Abstract
The securities market is expected to perform two major functions. One, the mobilization of public savings and allotting them to the entrepreneurs seeking them in the market at an efficient price; and second, ensuring that the allocated resources remain with those who can use them most efficiently, through reallocation. Such reallocation happens, first through the shareholders, and later through the creditors. The market for corporate control operates through the stock market in the form of takeovers and mergers initiated by the shareholders. The creditors initiate the reallocation process by admitting the defaulting companies to insolvency. If such reallocation succeeds, the corporate debtor creates value for itself and other stakeholders. The acquisition of Bhushan Steel (BSL) by Tata Steel (TSL) was one such successful case where the process of reallocation of BSL’s resources to TSL was carried out under the framework of the Insolvency and Bankruptcy Code (IBC), creating value for all stakeholders.
PLAYERS: CORPORATE DEBTOR AND RESOLUTION APPLICANT
TSL was established in Jamshedpur, India, in 1907 as one of the founder companies of the Tata Group. It is the 10th largest steel manufacturer and one of the lowest-cost producers of steel in the world. Besides, it has exhibited exemplary corporate citizenship and business ethics. It operates as a vertically integrated facility across the steel supply chain. Its facilities are spread domestically as well as globally. It has been growing aggressively inorganically to add capacities.
BSL was India’s third largest secondary steel-producing company, with a capacity of 5.6 million tonnes per annum (MTPA), established by Mr Brij Bhushan Singhal in 1983. It has three manufacturing facilities at Sahibabad in Uttar Pradesh, Khapoli in Maharashtra (downstream facilities) and Anjul in Odisha (integrated steel plant). It has offices, warehouses, service centres and sales depots across India. BSL owns approximately 50 acres of land near Sahibabad land along with railways that served as a major distribution hub and had a rented yard at Paradip Port for facilitating global trade. BSL was known for its technology prowess, the quality of its assets, and having premium customers in the auto and appliances sector.
REASONS FOR FINANCIAL STRESS
BSL was performing reasonably well financially and had exhibited its technology prowess before 2014. The case highlights the strategic advantages of BSL in terms of technologies, locations, customers, products etc. Predominantly funding its expansion by debt ultimately led BSL to default and subsequent insolvency. Due to certain unfavourable factors and circumstances, such as delay in the commissioning of several projects, non-allocation of capital iron ore mines and deallocation of coal blocks for which investments have already been made, the debt of BSL kept on increasing without generating matching revenues and profits, and it came under severe financial stress. By the end of FY 2018, BSL was reeling under the pressure of a debt of ₹628.14 billion, negative equity and a loss of ₹248.13 billion.
INITIATING INSOLVENCY PROCESS
State Bank of India led the BSL to insolvency with an aggregate debt of about ₹440 billion. The Corporate Insolvency Resolution Process (CIRP) was initiated on 26th July 2017. A resolution professional was appointed. A committee of creditors was constituted. Bids were invited. Finally, the TSL bid was selected. On 15th May 2018, the National Company Law Tribunal (NCLT) approved the TSL resolution plan. TSL had offered ₹351.00 billion up-front cash and 12.2% equity to lenders. This was expected to be funded by a bridge loan of ₹165.00 billion, and TSL would provide the balance by subscribing to preference shares of corporate debtors.
RESOLUTION PLAN
As per the resolution plan, Bamnipal Steel Ltd (BNL), a wholly owned subsidiary of TSL, acquired a majority stake of 72.65% stake BSL for approximately ₹1.59 billion. The remaining stake, 27.35%, was held by existing shareholders and financial creditors of BSL. BSL was rechristened as TSL BSL on 27th November 2018. Table 1 provides a snapshot of claims admitted versus claims resolved. Table 2 provides details about pre- and post-capital reorganization.
Claims Admitted vs Resolution.
Reconciliation of Share Capital: Pre- and Post-resolution.
It may be observed that the stake of erstwhile promoters (Bhushans) of BSL was written off to about one-third. This reduced their stake in BSL from approximately 44% to merely about 3% post-reorganization capital reorganization under the resolution plan.
STRATEGIC FIT: BSL FOR TSL
For TSL, the acquisition of BSL was part of a larger corporate growth plan that envisioned building capacities to 40 MTPA by 2030 (Figure 1). BSL posed an attractive opportunity to add 5.6 MTPA on an immediate basis. Once NCLT approved the resolution plan of TSL, it immediately paid approximately ₹352 billion without delay.
Before discussing specific strategic aspects, it is relevant to look at macro variables influencing the Indian steel industry and its potential in FY 2018. While there was a significant demand in H1, FY 2018, there was a dip due to global sentiments. India became the second largest steel producer, surpassing Japan, and was next to China, which controlled more than 50% of global production of 1,808.6 MTPA. The government of India was also on a spree of capex investments in various sectors that were likely to maintain the demand for steel to grow at a robust 7%, while global growth was subdued at 1.3%.
TSL, on the acquisition of BSL, expected the following strategic outcomes:
Deepening and widening of existing product portfolio Complementary products in its product portfolio Consolidate presence in the high-margin downstream product market in western India. Access to strategic assets like huge land plots strategically located near the Sahibabad plant and rented yard in Paradip Port for global trade, and the high-valued customers.
Table 3 provides expected areas of synergies on absorption of BSL into TSL. This was duly reflected in BSL continuous increase in its market value post resolution.
Strategic Alignment Between BSL and TSL.
A perusal of the market capitalization of BSL shows that it has risen from ₹9.08 billion in April 2018 to ₹37.18 billion in April 2019, an increment of ₹28.10 billion, which was more than 2× of expected synergy from this transaction. Compared with market capitalization by November 2021, there was an increment of ₹87.01 billion. It is almost 7× of the expected synergy. Can we say, this was indicative of value creation due to turnaround out of BSL? This would require further discussion.
VALUATION
Valuation exercises in these kinds of transactions are not routine though they uphold fundamental approaches such as cost, income and market. These cases are primarily distressed, undergoing a resolution process under insolvency law. The aim here is to balance varied interests such as financial creditors, operational creditors, new management, government, etc.
TSL, the new management in this case, had to bid for BSL, considering the outstanding debt of BSL, the quality of assets, the potential of BSL to generate surplus after its resolution, and the possibility of its successful integration with itself. While bidding for BSL, TSL had to consider conflicting objectives. Its bid should be the highest one at the same time it should not over pay, and above all, it should not lose BSL to others. The offer had to be such that the committee of creditors could not refuse.
It would not be suitable to benchmark the pricing of BSL with that of the bidder companies or the established players in the steel industry such as TSL, JSW, JSPL, etc. The earnings before interest, taxes, depreciation and amortization (EBITDA) multiple 1 (EV/EBDITA) of these companies ranged between 6× and 8×. They would not be suitable for estimating the value of distressed companies.
The case provides the view of three research analysts from different perspectives. Exhibit 6 of the case also provides the relationship between the total debt of the insolvent companies and the bids offered by the bidders and how much they were discounted to the total debt. 2 It averaged ∼57% with ∼76% maximum and ∼14% minimum discount. TSL’s adjusted bid was ∼58% of BSL’s debt. This had converged to an average discount.
Since this transaction involves the resolution of a stressed asset, it is recommended similar kinds of transactions are reviewed. Table 4 provides the estimates of enterprise value (EV) per tonne paid in similar transactions. TSL appeared to have paid premium as it was convinced of strategic value of BSL, and perhaps it did not want to lose this opportunity.
Resolution under IBC of Select Corporate Debtors in the Steel Industry.
It is observed that TSL has paid a relatively higher rate per MT compared to other deals. This is perhaps due to the quality of assets, facilities at strategic locations, high complementarity and alignment with TSL’s strategic vision. Also, BSL had reasonably positive EBITDA. Its EV/EBITDA multiple was 15.
One of the dimensions discussed in the asset approach to valuation is replacement cost, especially in transactions involving distressed company. It is estimated that it takes five years and investment in range of Rs. 50-Rs. 60 billion per MTPA to create similar facilities. In this case, TSL paid nearly ₹63.00 billion MTPA.
To gain deeper insights into the value driver in these kinds of transactions, sensitivity and scenario analysis is recommended to estimate the range of value for the deal.
INTEGRATION OF BSL INTO TSL
The integration is vital for the success of the merger/acquisition. The value creation envisaged earlier is created in this phase. It is relevant to quote the Tata ethos proclaimed by Tata Group founder J. N. Tata in 1895 and still practised by the Tata Group here, ‘In a free enterprise, the community is not just another stakeholder in the business but in fact the very purpose of its existence’.
The integration of businesses poses challenges, particularly when two different cultures are involved. It may be relatively easy to combine non-humane operations. However, combining the culture, values and ethos responsible for the combined operations requires sharper focus, clarity and high level of commitment. Again, these challenges are more complex in the case of merger transactions, particularly in horizontal merger transactions. This deal was a horizontal transaction with marginal branching out of geographic, product and technology extensions.
Significant Challenges Envisaged in Integration
Integration of businesses in horizontal combination poses relatively more complex challenges than that of other kinds of combinations. The challenges envisaged in this case are summarised below:
Organization structure: BSL operated on a centralized organization structure while TSL operated on the principle of delegation of power. Cost control: BSL and TSL were hard on cost control. However, as a principle, TSL, in its strive to control cost, does not compromise on employee welfare and development. Factory maintenance and approach to safety: BSL had a high tolerance for poor maintenance and imbalanced facilities. There were frequent accidents; still, BSL management was relatively less focused on safety standards than TSL. Developing a new organogram with clear roles and responsibilities, compliance culture, instilling Tata ethos and values and developing KPIs to induce desired behaviour, etc., are key challenges to integration. Another serious challenge could be introducing a new governance system, including the constitution of the board and responsibilities of members of the board, and institutionalizing the systems and processes for effective financial control and reporting, etc. Above all, a change of mindset towards the adoption of TSL practices should be the immediate priority for the TBSL–TSL integration in charge. Customer familiarization, which is otherwise a critical challenge, was not a major challenge in this case, as they were already a part of the TSL ecosystem. The most critical challenge referred to in the case, was: ‘Tata’s culture is built around value systems that are non-negotiable. Our concern was how we institutionalize these values into BSL.’
Recommendations to Manage the Challenges 3
Identify the area of assimilation (changes required to be adopted by the BSL), co-existence (changes required to be adopted by the BSL are low) and transformation (changes required to be adopted by the BSL and TSL to create more efficient systems and processes).
Merger integration requires complete commitment from top management. TSL’s top management needs to actively participate in the integration process.
Informal communication channels are most active during this phase. The TSL management needs to diffuse them and push one standardized and honest communication in Tata Steel Bhushan Steel Limited (TSBSL). Preparing a standard communication kit with common issues and questions and their responses is also recommended.
For efficient integration, TSL should appoint a resolution professional to create accountability for the successful integration of TSBSL.
The senior management team of TSBSL should be deputed to TSL to familiarize with systems and processes.
TSL should clearly communicate the revisions in the organizational structure of TSBSL and layout assessment criteria for retention or shift in role or retirement of position. This has to be based on objective assessment rather than subject to personal biases. Such assessment may be done by administering leadership tests, interviews and track records of the employee.
TSL should plan small but frequent workshops to integrate Tata ethos across the levels of management of TSBSL.
The TSL integration team would plan short-term, less prohibitive milestones to check progress and rework regularly.
TSL should also monitor the integration process closely and perform a periodical integration audit to ensure that it is on track.
Structure of the Deal Facilitating the Integration of Two Companies
The acquisition structure was envisaged as
Creating a special-purpose vehicle (SPV, in this case, a wholly owned subsidiary of TSL, BNL).
This would facilitate the implementation of the resolution plan in BSL.
Strategic control of BSL was acquired by BNL (72.65% stake), and BSL remained an independent entity, and its assets and liabilities would not directly integrate with TSL.
BSL was rechristened as TSBSL, and gradually, the operations were integrated—in terms of systems, processes and inculcating values and ethics. This will continue till TSBL is finally ready for complete integration.
TSBSL would finally merge into and become an integral part of TSL.
IMPACT OF IMPLEMENTATION OF RESOLUTION PLAN
Financial Impact
Table 5 compares various performance parameters before resolution (FY 2018) and post-initiation of the resolution process (FY 2019). This could be an initial testimony of how the resolution plan was implemented and what their initial signals were. Financials in FY 2019 were quite encouraging. Leverage was balanced, profitability, working capital management and cashflow generation from operations were improved. This implied that expected synergies from the strategic fit between the companies had started to be realized.
Impact of Implementation of Resolution Plan on BSL Financials (₹ in Billion).
Market Value Impact
Improvement in performance, generation of synergic benefits and higher level of efficiency in utilsation of BSL’s resources in the fold of TSL were reflected in its increasing market capitalization over time. Higher TSBSL value under the TSL fold signalled the success of the reallocation of resources from BSL to TSBSL. Table 6 provides changes in market value of the BSL and various categories of its shareholders. Market value of BSL had grown at 46% CAGR, and the new management’s stake at more than 200% CAGR, during 2018 to 2021.
Market Capitalization of TSBSL during Pre- and Post-resolution Plan Implementation.
(2) Include financial creditors who settled for shares against their claims and the invocation of pledged shares.
(3) Prices are weighted average prices extracted from the website of the Bombay Stock Exchange.
VALUE CREATION AND DISTRIBUTION
IBC 2016 requires CIRP to balance the interests of various stakeholders’ interest. It is the most delicate part of CIRP given the conflicting interests of multiple parties in the resolution process. Various stakeholders are expected to sacrifice their claims, to rescue the corporate debtor from liquidation. The stakeholders include financial creditors, operational creditors, employees, government authorities, outgoing promoters, the shareholders of corporate debtor, etc. The financial creditors will try to minimize the haircut. On the other hand, the resolution applicants (the bidders) would like to maximize the haircut or discount to the admitted claims to increase the chances of the turnaround of the corporate debtor. It has been observed that in a successful turnaround of a corporate debtor, the benefits of the turnaround are highly skewed in favour of the new management vis-a-vis the rest. The stakeholders who have sacrificed their claims hardly receive any benefits from the turnaround of the corporate debtor. Going forward, this could raise concerns with policymakers about the efficiency of the insolvency framework in balancing the interests of stakeholders.
Footnotes
DECLARATION OF CONFLICTING INTERESTS
The author declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.
FUNDING
The author received no financial support for the research, authorship and/or publication of this article.