Analysis. Tata Steel-thyssenkrupp deal: Gaining stability

As part of the restructuring process of its loss-making European operations, Tata Steel has recently signed a definitive agreement (non-cash deal) with thyssenkrupp AG (tk) to form a 50:50 joint venture (JV).

The JV combines the flat steel businesses of both companies to form Europe’s second-largest flat steel company (behind Arcelor Mittal), with expected 21.3 million tonnes of shipments.

Since September 2017 (when the MoU was signed), while tk’s steel business has improved, profitability at Tata Steel’s European operations has weakened.

Under pressure from tk’s shareholders to alter the terms of the agreement, the deal has been tweaked a bit.

The new terms provide assurance to tk — in case an IPO of the newly-formed entity goes through, it will get a higher share of the proceeds, reflecting an economic interest between tk and Tata Steel in the ratio of 55:45. It is to be noted that the deal is subject to approval from the European Commission — expected by the end of this calendar year.

Here we highlight the implications of the new deal for Tata Steel shareholders.

Better off

Though the European operations contribute nearly 45-50 per cent to the consolidated revenue of the Tata Steel group, it has been at the cost of profitability.

In FY-18 too, the performance has been weak due to subdued demand, high levels of imports and restructuring activities.

Though sales were marginally higher, operating profit of Tata Steel Europe has reduced by 19 per cent to ₹3,792 crore. Also, net losses (before exceptional items) have nearly trebled from ₹762 crore to ₹2,164 crore.

The net worth of the European business, as of FY-18-ending (prior to restructuring), was negative, while that of the Tata Steel group was about ₹60,870 crore.

At this juncture, spinning off the European operations from the group means that the profits earned in India would remain and not get eroded after consolidation.

Besides, this restructuring de-consolidates ₹20,000 crore debt from the consolidated books of Tata Steel that will lighten its balance sheet to some extent.

The thyssenkrupp Tata Steel BV — the new JV company — is expected to generate sales of €17 billion and achieve annual synergies of €400-500 million, through joint purchasing, shared logistics services, higher equipment utilisation and reduced administrative expenses.

The estimated operating profit after considering the synergy benefits is around €2 billion per annum or about ₹16,000 crore — likely to be achieved after two to three years.

This increases the profit contribution from the European operations to Tata Steel, which will receive dividends.

Compensatory tweaks

Sales from Tata Steel Europe and tk in the year to March 2018 were about €7.9 billion and €8.9 billion, respectively. The average operating profit margin of the former was about 6 per cent, about half the latter’s levels.

Tata Steel will be entitled to equal board representation and dividends.

A new clause added is that it is at tk’s discretion to decide on the timing of an IPO and that it would get an extra 10 per cent proceeds from the offer. This additional amount is the compensation for better operational performance of the company.

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