The IBC (Insolvency and Bankruptcy Code) provisions allow a financial or operational creditor to file an insolvency petition with NCLT (National Company Law Tribunal) in the event of a default by the company.

 

Post the RBI guidelines on the dirty dozen (refer to why did Bhushan Steel go into IBC) SBI, which had dues of around INR 4300 crores from Bhushan Steel, had filed an insolvency petition with the NCLT. On admission of the petition, bids were invited for the companies by the RP (resolution professional). The bidders for Bhushan Steel were JSW (Jindal Steel) and Tata Steel. Tata Steel’s bid amount was 40 percent higher than that of JSW at INR 35360 crores versus JSW’s INR 20000 crores. With value maximisation being the main focus for the lenders, Tata Steel emerged as the winning bidder for JSW (Jindal Steel).  Post approval of the resolution plan by the CoC (Committee of Creditors), Bhushan Steel board had also approved the takeover of the company.

 

Jindal Steel, Tata Steel and Liberty House were the bidders for Bhushan Steel. Jindal Steel and Tata Steel are leading integrated steel manufacturers in India. Jindal Steel is India’s second largest steel producer with manufacturing plants in Southern and Western India having a total capacity of 18 MTPA.

 

Tata Steel is India’s third largest steel producer with manufacturing plants in Eastern India having a total capacity of 13 MTPA. Liberty House is a global industrial and metals company based out of UK. 

 

Liberty House was disqualified from bidding as it had submitted its bid five days after the deadline had elapsed. For Jindal Steel and Tata Steel, the value proposition for Bhushan Steel lay in the prospect of garnering huge capacity at lower than replacement cost. Moreover for Jindal Steel, an added benefit was the potential for diversification of its manufacturing capacities. Bhushan Steel’s massive new plant in the eastern state of Odisha would enable diversification of Jindal Steel’s existing plants which are located in the western and northern states of India. 

 

What makes Bhushan Steel attractive to bidders are its high realisation per tonne and low current capacity utilisation. The company has one of the highest realisations per tonne among Indian steel makers on account of high margin products such as automotive and white goods steel constituting a significant portion of its product mix.

 

 

• Production- Sourced from IBEF report on Steel Industry. Sales is estimated at 90 percent of total production

 

Given that steel prices were on an upward trend in FY-17, we estimate that Bhushan Steel’s realisation per tonne (INR) would have increased by around 5 percent in FY-17, taking its realisation per tonne to around INR 45,200.  This compares favourably to Tata Steel’s realisation per tonne of INR 45,900 in FY-17.

 

 

Sales (MTPA)-As per press release of Tata Steel on 16-Apr-2018

 

Sales Value (INR Crores) - Standalone sales of Tata Steel as per Tata Steel’s 2016-17 Annual Report

 

Bhushan Steel’s capacity utilisation is also very low when compared with that of Tata Steel and the Indian steel industry. Given the paucity of data on Bhushan Steel, we have estimated its capacity utilisation based on the available data.

 

 

Based on the estimated realisation per tonne (INR) in FY-17 and the gross revenue of the company in FY17, the capacity realisation of the company in FY-17 was only around 62 percent. 

 

 

The question that needs to be asked here is: Why is the capacity utilisation of Bhushan Steel so low when compared to the industry average? Could it be that the company doesn’t have adequate raw materials to significantly increase its production and thereby capacity utilisation? Iron ore mining was banned by the Supreme Court in Karnataka in 2011 and Goa in 2012. Post ban, India’s iron ore production slumped from 168 million tonnes to 18 million tonnes in 2012-13. Though the ban was lifted in 2013 and 2014, production caps were imposed in lieu of the same. Iron ore which is a key raw material for steel production is still in short supply in India.

 

The same is evidenced by the huge 22 percent increase in ore prices by the government owned miner NDM in January 2018.

 

Though Bhushan steel is an integrated steel producer, its captive mining capacity may not be commensurate with its steel production capacity. Tata Steel on the other hand, has substantial captive iron ore mines and hence shouldn’t face raw material constraints in increasing the capacity utilisation of Bhushan Steel.

 

Mismanagement, rather than raw material shortage looks to be the key reason for Bhushan Steel’s low production as compared to total capacity.

 

While Bhushan steel may have had issues with managing their finances, all of their plants and subsequent expansions have been designed and built to international standards.

 

Although exact information is not available as to why Bhushan Steel is a good buy for Tata Steel, research indicates that Tata Steel believes it would be able to ramp up the production at Bhushan Steel.

 

Bhushan Steel has been making net losses since FY-2015. Hence we have used the method of comparables to value Bhushan Steel. The multiple that we have used is EV/EBDITA.

 

 

Tata Steel and JSPL are not strictly comparable. A significant portion of EBITDA for Tata Steel is from its European subsidiary (Corus), while for JSPL, its power division contributes a huge portion of its EBITDA. On comparison with JSW and SAIL, Bhushan Steel is overvalued. The presumption of Tata Steel would be that the low EBITDA is temporary and there is significant scope for increase in EBITDA and net margins. Moreover Tata Group’s valuation might have more to do with Bhushan Steel’s huge capacity rather than its current earnings.

 

In order to truly understand whether Bhushan Steel is a good buy at the current bid value, we have also undertaken a replacement cost valuation analysis of Bhushan Steel. The current capacity of Bhushan Steel is 5.6 MTPA.

 

Steel is expanding its capacity in Kalinganagar in Odisha by 5 MTPA at an investment of INR 23,500 crore. The expansion cost/MTPA works out to INR 4,700 crore for Tata Steel. At 5.6 MTPA (Bhushan Steel capacity), the replacement cost for Bhushan Steel would be around INR 26000 crore for Tata Steel. The acquisition cost of INR 35,200 crores would be a nearly 34% premium to the replacement cost and hence steep on that basis. However this metric ignores the present value of cash flows of a brownfield versus Greenfield expansion of capacity.

 

Given the myriad amount of clearances and approvals involved, a green field expansion of capacity could easily take a minimum of 4-5 years. According to Tata Steel estimates, the present value of cash flows for 4-5 years from Bhushan Steel is about INR 13,000 crores. Taking into the present value of cash flows, Bhushan Steel acquisition seems reasonable on a replacement cost basis.

 

 

Before the IBC came into the picture, the banks could sell their bad/non-performing assets to Asset Reconstruction Companies (ARC), in an effort to clean up their balance sheet. The price was negotiated between the bank’s and ARC’s and generally at Arm’s Length Principle. ARC’s were governed by the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) act which permitted them to issue bonds or debentures in exchange for the NPA’s. The maximum maturity of these securities were set at six years and the minimum rate was set at 1.5 percent above the RBI’s base rate. The year 2013-14 saw a big boom in the reconstruction business.

 

ARC’s aggressively bought NPA’s from banks. However, as RBI changed certain norms for the securitisation business, the asset reconstruction business saw a decline from mid-2014. Another significant event was the removal of special asset status benefit to restructured assets from 1st April 2015 in order to match international norms. This made the asset reconstruction business less profitable.

 

India currently has 19 ARC’s. However even put together, their capital base is insufficient to tackle the INR 800,000 crore NPA’S. ARCs generally buy the debt at a significant discount and then profit when there is a revival in the company in which it is acquired. Furthermore ARCs generally negotiate deals on a one to one basis with banks and other holders of the distressed debt.

 

Another point to be noted is that ARCs do not pay the entire cash upfront for the acquired debt. Until 2014, ARCs used to operate on the 5:95 model, wherein only 5 percent of the acquisition cost of the debt were paid upfront. The remaining 95 percent of the acquisition cost of the debt were paid through security receipts which were redeemed over a period of 5-8 years. Though the upfront cash payment has increased post the new RBI norms, it still amounts to only 15 percent of the total acquisition cost of the debt.

 

The provisions of the IBC code are quite different from the operating model of the ARCs. The resolution plan by the bidder would need to be approved by 75 percent or more of the committee of creditors. ARC’s prefer to negotiate with creditors on an individual basis rather than as a group. IBC code also requires upfront payment of the entire acquisition cost as opposed to the 15:85 model being followed by ARCs.

 

Tata Steel has acquired Bhushan Steel through payment of INR 35200 crores to the creditor banks. The INR 35200 crores amounts to two-thirds of the total debt exposure of Bhushan Steel, leading to a haircut of 35 percent for the banks.

 

In early April 2018, RBI had reduced the required provision for secured portions of the large NPA accounts referred to the NCLT from 50 percent to 40 percent. However the revised norms have no effect on Bhushan Steel, since its resolution was already in progress under the IBC. The provisioning requirement for the unsecured portion of the large NPA accounts referred to the NCLT was maintained at 100 percent. Based on the available information in Bhushan Steel’s Annual Reports (2016-17), the secured debt works out to around 70 percent of the company’s total debt exposure of INR 56,000 crores. Based on the prior provisioning norms (50 percent- Secured; 100 percent- Unsecured), the total provisioning by banks for Bhushan Steel, would be around INR 35,000 crores. However, the haircut is only INR 20,000 crores (35 percent of INR 56,000 crores), leading to a net write back gain of INR 15,000 crores for the banks.

 

There is no doubt that the prior promoters and management of Bhushan Steel were in no position to make good on debt obligations of the company. With the RBI taking a tough stance on ever greening of loans, the only options for lenders in lieu of going to IBC was to fully write off their loan exposures to Bhushan Steel. A point to ponder is what would have happened if the Bhushan Steel case wasn’t successfully resolved in the IBC. As per the provisions of the IBC, the company would go into liquidation, if a resolution plan wasn’t approved by 75 percent or more of the committee of creditors within 270 days of admission of the IBC petition by the NCLT. The liquidation value for Bhushan Steel has been estimated at INR 14,500 crores which is a mere 42 percent of the INR 35,200 crores that would be received by the lenders pursuant to the acquisition by Tata Steel. Moreover as per the agreed resolution plan lenders would be obtaining a 12 percent stake in the company, giving them a partial stake in a future upside in the company. In our view, mandating liquidation in case a resolution plan not being passed within 270 days is not a good option. Other options would need to be looked at.