This article has been written by James Sibi, pursuing the Diploma Programme in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.

Introduction

Mergers and acquisitions possess a great potential for integrating resources from different parts of the world and building something even bigger from it. On 2nd April 2007, India saw one of the biggest acquisitions ever. Tata acquired Corpus steel, the two steel giants together possessed a lot of potential for both the Indian and global steel industry. It might have started with brilliant plans and great expectations, instead turned out to be a case study of a failed acquisition. Even though it was an obvious thing to happen, experts are still researching the reason for its failure. “This acquisition of Corus by Tata Steel represents a big step forward in the company’s worldwide strategy and represents an exciting prospect for the two companies,” said Ratan Tata, President of Tata Steel and Corus.

Tata Steel industry

Tata Steel was established in 1907. During the year 2005/2006, the steel giant had revenue of US $5 billion and crude steel production of about 5.3 million tonnes. Being one of the most profitable steel producing companies, tata steel was on its way to expanding globally. In 2005, Tata steel purchased Natsteel Asia in Singapore and acquired majority control of Millennium Steel in Thailand.

The Indian steel industry has a pivotal role in the development of the nation. It could be used as an important parameter to measure the economic development of the country. The production of finished steel in India increased from 1,1 million tonnes in 1951 to 31,63 million tonnes in 2001-02. This can be considered an outstanding example of India’s economic progress where Tat Steel had made a significant contribution. As a result, the consumption level of steel from 1990 to 2002 was continuously increasing. In 2003, there was a dramatic reduction in steel consumption and production. This happened mainly due to the inconsistencies happening in the global market.

The steel industry and the global scenario in the 2000s

The world’s crude steel output increased by 7-8 per cent a year from 2002-2006 owing to rapidly increasing Chinese auto manufacturing, shipbuilding sectors and the major infrastructure growth, including key projects, such as the Beijing Summer Olympics facilities in 2008. After 2004, steel prices went up and the global steel demand continued to rise until the emergence of a global economic crisis. The costs of production depended mainly on manufacturing and access to power and raw materials for production. Steel industry all over the world was witnessing mergers to pool their resources, especially that of raw materials and manufacturing technology.

In the mid-2000s, rapid growth in China’s economy and other developing countries, like that of India’s, also created a growing steel demand. China was unwilling to depend on its domestic supplies so it relied on international markets to satisfy their growing demands for steel. During that time, China, the world’s largest steel manufacturer, was expected to expand its steel capacity, which could lead to lower global costs for steel. At the time when Tata acquired Corus Steel, there weren’t many options for steel companies other than to acquire companies or be the target for acquisition. These mergers and acquisitions were made so that they would create even bigger giants in the steel industry, eventually resulting in instability in pricing and higher profits for the companies that produced steel.

Corus Steel

Corus was the second-largest steel producer in Europe, generating revenues of 9.2 billion pounds in 2005 (18 billion dollars and 18.2 million tonnes’ crude steel production, mainly in the UK and Netherlands). Corus offered innovative solutions in various sectors like automobile, construction, manufacturing technology. Corus had a workforce of 41,100 in more than 40 countries along with sales and service centres all over the world. The brand depicted quality and strength due to its global expertise and regional customer service.

The services offered by Corus were purchased by customers in various industries, like military aerospace, automobile, construction, manufacturing, defence industries, as well as in the rail and shipbuilding industries. In 2005, Corus Steel was the largest producer of steel in the U.K £10,142 million of annual revenue and a workforce of 50 000 employees. The company invested over £6 million per year for the purchase of various products and services such as iron ore, coal, and alloys, to sustain production and distribution operations.

The process of Acquisition

The process of the acquisition began on September 20, 2006, and ended on July 2, 2007. Both companies have experienced many ebbs and flow throughout the process. On April 2, 2007, the Court of Justice in England and Wales declared the finalised transaction between the two companies to be effective and in accordance with the Scheme of Arrangement made by Tata Steel. This transaction was valued at £6.2 billion (US$12 billion). 

Tata Steel, the auction winner for Corus, declared a bid of 608 pence per share, which was higher than the final bid of 603 pence per share from Brazilian steel company Companhia Siderurgica Nacional (CSN). Tata Steel was required to deliver the consideration within two weeks after the date of completion of the proposed transaction according to the regulations in the scheme. Tata Steel and Corus were interested in the M&A deal before the start of the deal for a variety of reasons. According to the official press releases made by both the companies, the combined entity will set up to have a  crude steel production of 27 million tonnes in 2007, with 84,000 employees spread across the globe and a joint presence in more than 40 countries. The merger possessed a huge threat to its competitors. The world’s crude steel output increased by 7-8 per cent a year from 2002-2006 owing to rapidly increasing Chinese auto manufacturing, shipbuilding sectors and the major infrastructure growth, including key projects, such as the Beijing Summer Olympics facilities in 2008.

What went wrong with the deal?

The main reason for the failure of the operations lies in the failure to pass the high cost of raw materials with the customers due to the weak steel demand. During the five years after the deal, Tata Steel has invested in iron ore and coal mines in various countries like Canada, Africa and Australia, to resist the inconsistencies with the input costs in Europe. These steps were taken to insulate the loss and to increase the profit margins over time. To complete the acquisition, Tata steel incorporated an indirect subsidiary called Tata Steel UK.

Corus’ aluminium and chemical business were some of the promising assets which were sold off by Tata Steel. The reverse integration moves by Tata Steel to secure iron ore led to a win back gain. The addition of domestic capacity was a key step to improve the insulation for  Tata Steel against the fluctuations in the cost of raw materials.

When the deal was entered into, there were several advantages in favour of Tata Steel and the international steel industry was highly bullish due to the Chinese consumption. There were many benefits to Tata Steel when the transaction was concluded, and Chinese consumption led the international market to be highly bullish. Things have not worked out as expected and the global market entered into a spiralling recession. There are various internal and external reasons that made the deal a mistake. Let us take a look at some of them.

1. Bad economy

Since the takeover, European Tata Steel operations had been stagnant. Steel manufacture in the UK collapsed in July 2011 with a flat line in the seven months. Steel production in the Netherlands was increasing and recovered much faster from the fluctuations of the market. Further, the demand from the regional user industries such as automobile, consumer durables and capital goods decreased. All these were reflected in the financial performance of the company.

2. The shadow of the Chinese market

Cheaper Chinese steel flooded the European market, causing global market conditions to be distorted and stress was placed on steel producers in the UK. China’s steel industry has witnessed massive growth, supplying about 48% of the world’s steel consumption. Whereas the European Union contributed only 12 %. Growth in the Chinese economy and government investment in the business sector during the high growth phase were the main reasons for the rise in demand for steel. The slowdown reduced this demand sharply and thus China was left with more steel than it required.

3. High energy costs

High energy costs in the UK have adversely impacted energy-intensive businesses like steel mills in comparison to other neighbouring countries. In 2015 these companies had to pay around 9.55 ppm a kilowatt-hour, compared to a low of 6.7 pence an hour per kilowatt-hour in 2010. The environmental policies of the UK along with the green tax substantially increased energy costs for heavy manufacturing sectors since 2010.

4. Lack of control after the acquisition

The success of any merger or acquisition could be ensured only after taking control of the new entity. There must be a plan to take control and sustain the business operations as a going concern. Tata continued its activities in Europe with Philippe Varin, Chief Executive Officer of Corus since 2003. Corus recorded a loss of £458 million in 2002 only a few weeks before his arrival.

After the acquisition of a company, the parent company must analyse the problems and solve them with their employees. They must be present, not only as an advisor but also as an executive authority.

5. Lack of knowledge transfer

Mergers and acquisitions provide scope for enhancing the core skills, improve synergy and meet the needs of customers by exchanging valuable information. A proper transfer of knowledge gives the companies a competitive edge and helps them to sustain the business. In this case, there was a lack of proper knowledge transfer which affected the synergy and incurred losses to the company.

6. Paying too much for the acquisition

Tata’s acquisition of Corus, like many of its earlier purchases, was motivated by a desire to execute bigger deals, although it could not add much value due to the huge cost of acquisition. Tata paid far more than Corus was worth in the transaction. Tata paid 608 pence per share in cash for Corus, which was 34% more than the previous offering of 455 pence per share. The total settlement amount was $12 billion, with $6 billion being a debt.

The reason Tata’s acquisition was overvalued is simply that the transaction was far too lucrative at the time, and Tata’s management went along with the spirit of competition and paid more than they’d like. They overlooked the fact that the connection between both the cost and the performance was proportional. The right price for the purchase is subjective, which means there cannot be a single right price for any transaction. When its competitors were already acquiring companies, Tata would have expected that the acquisition would place them ahead in the game. Tata, on the other hand, lacked the self-discipline to not spend any money more than it could afford. 

7. Failing to create the expected value

In this acquisition, the created value was less than the expected value.  By two years, the profitability of Corus steel started to decline. After a month of its release, the share price started to reduce to 20%. This indicated that the shareholders believed that the acquisition would damage the value rather than increasing them.

8. Cultural issues

Corus steel is a company based in the UK and Tata steel is an Indian company. To get the best results from the acquisition, the cultural dilemma which would impede the integration of the company has to be fixed. These cultural difficulties are deeply embedded in the management of a company but have been complicated due to the cultural differences between the countries.  These issues had to be addressed before any integration.

Conclusion

The Tata Corus acquisition was the largest private-sector transaction conducted by an Indian company outside of India. At one point the merged entity became the fifth most revenue-generating steel company all over the world. This acquisition may have resulted in a variety of benefits. Tata Steel was one of the world’s most lucrative steel businesses, and the acquisition gave space for a lot of research and learning space. English being one of the most common languages in India has aided the process of integration.

Tata Steel had done many successful cross border acquisitions in the past. Unfortunately, the merger did not turn out to be successful and incurred losses. The storey of Tata’s acquisition of Corus ended on a sad note.  It is important to analyse the reasons and understand where it went wrong. Being a better provider of capital investment, offering excellent management supervision and transferring valuable knowledge are the most important conclusions that could be drawn from the mistakes. The various concerns raised need to be taken care of while companies go for acquiring companies across borders much bigger than them.

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