Tata Sponge: Acquisition of Usha Martin could prove value accretive

Trade

• Watchlist
• Portfolio
• Message
• Set Alert

 

 

Choose Stock Exchange: BSE LIVE NSE LIVE

26 Aug, 2025 12:21

Volume

Todays L/H

More

×

Jitendra Kumar GuptaMoneycontrol Research

Tata Sponge, a Tata group company and the subsidiary of Tata Steel, is currently operating at over 110 percent capacity utilisation even though the company has cash and cash equivalent of close to Rs 670 crore, or about 68 percent of its net worth, to set up a new facility.

The company did plan to deploy this cash and last year expressed an intent for a forward integration by way of making steel. But the market did not take it enthusiastically as it came in a little late considering at least 3-4 years are needed to commission such plans, particularly during volatile commodity cycles.

While it partly missed capitalising on the up cycle in the steel industry, the move now to acquire Usha Martin’s value-added long products steel business could prove to be shot in the arm.

Value accretive

Usha Martin has an integrated operation for making 1 million tonne of specialised alloy-based long products supported by captive iron ore, coal and power plants. These assets will be acquired on a slump basis, which will cost around Rs 4,300-4,700 crore. This division of Usha Martin currently generates earnings before interest, tax, depreciation, and amortisation (EBITDA) of about Rs 350 crore. Based on this, the valuations of these assets works out to around 12-13 times EV/EBITDA.

However, a large part of the value lies in turning around its operation to its fullest capacity. For instance, this facility is generating an operating profit of Rs 5,500 per tonne, which is far lower than peers' at Rs 10,000-11,000 a tonne. Post-acquisition, the strategy would be to bridge this gap.

Currently, the division is operating at a capacity utilisation of about 71 percent. Conservatively assuming a capacity utilisation of about 90 percent with a corresponding 50 percent improvement in operating profits to about Rs 8,200 a tonne, it has the potential to generate EBITDA of close to Rs 750 crore. Taking that into account and the acquisition price, valuations works out to 5.7 to 6.2 times which is reasonable. Based on this, the pre-tax return on capital comes to about 16-17 percent.

Near-term dilution risk 

The acquisition has its own cost considering the limitation of resources with Tata Sponge. Cash in the balance sheet (Rs 670 crore) can partly help but there will still be a need for capital. The company plans to take board approval for a rights issue up to Rs 1,800 crore, external borrowings up to Rs 2,500 crore and issue of non-convertible redeemable preference share up to Rs 1,000 crore.

After the acquisition, the balance sheet size of the company will be about Rs 5,000 crore (net of cash). Even at a debt-to-equity ratio of 1:1, the company will require to raise additional equity. A rights issue of Rs 1,500 crore (rest through preference shares), would dilute equity by 55 percent. However, that should not be a cause for worry as the combined entity would have an enterprise value of about Rs 5,200 crore, which is about 5 times their expected EBITDA over the next two years. Moreover, over the next two years, this would ensure growth and improve return ratios of Tata Sponge, which is struggling to deploy its excess cash.

Follow @jitendra1929

For more research articles, visit our Moneycontrol Research Page.