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.) 




7 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.


7 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 7 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

7 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.

Forecast 2011: Kotak expects a ‘blockbuster' year for top three Indian ITs

Based on a strong quarter of consulting sales and bookings by Accenture, and robust growth in new licence sales by Oracle, Kotak Institutional Equities expects blockbuster growth for the top three Indian IT services firms–TCS, Infosys and Cognizant—in the new year

Accenture's November 2010 earnings saw consulting revenues driving growth with a 15% quarter-on-quarter uptick, which clearly suggests increasing discretionary spends, according to Kotak Institutional Equities. Outsourcing revenues also grew a strong 6.5%. Constant currency revenue growth hit double digits for the first time in several quarters and outsourcing order booking was up 28%.

Oracle saw a 14% q-o-q growth in dollar terms. New software licence sales amounted to $2 billion, up 23% year-on-year. This was the highest-ever new licence sales in the November quarter.

Based on these numbers, Kotak Institutional Equities gave a heads-up to its clients about possible upgrades in estimates of tier-I companies. "Our current estimates do not factor in this possibility yet (potential of 30%+ constant currency revenue growth year) and we believe that neither do the consensus numbers. We clearly see a possibility of further revenue upgrades for tier-I names. Also, with most of the Street having reset their rupee/$ assumptions to 43-44.5 for FY12, a weaker rupee could lead to meaningful EPS upgrades as such."

A large part of the hope for higher discretionary spending by US companies is based on Federal Reserve data which suggests that American corporations are sitting on roughly $1.9 trillion in cash!

Kotak expects the best growth to come in mid-cap names such as Hexaware, Mindtree and Satyam. Best large-cap growth is expected from HCL Tech and Infosys. TCS and Wipro seem to be lagging behind in terms of growth and yet they are the most expensive.

IT companies have been outperformers in the last month or so, as they were considered safe havens in the middle of the scams that broke out, and the relatively positive data coming out of the US. Infosys has gone up almost 14% from a low of Rs2,950 on 24th November, while TCS and HCL Technologies are up 16% and Wipro is up by as much as 20%.


Forecast 2011: Nomura expects EMs to outperform; year of consolidation for India

Nomura says China will contribute three times as much as the US to global growth in 2011. India, the brokerage says, will contribute as much to global growth as Western Europe and Japan combined

Nomura, the global financial services firm, expects overall global GDP growth at 4.3% with developed market growth at 2.2% and emerging market growth at 6.6% in the new year. The US is expected to grow at 2.5%, with the best growth in Latin America expected Chile at 6.5%. The Asia Pacific region is expected to grow at 6.7%. Australia, New Zealand and Indonesia will see steady growth, while Japan, China, Hong Kong and India are expected to have moderate growth, whereas growth in Singapore, Thailand and Taiwan may fall sharply.

Nomura believes inflation in the developed world will be contained, but it expects the European Central Bank (ECB) and the Bank of England (BOE) to raise rates way ahead of the US Fed and the Bank of Japan (BOJ). Inflationary pressures will mount in emerging markets as funds keep flowing in and the authorities intervene to stem rising currencies.

In its report published recently, Nomura says India’s GDP growth should consolidate at 8% year-on-year in 2011, after a strong 8.8% in 2010 on account of three factors: (1) Agricultural output will normalise and growth will be lower due to base effects. (2) Growth in government consumption will slow. (3) Net exports will be a larger drag on growth as imports pick up in line with improving domestic private demand.

Nomura expects private consumption in India to remain strong, supported by rising wages and good rural demand. “We expect investment to be led by infrastructure, real estate and services sector capex.” The brokerage expects inflation to remain elevated (averaging 7.3% through 2011) due to a structural rise in commodity prices and a closing output gap that will result in greater demand-side inflation. Nomura also predicts that persistently higher than expected inflation will lead to up to 75 basis points of rate hikes from the RBI. “This will come on top of the aggressive 150bps of hikes in 2010 shifting the monetary policy stance to modestly tight.” 

“We judge the year 2011 to be a year of below-average returns for the market and set our December 2011 Sensex target at 22,100, implying a potential market return of around 12%. We expect some downside to consensus earnings growth expectations of approximately 20% year-on-year. At the same time, the policy environment will likely tighten more than expected, restricting premium expansion for equities,” says Nomura.

Inflation, consumer demand and labour shortages in India should be keenly watched, the brokerage suggests. A global rise in commodities could provide a huge spike to India’s inflation. The pick up in the investment cycle for 2010 has been disappointing, it says. “This has been because of a host of factors, including muted risk-taking ability on an aggregate basis, uncertainty in the macro environment, problems of resource shortages (difficulties in land acquisition and scarcity of labour) and policy hiccups in infrastructure areas, especially in telecom and roads. The recent slew of scandals and scams implicating the government will also likely impede the investment cycle.”

For Asia, rising inflation will be a big macro theme and it will be difficult to control if countries keep holding back appreciating exchange rates, Nomura says. For China it expects 9-10% growth in 2011-12 as the government implements structural policies to promote consumption, and in India supply constraints will keep inflationary pressures elevated, even as growth consolidates in 2011. Australia's GDP growth will lift sharply from mid-2011 on much stronger capex in the resource sector.

In fact, one key grouse Nomura seems to have with emerging market policymakers is that they are “prone to resist nominal exchange rate appreciation by stepping up foreign exchange intervention and imposing distortionary capital controls, with the result that over time the real exchange rate appreciation will likely end up occurring via domestic overheating and inflation.”  It worries that rising food and commodity prices create particular challenges for emerging economies given the importance of food in their CPI baskets. It votes for more flexible exchange rates that would also allow these economies to better absorb such price shocks. It warns that “the scope for inflation to overshoot on the upside in EMs is on the rise.”

Key overall global downside risks include an escalation in the euro area fiscal crisis, an investment pull-back in China, or the EM overheating turning sour, says Nomura. It expects the US dollar to consolidate against major currencies but weaken against EM currencies.

In China, Nomura expects government policies to focus on enforcing better working conditions, large minimum wage hikes and social welfare reform. Exports will grow at only 12%, low by Chinese standards, says the brokerage, but imports at 14% will be stronger due to strengthening domestic demand. China’s CRR is expected to rise to 20.5% in 2011 from 18% in 2010.

For the US, the brokerage sees a slow recovery process mainly because of several headwinds. It believes that reforms in the financial and healthcare sector could actually prove detrimental to hiring and therefore growth. While household debt still remains at excessive levels, household deleveraging will limit consumption. State and local government budgets are under pressure, housing recovery is still shrouded in uncertainty, and employment will improve but very slowly. Nomura believes the Fed’s $600 billion treasuries-buying programme will be enough to boost growth and stabilise inflation expectations. With the huge deficit looming large, fiscal policy will shift toward long-run reforms of taxes and entitlements.

For Europe, it believes there will be “gradual recovery in UK growth despite the dampening effect of deleveraging and fiscal consolidation. Inflation will likely stay above target during 2011 in the UK, and hover around the 2% target ceiling in the euro area. We expect no further QE with a first BOE rate hike in August 2011, the ECB’s in September 2011.” For the UK, Nomura is optimistic that the tailwinds of loose monetary policy and the persistent weakness of sterling will prove stronger than the headwinds of the fiscal consolidation programme, poor credit availability, a deterioration of real wages and a shaky housing market.  For the Euro area as a whole, consumer spending looks set to increase in 2011 and 2012, as labour market conditions improve and the unemployment rate starts to decline from early 2011.

Nomura expects the Japanese economy, which has hit a soft patch, to start recovering by mid-2011. It actually expects Japan’s CPI to turn positive by the end of 2012, marking Japan’s exit from its deflationary phase. “For the FY11 budget, deliberations are under way to reduce Japan’s corporate tax rate for the first time in about 12 years. We expect Japan’s central bank to implement additional monetary easing measures in response to a renewed upsurge of the yen, resulting in an increase in the asset purchase programme to ¥8–10trillion.”

For Russia, the recent severe drought and rising inflation will remain overhangs in 2011. However, there are things to look forward to. “The government accepts that the development of the economy is being hindered by the high level of state ownership, and has therefore announced a large privatisation programme for 2011-15, which should generate about $50 billion in revenue.” However, none of this will flow through in 2011. Another positive, Nomura points out, is that Russia has nearly ironed out all differences with the EU and US, and a possible entry into the World Trade Organisation in the second half of 2011 will be a positive.

(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.) 


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