The latest deal in the domestic steel industry where Sajjan Jindal-led JSW Steel is snapping a near majority stake in financially sick steelmaker Ispat Industries has elements of consolidation as well as smart financial hedging on the part of Jindals.

Among the key outcomes of the deal would be JSW Steel becoming the biggest steel firm in the country overtaking even state-owned SAIL marginally in terms of production capacity and also extending its lead against Tata Steel as largest private steel maker in India. Last financial year, JSW Steel had overtaken Tata Steel as the second largest domestic steel firm in terms of production capacity.

Acquisition of Ispat will bring an estimated 3.3 million tonnes capacity of steel and coupled with ongoing organic expansion programme JSW will have total capacity of 14.3 million tonnes by March’11, bringing  it close to being reckoned as one of the significant global steel producers. Tata Steel along with its UK arm Corus is however much bigger in size in terms of global operations. JSW had earlier disclosed plans to reach a capacity of 34 million tonnes by 2020.

Dissecting the deal structure throws up some interesting aspects. For starters, JSW will subscribe to fresh shares that will give it 41.29% stake (post equity dilution and taking into account conversion of some debt into equity by lenders of Ispat).

JSW is banking on turning around operations of the debt laden firm that allowed Ispat to make profits in recent times only when steel prices hit a high at the peak of the economic growth before the sub prime crises hit the globe. With better financial management and refinancing the entire existing loan Jindals plan to see through a restructuring of Ispat.

The existing promoters own around 39% stake (around 95% of which is pledged), which will come down to around 26% post entry of JSW. Vinod Mittal will become executive vice chairman after this deal and will be redesignated as non executive vice chairman after a transition period last eighteen months.

JSW plans to reduce operating cost by integrating key inputs of coke, pellet and power and bringing down financial stress with the infusion of equity. JSW also intends to drive synergies for faster turnaround of Ispat that will be renamed as JSW Ispat Steel Ltd.

In particular JSW plans to facilitate sourcing of key inputs for Ispat to reduce cost and also leverage its own pan India network to better penetrate the market. It also hopes to reduce cost by rationalising sourcing of iron ore lumps and fines.

Its medium term initiatives include building a captive coke oven, pellet and power plant at Ispat for completing integration of steel making process within the next 36-48 months. JSW also plans to debottleneck existing operations to expand capacity from 3.3 million tonnes to 4.2 million tonnes per annum at Ispat.

The key consideration in all deals is financing structure and debt to be taken as a result of the transaction. This becomes even more so for a heavy debt laden company like Ispat. Some analysts have started raising concerns on the amount of debt that will pile up on JSW’s books due to this acquisition. It will certainly add some debt(after having reduced it to a comfortable level recently through equity infusion by Japan’s JFE) but a real possibility is of JSW betting on ‘not’ getting a majority stake in Ispat, atleast immediately.

JSW will get a less than half of the company’s equity through fresh issue that will not necessitate it to consolidate the numbers of Ispat with itself. Indeed, JSW will be making a mandatory open offer to shareholders to buy another 20%. But the pricing of the offer is expected to be less than the current market price or expected market price in the next few weeks when investors take the stock up in the hope of better management turning the fortunes of the firm.

This could make the open offer irrelevant and will restrict JSW’s holding below the threshold at which it would need to consolidate the financial statements. As per this interpretation of the transaction, JSW will not take the large amount of debt with Ispat on its own book at the consolidated level but will possibly just need to borrow the money to finance the cost of subscribing to the preferential issue. That may not be too costly affair.

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