JSW may emerge as the largest domestic steel producer as debt-stricken Ispat returns to profitability, say analysts.

JSW Steel’s move to acquire Ispat Industries is a win-win deal for both companies. On the one hand JSW will get to consolidate its position in the domestic steel manufacturing industry and will emerge as the largest steel producer with a total capacity of 14.2 million tonnes per annum (mtpa) and on the other hand, Ispat Industries, which has high debt and accumulated losses on its books and was feeling the heat on profitability, is estimated to mark a turnaround in its fortunes.

Being dependent on imported key raw materials such as coking coal and iron ore, the costs of which are moving northwards, the deal will allow Ispat to source it from the JSW group at relatively low rates. Additionally, in the absence of captive power, the higher power costs have added to its woes. With JSW’s entry, Ispat will get power at cheaper, leading to better profitability.

Lastly, refinancing of the existing debt and the infusion of fresh equity will lower its interest outgo, which along with a better operational performance should help Ispat return to profitability.

The deal
The deal with an enterprise value of $3 billion will see Ispat issue 108.66 crore (1.09 billion) equity shares to JSW Steel (at Rs 19.85 a share) for a total consideration of Rs 2,157 crore. This price is at a 20 per cent discount to Monday’s closing prices of Rs 24.95 for Ispat Industries on the BSE. Thus, the stock plummeted 15.03 per cent on Tuesday to close at Rs 21.20 and given that JSW’s offer price will be Rs 20, it should remain subdued.

Benefits to Ispat Industries
While the deal valuations look cheap and in favour of JSW, say analysts, the deal will also be positive for Ispat which had a debt of Rs 8,040 crore and another Rs 877 crore as short-term payables (negative working capital). With the infusion of fresh equity, conversion of preference capital to equity (worth Rs 1,257 crore) and marginal conversion of debt to equity, the company’s debt-equity ratio will fall from the over 38 times pre-acquisition levels to about one time. The company also says it will lower the cost of debt from the 13 per cent level by 250-300 basis points, which will help lower the interest outgo.

Operationally, Ispat was also seeing an impact on its profitability. Its Maharashtra-based plant has seen a prolonged shutdown for some time. Profitability was being impacted due to the absence of captive power as well as being dependant on imported coal and iron ore, the prices of which have continued their northward journey throughout the current financial year as the contract prices of $200 a tonne were 56 per cent higher year-on-year — they are now at $230 a tonne and are expected to rise further. Iron ore, the other major raw material, is following the same trajectory. It averaged around $110-120 a tonne in the June quarter (it was up 80 per cent year-on-year), but is now at the $135-140 levels.

With JSW now in the driver’s seat, Ispat will get captive power from JSW’s Ratnagiri plant. The company estimates that Ispat’s power costs will fall from the current levels of Rs 5.85 per unit to Rs 4.50 per unit, as soon as the deal is completed. In 2009-10, Ispat spent Rs 1824 crore on power and fuel costs. Thus, expect these costs to come down significantly from January 2011 onwards.

JSW Steel will also facilitate the sourcing of key raw materials, including coking coal and pellets for Ispat, which will help lower the operating costs further. While the mining expertise of JSW will help bring Ispat’s mining facilities into operational mode, Ispat until now was selling around 40 per cent of its produce outside Maharashtra and was not being able to get benefits on VAT. However, the arrangement with JSW will ensure it sells its products in Maharashtra itself and thus enjoys VAT benefits too. With all these benefits accruing, analysts at Edelweiss estimate the Ebitda per tonne for Ispat to increase to $175/tonne by FY13 from $100 a tonne in FY10. JSW, though, believes Ebitda will increase to about Rs 2,000 a tonne immediately (due to lower power costs) and later to over Rs 4,000 a tonne, when all the benefits begin to accrue.

Benefits for JSW too
JSW Steel is undergoing capacity expansions and will see its total capacity rise to 10MTPA by March 2011. While JSW was already ahead of its peers in terms of seeing benefits on volume expansion, it gets another 4.2 MT of Ispat. The Ispat acquisition is operationally positive, considering the benefits of scale and the turnaround potential because of efficiency improvement, financial strength and superior managing capabilities of JSW. An effective turnaround implies EV/Ebitda of 4.9 times for the transaction, which is reasonable according to Edelweiss estimates. Given the deal structure, JSW’s consolidated debt-equity ratio too would remain within manageable limits.

source: Business Standard

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