Brokerages not enthusiastic about JSW's takeover of Ispat

Some prominent firms say that the acquisition is expensive and that reviving the small-capacity steel maker will put a heavy financial burden on JSW

JSW Steel is to acquire 39% of Ispat for Rs21.4 billion and make an offer to buy another 20% from the public by March 2011. JSW is also to refinance Ispat's debt by September 2011. Ispat runs a 3.3 million tonnes per annum plant (mtpa) near Alibaug (on the coast) which is incurring losses due to lack of raw material integration and high power costs. Brokers assume the enterprise value of the deal between $750 and $950 per tonne, which is lower than its replacement value of $1,000 per tonne. JSW will get management control, but with a 26% stake the Mittals still hold veto rights.

CLSA believe the best part about the deal is that JSW has valued Ispat at an EV per tonne of $756 against a replacement value of $1,000 per tonne. However, it is concerned that the deal values Ispat at nine times FY10 EV/EBITDA and that's expensive. The rationale for the deal, CLSA says, is the long delays in setting up steel plants in India, so buying one makes a lot of sense.

But JSW will have huge challenges ahead: It has to improve Ispat's EBITDA per tonne to $100 by Q4 from the negative levels in Q2 and refinance Ispat's debt at lower costs by mid-FY12. "Longer-term, JSW is targeting to improve margins to $175 post-completion of multiple projects and hopes to improve raw material integration in 2-3 years, but we believe that it is too early to factor in either. Overall, we don't see the acquisition either adding to or taking away much from JSW's earnings and valuations in the near-term."

"Why Ispat was not able to procure inputs at cheaper rates on its own remains a mystery," CLSA says, but it feels that the company will see a rise in profits in the coming quarters.

At the core of JSW's game-plan is cost reduction. "JSW plans to cut Ispat's costs by about $50 per tone, by sourcing lower-cost power from JSW Energy, lower-cost coke from Jindal Stainless and surplus pellets from its own Vijaynagar plant, boosting EBITDA per tonne to $100 by Q4FY10 from negative levels in Q2," says CLSA. The brokerage also likes the fact that JSW is buying fresh shares, as this will mean that the "cash will stay within the consolidated entity and go towards reducing debt."

The task is not as easy as it appears on paper. Ispat has reported losses in four of the last five years and in FY10 EBITDA per tonne was just $109. The biggest problem, CLSA points out, is that the whole margin improvement project will take at least a couple of years, until which time Ispat (and by association JSW) remain vulnerable. "There is a risk that JSW might have to support Ispat's capex plans and debt-servicing requirements if steel prices dip and stay lower for longer. The deal also increases JSW's FY11 consolidated net debt-to-equity to 1.21x from 1.01x, reversing the trend of declining gearing of the last two years."

CLSA is not very convinced about JSW's track record in acquisitions either. However, the fact that EPS dilution will be just 3-5% even if one were to assume a lower EBITDA per tonne of $110 over FY12-13 (instead of it improving to $125-130 per tonne to make the acquisiton EPS neutral) is slightly comforting.

In the medium term, Ispat needs a capex of around Rs32 billion-this includes Rs5 billion for a 110MW power plant, Rs6 billion for a 3mtpa pellet plant, Rs5 billion for a 1mtpa coke oven plant, and the big daddy, capacity expansion from 3.3mtpa to 4mtpa for which it needs Rs14 billion.
Credit Suisse mentions an issue that not many other brokers are talking about. "Turning around Ispat is likely to be tricky with existing promoters still holding veto power." It has a divergent view about EV per tonne being below replacement costs too. "EV per tonne is $940, but with further (about) $430 million needed to raise profit to normal levels EV per tonne reaches (about) $1,080."

Credit Suisse believes that with Rs23 billion of cash from the JFE deal still on JSW's balance sheet, funding should not be a problem, but leverage will once again become an issue, since cash contribution from Ispat is a while away.

To get 6x EV per EBITDA, EBITDA per tonne must reach $155, which is targeted after 2-3 years, Credit Suisse points out. "This includes coking coal and iron ore supplies from its own mines (coal from Colombia and ore from Maharashtra)."

Here are Credit Suisse's key takeaways from the analyst meet yesterday.

  • Deal closure expected before the end of this financial year. Open offer to start on 11 February 2011 and end on 2 March 2011.
  •  Informal agreements are in from 70% of the lenders.


  • Even though JSW categorically denied the need for Ispat to raise more equity, the latter needs $550-600 million in new capex over the next two years. Of this, about $170 million is expected to come from JSW's infusion, implying that Ispat must generate a further $430 million in cash, in addition to refinancing most of its rupee debt by September 2011.


  •  Even if Ispat becomes EBITDA positive by March 2011, it is unlikely to become materially EPS positive before FY13. The impact on JSW's EPS is thus likely to be a negative 8-10%.


  • Ispat promoters continue to hold the veto power and this could complicate the turnaround, as some decisions may be tough to take.

HSBC Securities and Capital Markets does not think much of the deal either. "Our analysis suggests all synergies, if realised, would help Ispat save Rs1,700 per tonne on costs on an annualised basis. Assuming JSW manages to increase EBITDA per tonne to $170 eventually (2005-10 average being $100 per tonne) the upside to JSW's market cap would be just 6%."

HSBC believes that JSW can help save power costs for Ispat through power purchases from JSW Energy. However, since JSW Energy is a listed company, the transaction will have to happen on an arm's length basis. Even so, it can be far better than the Rs5 per unit electricity cost that Ispat is working with right now. A saving of just Rs0.50 per unit can result in savings of Rs1.2 billion or Rs300 per tonne for Ispat on an annual basis, the brokerage points out.

JSW plans to supply 350 kilo-tonnes per annum (ktpa) of coke to Ispat and rent out Jindal Stainless' excess capacity-Ispat needs 700ktpa of coke at $377 per tonne. HSBC calculates that savings of $50 per tonne on coke costs can result in a savings of Rs1.6 billion (or Rs400 per tonne) for Ispat on an annual basis. According to its other calculations, savings of $25 per tonne on pellets can result in a savings of Rs1.6 billion (or Rs400 per tonne) on an annual basis. "Ispat can also avail Rs1,300 per tonne VAT benefit selling in Maharashtra and Rs1 billion on freight costs."

(This article is based on secondary research. The report is for information only. None of the stock information, data and company information presented herein constitutes a recommendation or solicitation of any offer to buy or sell any securities. Investors must do their own research and due diligence before acting on any security. Some of the opinions expressed in this article are the author's own and may not necessarily represent those of Moneylife.) 




6 years ago

It has to happen as ispat was goning on in the loss path.
its nice to hear that JSW has acquired the shares,although Arcelor mittal was there too.
Good for Indian Steel Industry ,which has to achieve the goal of 200mtpa in 2020.


6 years ago

Having some considerable experience with both Essar and the Mittals I tend to agree with the Foreign analysts assessments. Ispat shares are dead money. In his hurry I suspect SajjanJ could not see the forest for the trees. While Dolvi et al are technically fine facilties, the "logistics" are all wrong. Too much debt, far too much in contingent liabilities from immediate capex reqts, unknown liabilties such as PKM committments to various lending parties which, I am sure, he has tried to palm off on SJ, and the continued presence of the younger Mittals.. Like PK's failed foreign adventures (note Kremikovtzi bankruptcy) the logistics are al wrong.. a plant producing products that have input dependencies (cost of coke, ore, power).. Ispat had another disadvantage..need to sell thru agents at a discount.. this is the easiest for SJ to solve..BUT, w/o a explicit Guarantee from JSW, the PSU's will refuse to "restructure" and accept a lower interest rate.. in time, this will act as a drag of JSW itself..
Laxmi Niwas was the preferred acquirer. Only the older brother could have solved Ispat's myriad of problems and his credit rating is impeccable. He knows Ispat inside and out having spent his early years at the plants.. he has access to the latest in technology and European experienced executives he can move around at will.. last few years he has assigned a Team to study Ispat so he is well up on it.. Great Pity.. animosity so great between the two, Pramod chose to cut off his nose to spite his face.. I had offered for years to act as intermediary to patch up.. BUT Pride.. he brushed me off with a terse comment "internal family problem".. Vinod has better relations.. OF course, to be fair, it works both ways.. As a devout Hindu, older brother Laxmi could have reached out...



In Reply to pravin 6 years ago

Truely agree with you. LN Mittal would been a better option . lets wait and watch how Ispat goes now from here on the shoulders of JSW.

Vinay Isloorkar

6 years ago


Call it corporate governance, shareholder friendly track record or plain good intentions, Jindals will be good news for any enterprise. What sets them apart is ( as Steven Covey puts it ) abundance mentality. The only worrisome part is the lingering presence of Mittals.

Patel Engg-led consortium wins Rs300 crore order

Patel Engineering Ltd in consortium with BS TransComm and Simplex Infrastructure has won a transmission project worth Rs300 crore from REC Transmission Project Company.

The transmission project associated with the Krishnapattanam Ultra Mega Power Plant includes establishing a 210 km, 765 kV transmission system from Raichur to Solapur and operating it for 35-years after completion. The project is expected to be complete by March 2014.

On Wednesday, Patel Engineering increased 3.74% to Rs318.65 on the Bombay Stock Exchange, while the benchmark Sensex closed 0.22% down at 20,015.80 points.


RInfra upgrades suburban power distribution system

To serve efficiently to its 28 lakh customers, Mumbai-based electricity distribution company Reliance Infrastructure Ltd has upgraded its distribution network by adding new substations and cable lines in its distribution network.

As a part of its network augmentation programme, the company has added 303 new sub-stations to its distribution network during 2009-10, thus, taking the tally of sub-stations in the system to 5,384, the release said.

The company has also added new cable network of around 425 km, taking the total cable network length to 7,930 km. RInfra has also enhanced its installed capacity of power transformer to 2,752 MVA so that it can bring in the additional power flow from various supply sources.

RInfra’s other initiatives for all its consumers include speedy new connection service, where all formalities have been complied with by the applicant, world-class customer care centres with multi-lingual agents and single window services, 24x7 power help lines for complaints and reporting of power thefts.

The company also offers several options for billing services, payment facilities, etc.
On Wednesday, RInfra decreased 1.74% to Rs794.45 on the Bombay Stock Exchange, while the benchmark Sensex closed 0.22% down at 20,015.80 points.


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