Tisco has announced the acquisition of Singapore's NatSteel's steel business subject to regulatory approvals and that of the board members of the latter.

The enterprise value of the acquisition is Singapore$ 486.4 million (Rs 1313 crore). Just to put the acquisition cost in perspective, the amount is equivalent to 1/3rd of the NatSteel's steel business turnover of 2003 (excluding inter-segment sales) and over 13 times its steel business profits.

Under the terms of the agreement the enterprise value is subject to certain adjustments including those for any net debt, minority interest, other liabilities and for working capital variance relative to S$225 million.

NatSteel's steel division has a regional presence in Singapore, Malaysia, Thailand, China, the Philippines, Australia and Vietnam. This acquisition is in line with Tisco's plans of augmenting its capacity.

It must be noted that earlier this year, Tisco had unveiled its capacity expansion plans, which entailed hiking the Jamshedpur capacity to 7.4 m tonnes (MT) from the current 4 MT by FY09. The company is already in the midst of augmenting its capacity by 1 MT, which is slated to be completed by 2QFY06.

The capital expenditure for this part of the plan (including the 1 MT) is pegged at approximately Rs 10 bn. Further, it must be noted that this capacity expansion is part of the bigger plan of the company of increasing its capacity to 15 MT, the balance coming from acquisitions, both in the domestic and international markets and also the possibility of a greenfield venture.

Getting back to NatSteel, the company has had a track record of diversifications in the past (electronics and trading services to name a few), which it has been disposing off in the last five years.

The company has a fragmented presence across the above-mentioned 7 countries with an aggregate steel capacity totaling 3 MT. The group is focused on long steel products like rebars and wire rods and certain downstream activities also.

Looking at the financial ratios of NatSteel, while it is clear that the profit before tax (PBT) margins are significantly lower than that of Tisco, it also signifies the potential for operational improvement going forward.

The fact that the net debt to equity (debt minus cash upon shareholders equity) is only about 1.1 (for NatSteel) times is heartening, as the turnaround will be faster (unlike other Tata Group acquisitions in the past).

NatSteel - Snapshot
(S$ m)	FY00	FY01	FY02	FY03	FY04
Turnover - Overall	1,717.0	1,738.9	1,585.4	1,440.7	1,401.5
PBT - Overall	1.0	210.2	(118.0)	949.6	120.7
PBT margin - Overall	0.1%	12.1%	-7.4%	65.9%	8.6%
PBT margin - steel	8.7%	0.4%	-2.8%	2.1%	3.3%
Total assets	1,401	1,815	1,857	3,162	2,125
Sales/total assets	1.2	1.0	0.9	0.5	0.7
Sales/employee (Rs m)	2.7	2.7	2.5	5.2	5.6
Net debt/equity	0.2	(0.4)	0.2	(0.2)	1.1
Tisco - Snapshot
PBT margin	8.2%	13.0%	6.9%	17.1%	27.0%
Sales/total assets	0.5	0.6	0.6	0.7	0.8
Sales/employee (Rs m)	1.2	1.4	1.5	2.0	2.6
(Source: NatSteel website and our estimate, NatSteel is a Dec. ending company)

While NatSteel is expected to benefit from Tisco's backward integration (i.e. iron ore mining), NatSteel's manufacturing plants in select South East Asian markets and China offers an opportunity for Tisco to diversify presence and consequently, reduce the dependence on India.

Further, the fact that China's demand for steel is primarily for long products (about 70% of total), NatSteel's large presence in this product segment is another positive for Tisco. The Indian domestic major would also have the access to the formers advanced technology.

Our view
While the near-term impact is likely to be negative on the consolidated financial results of Tisco (the deal is likely to conclude in January 2005, source: NatSteel), the acquisition offers significant growth opportunity from a long-term perspective, more so considering the ample scope of improvement in the operational efficiencies of NatSteel.

Further, with this acquisition, Tisco gets a presence in the lucrative Chinese market, which currently controls nearly 25% of the worlds steel market and is likely to become a larger player over the next couple of years.

However, the turnaround process of NatSteel could be adversely impacted (to an extent) if the steel cycle were to reverse, which we believe is expected to happen towards the end of FY05.

Even without this acquisition, we have been maintaining a cautious stand on steel stocks given the fact that risks outweigh returns. Overall, we would wait for more clarity.

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