Has Tata Steel overpaid for Usha Martin unit?

Tata Steel signed a definitive agreement on September 22 to buy Usha Martin’s steel unit for about Rs 4,600 crore.

When the market opened on the following Monday, Usha Martin’s shares rallied 15 percent even as the Sensex tanked 500 points. Tata Steel's shares ended a percent down.

Was Tata Steel overpaying for the unit?

The deal value may seem high if one considers that just two of the five bidders ended up bidding for the unit, which includes a steel plant with an annual capacity of a million tons. The five bidders were Tata Steel, JSW Steel, Vedanta, Kalyani Steels and Liberty House.

Of these, only Tata Steel and Liberty House put in a bid.

“We did give an expression of interest, but didn’t bid,” said a senior executive from one of the companies that didn’t submit an offer.

“The plant was shut, is operational now but would still need a significant amount of investment,” said an executive from another company. “Tata Steel offered much higher because it doesn’t want competition to enter its backyard,” the executive added.

According to sources, the second bid was around Rs 3,500 crore.

Apart from the Jamshedpur-located steel plant, the unit also comes with a captive power plant, and iron ore and coal mines. The city is synonymous with Tata Steel's plant, which is over a century old.

Usha Martin's steel business managed to turn around in the first quarter of the current financial year, generating a profit of Rs 112 crore, against losses of Rs 30 crore a year earlier. Much of the turnaround though would be thanks to the present upswing in the domestic steel market.

“Indian steel environment currently is strongest over the last few years,” said a note from JP Morgan.

Small dent

The sector’s optimistic outlook is one reason Tata Steel wouldn’t mind the Rs 4,600-crore bill.

Also, the acquisition is a small one for the company, especially going by the previous Rs 32,000-crore deal to acquire Bhushan Steel. And it adds just 6 percent to its debt.

As a report pointed out, Tata Steel’s first quarter earnings before interest, tax, depreciation and amortisation (EBITDA) of Rs 5,072 crore is enough to service the debt from the Usha Martin deal.

The valuation of the acquisition too, added the JP Morgan report, is “attractive.”

And even though Usha Martin’s pellet plant is running at a capacity utilization of just 38 percent, Tata Steel will ramp up the production. “Pellet prices have already risen ~70-75 percent over the past two months to INR9,000-9,500/t, a seven-year high level,” observe Amit Dixit and Meera Midha of Edelweiss Securities in their note.

Integrating the Usha Martin unit will come easier for Tata Steel than for any other steel player. One it’s a familiar asset. Tata Motors was one of the clients the unit supplied its steel products to.

And the Usha Martin unit is just a few kilometers away from Tata Steel’s facility, making logistics the least of the challenges.

But the most important piece in the turnaround strategy for Tata Steel will be the steel prices, and the company needs rates to hold for at least a year or two to make the most out of the Usha Martin deal.