FCC

IBC, infra push put steel sector in an M&A sweat spot

2018-10-31

With the capacity of sizable scale available at bargain prices, the sector will see a lot of Mergers and Acquisition (M&A) activities as bigger players with deep pockets eventually closing in on financially weak but potentially viable smaller firms. The deal making in the domestic steel sector is poised to grow at a faster clip, going forward with cash-rich players lining up to lap up stressed assets at bargain prices with lenders' consent. The sector is also likely to shrug off the deceleration blues triggered by the global glut and overcapacity that have capped the pricing power of firms. More, key policy initiatives such as the new resolution law christened, Insolvency and Bankruptcy Code (IBC) and the government's big ticket infrastructure investment push will play out as game changers for the steel sector in the coming days. All these along with the Resolution Professionals (RPs) fast-tracking bankruptcy procedures with the approval of creditors will see the steel landscape changing at a pace faster than expected. For starters, the IBC has set off a keenly contested race for stressed steel assets worth more than USD 26 billion among dominant players. It has spurred interest from global metals giants such as Arcelor Mittal and Vedanta Resources Plc as well as home-grown corporations like Tata Steel. Players with strong financial footing have been using this opportunity to fortify their position in the vertical. The deal landscape is getting wider as new players and fund houses have joined the race for bargain hunting. Once these themes play out in full, the steel landscape in the country will see a sea change. Bidders are being lured by an uptick in demand and prices powered by Prime Minister Narendra Modi's bulge bracket investment programme to update India's infrastructure. This is expected to perk up demand for steel at an average rate of 6.5 per cent driven by traction in key user industries such as construction, capital goods and consumer durables. The government's core sector push through big ticket initiatives such as Housing for All, setting up of 100 smart cities and the launch of National Infrastructure Investment Fund is expected to turn the tide in favour of the construction sector which has been in the doldrums. Also, a benign inflationary environment along with comparatively moderate interest rates is expected to spur demand for capital goods, consumer durables and automobiles, especially for tractors and two-wheelers. These factors will go a long way in perking up the demand for the steel sector. With the capacity of sizable scale available at bargain prices, the sector will see a lot of Mergers and Acquisition (M&A) activities as bigger players with deep pockets eventually closing in on financially weak but potentially viable smaller firms, which were not been run very efficiently in the past. Steel companies with about 22 MT of capacity have been referred to the National Company Law Tribunal (NCLT) in the first round of the stressed assets resolution process. Resolution of these cases would alter India's steel sector landscape in three ways: 1) Over half of the steel sector's outstanding debt would stand resolved. 2) About a fifth of India's crude steel capacity held by these companies will move to stronger hands, resulting in better working capital and liquidity management and cash flow, which in turn, would lead to improving capacity utilisation levels. 3) The flat steel segment would consolidate further and be controlled by fewer players, both domestic and foreign origin. A beginning has been made by Tata Steel with the successful acquisition of twin assets of stressed Bhushan Steel. If completed by March 2019, the buyout will help Tata Steel zips past SAIL and JSW to become India's biggest steelmaker. The shift in focus has come at a time when India is shelling out trillions of rupees to build up infrastructure, lighting up the prospects of steel-makers. Banks had sweetened the deal for Tata's by agreeing to take a haircut to the tune of 50 per cent on the outstanding debt of Bhushan Steel. The successful resolution of Bhushan Steel's assets is a positive structural development for the banking sector as well. Earlier, Vedanta got the nod from NCLT for the acquisition of ailing Electrosteel Steels. I believe for acquirers of these assets, apart from attractive product portfolios and locational advantages, these assets also offer easy scalability. The 22 MT of capacities under resolution have brownfield expansion potential of another 20 MT-21 MT. This is a critical factor that puts stressed steel assets in an M&A sweet spot, since setting up greenfield plants to augment capacity is not only far more expensive but also time consuming. Looking at various acquisition scenarios, the flat steel market in India was expected to consolidate further from the current scenario, of 85 per cent being controlled by six players to three or four players. Already, India's biggest steelmakers such as JSW Steel, posted a record net income and outlined a USD 6 billion plan for a capacity update. Tata Steel, which aims to double domestic capacity, bounced back to black, helped by a one-time gain. Both are ramping up capacity to meet an anticipated surge in domestic consumption, with the government set to spend trillions of dollars on expanding infrastructure. Authored by Mahesh Singhi, Founder and Managing Director, Singhi Advisors