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A Corus line: Did Tata do the right thing?
February 13, 2007
The markets hammered Tata Steel's stock on concerns that it overpaid for Corus, but the jury is still out on whether the acquisition was overall a wise thing. Based on the bare numbers alone, it does appear that Tata was bruised by the bidding war and did pay about 20% more than Corus was really worth (and which was close to their original offer).
It turns out that Tata is paying 68% more than the average of Corus' stock price over the year ending October 4, 2006, which does seem high. Pyrrhic victory? Winner's curse?
There are many layers of irony in the whole episode: first, Corus includes British Steel, once an exemplar of that country's industrial might and thus of its dominance over India; second, considering Arcelor-Mittal's Indian connections, and the new domestic projects expected in Orissa and Bengal, India may now be a bigger factor in the metal now than at any time since its predominance of world steel production in the 1000-1500 CE timeframe when high-carbon wootz -- known as damascene to Christian crusaders who felt its bite in Mohammedan scimitars -- was the best steel in the world.
Third, Tata Steel, once written off as an also-ran because of its high costs a few decades ago, has reinvented itself as one of the lowest-cost steelmakers in the world, partly through new technology, but as case studies from the IIMs show, also significantly because they were able to hammer out a pact with their workers, transforming the company and the way they made steel.
The old-fashioned commitment by the Tata to their workers and their communities -- as seen most vividly in the remarkably well-maintained flagship company town of Jamshedpur -- has paid huge dividends in an era of robber-baron management.
Clearly, these things go in cycles -- long or short, as the case may be. I was reminded of another, extremely short cycle, when Motorola recently took a hit on their earnings: apparently, their big hit product of two years ago, the RAZR, is now such a commodity item that it is dragging down profits! The cell-phone has now become a fashion accessory, and like all fashion items, it needs constant revision.
In the larger picture, I am not a fan of heavy industry, as I am a firm believer in India's core competence being in agriculture, intellectual property and light manufacturing. However, this doesn't mean -- as allowed by Adam Smith and David Ricardo under comparative advantage -- that India should completely abjure heavy industry, either, especially in areas where it has strengths.
For instance, exporting millions of tons of Kudremukh iron ore to China, as India has done for years, is as brain-dead as the old export of cotton to British mills: the value-added stuff was then re-exported to India. But at least then it was extortion, now there is no excuse in freely allowing a foe to use our resources.
The Tatas have earned enormous goodwill in India, and their image is that of a benign, ethical entity: there is some danger of this image being dented by their alliance with the Marxists of West Bengal. Nevertheless, the value of their goodwill, and of their brand value -- I read somewhere that Tata now is roughly in the top 100 brands worldwide -- continue to be enormous.
There are both threats and opportunities with the Corus purchase. The main rationale for the purchase have been a) synergy, b) access to markets, c) access to technology, and d) economies of scale. On the other hand, steel is at a cyclic peak in demand and price right now, and it is likely that with a cooling predicted for China this year that commodity demand will slow.
There is serious competition, too: Arcelor-Mittal, the consolidating Japanese, and increasingly muscular Chinese firms. New capacity is coming online in both China and India in 2007, as well.
The synergy issue is interesting, although it is best to be a little wary of this expectation after disastrous M&A deals in the 1990s (for example, AOL Time-Warner) wherein the anticipated benefits did not materialize. However, there might be value for Tata if this acquisition is intended for the Tata Group, not just Tata Steel, to expand itself.
For instance, Tata Motors may be keen to enter European markets (after its aborted deal with a British auto company), and acquiring Corus may well be the first step towards a vertical integration by acquiring a local auto plant as well: design in India at low cost, and produce in Europe for local markets.
The distribution angle, and the access to Corus's existing customer list, may not be a great advantage, given that growth in demand for steel is likely to come not in Europe but in Asia. This is diametrically opposed to the approach Tata Sons took with the acquisition of Tetley Tea and access to OECD markets.
The issue of technology and plant is unclear. Apparently Corus has a number of patents, but I doubt that their technology is unique and advanced enough to make a difference. Otherwise, it would not be on the auction block.
Besides, along with the technology come obsolete plants, and, worryingly, unionised British labour: the kind of problem US Steel had. This is possibly the most dicey part of the deal, because these are poor-quality organised workers; and this is the real reason Corus had such low valuation -- Britain's militant union labour is comparable to its football hooligans: unruly, difficult to manage. Tata's vaunted HR skills will be tested sorely.
The scale argument has some merit. After all, Arcelor-Mittal's merger rationale was that it would be able to distance between itself from the next smaller firms in the industry. There is value in creating seller power in an otherwise fragmented industry.
There are plenty of pluses and minuses in the deal, and we shall have to wait and see how it pans out. However, the only people who have clearly benefited are Corus' shareholders. A skeptic wondered whether the losing bidder, CSN, was in cahoots with Corus management.
They certainly managed to hand over to Corus owners a huge windfall at the expense of Tata Steel (a premium of 49% over the closing price on October 4, 2006).
There are lessons from this exercise for India's other corporate giants who are on the prowl for acquisitions. IT services firms have concentrated on buying customer lists; pharma companies have looked at technology and market access. But it is necessary to focus on the true value of the acquired firm, and not get caught up in the emotions of a bidding war.
"Buy low, sell high" should be the mantra, as the 'synergy' often ballyhooed by the M&A specialists may or may not materialise.
Comments welcome at my blog at http://rajeev2007.wordpress.com
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