tata Steel Europe. During FY10 and FY16, TSE accounted for more than 50 per cent of the sales volume and close to 60 per cent (aided by exchange rate conversion) of the consolidated revenues of Tata Steel. But its contribution to the group’s operating profit was less than 20 per cent most of the time.

Also, while the operating profit margins of Indian operations during the said period were around 30 per cent, European business’ profit margins were less than 5 per cent. Then, TSE started to bleed the consolidated financials of the group.

Since then, Tata Steel has turned to restructuring, hiving off parts of its debt-laden, loss-making European business such as long products and specialty steel. Also, to reduce the liability under the British Steel Pension Scheme (BSPS), TSE separated Tata Steel UK from BSPS by paying £550 million and offering a 33 per cent stake in Tata Steel UK to BSPS Trustees.

Tata Steel’s efforts at restructuring its European business through the proposed 50:50 joint venture (JV) with Germany’s thyssenkrupp AG looked like a shot-in-the-arm for the parent.

The non-cash deal (MoU entered in September 2017) to merge the flat steel business of the two companies was expected to cut the losses of Tata Steel.

The company’s decision to de-consolidate the European business and focus more on profitable businesses such as India operations improved investor sentiment.

The JV was expected to take significant debt off the books of the two companies and offer cost synergies of €400-600 million per annum. While the company’s consolidated sales would have come down post the JV, it was expected to cut the consolidated debt burden of Tata Steel by about €2.5 billion and improve leverage levels.

However, the deal faced roadblocks since the beginning. Starting with the resistance from the labour unions and the resignations of top management at thyssenkrupp, the deal has been claimed to be not in the interest of employees or the European steel industry.

Until next

The JV, which was expected to be concluded this fiscal, may no longer see the light of the day. Now, back to square one, it looks like Tata Steel has a long way to go to achieve the expected of the JV and focus wholly on the Indian business.

Though the operational performance of the European business was improving in the last two years, profits continued to be under pressure dragging down the margins of the consolidated entity. The operating profit per tonne of the consolidated entity in the recent quarter ending March 2019 was ₹10,934 (including TSE) and ₹12,393 (excluding TSE).