JSW Steel-JSW Ispat merger to create largest Indian steelmaker, but what about value, ask analysts
JSW Steel

JSW Steel scrip dropped 3.65 per cent on Monday after it announced a self-merger with its associate firm JSW Ispat in a deal that would catapult it to become the largest steelmaker by production capacity in India. In the process, it would overtake Tata Steel and govt-controlled SAIL. Although Tata Steel is the largest steelmaker by global production capacity and revenues, much of its business is outside India as a part of the UK-based Corus which it acquired in a multi-billion-dollar deal more than five years ago.

The investors’ reaction to the announcement (made during the weekend when markets were shut) only goes to emphasise the concerns that analysts have regarding the value the deal would bring to JSW Steel. JSW Ispat (formerly Ispat Industries) is a debt-laden firm, which had huge accumulated losses.

As delineated by VCCircle earlier (read more on that here), Sajjan Jindal-led JSW Steel managed to get control of Ispat Industries, making it the largest steel group in terms of capacity in India in December 2010, without loading up its balance sheet with debt as it did not buy a majority stake. The smart financial engineering, however, had to eventually give way to a merger to create synergies of operations.

Analysts on the street have come down heavily on JSW Steel by revising their price targets or maintaining an underperform rating on the stock because they reckon that the merger is earnings per share and value dilutive, at least in the short-to-medium term.

As per the deal, the swap ratio has been set at 1:72, which means one share of JSW Steel for every 72 shares held by shareholders of JSW Ispat. JSW Steel itself owns 46 per cent in JSW Ispat, which will be extinguished, and therefore, there would not be any treasury stock as a result of the merger.

JSW Steel will issue 1.86 crore new equity shares, thereby increasing its outstanding shares to 24.17 crore and its equity capital to Rs 241.72 crore. This move will dilute the promoters’ stake to 35.12 per cent from the present 38.05 per cent. JFE, the Japanese steelmaker that had earlier invested in the company, will see its holding come down to 14.92 per cent. The Mittal family, who own around 20 per cent stake in JSW Ispat, will get to own around 2.8 per cent of the merged entity.

Although the consolidation was imminent, JSW Steel had earlier said that the merger would take place only after JSW Ispat became profitable. But with recurrent pressure from the lenders to JSW Ispat, the Jindals were left with only two choices – either to undertake a rights issue or merge the companies – and they chose the latter.

With this merger, JSW Steel now has a combined debt of Rs 25,000 crore with a debt-to-equity ratio of 1.15x. According to a CLSA’s report, “JSW Steel’s acquisition cost for Ispat at 16x FY14 EV/EBITDA is extremely expensive and the company’s risk profile will worsen with deterioration in cost structure and balance sheet.”

The merger, however, does brings tax benefits to the steel major. As JSW Ispat is a loss-making firm, it brings a tax credit of Rs 2,090 crore.

With this merger, JSW Steel will have a combined capacity of 14.3 million tonnes, making it the largest Indian steelmaker by domestic capacity. It is undertaking expansion in the Dolvi unit of JSW Ispat where it is increasing the capacity to 7-8 million tonnes per annum, from the present 3.3 mtpa. JSW Steel is also mulling to increase its Vijaynagar facilities’ capacity to 16 million tonnes from the present 11 million. However, it is going to slow down its production in West Bengal and other plants.

In 2010, JSW Steel had acquired Ispat steel for $476 million in a quick acquisition.

KPMG India and Price Waterhouse & Co were the independent valuers for JSW Steel and JSW Ispat, respectively. Enam Securities and Citigroup Global Markets India provided the fairness opinion to JSW Steel and JSW Ispat. Amarchand & Mangaldas & Suresh A Shroff Co was the legal advisor.

(Edited by Sanghamitra Mandal)

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