Tata Steel Ltd’s shares are falling owing to fears that its European joint venture (JV) has hit a roadblock. They may be overreacting. Both Tata Steel and Thyssenkrupp AG remain keen on the idea of moving the European steel businesses off their books. The opposition from some Thyssenkrupp investors, which may be causing concern, is on the structure of the deal. Even the opposition from workers could be a negotiation tactic to get better terms.
Since the final contours of the transaction are being worked out, there is time to make changes to keep both investors and employees happy.
The most recent cloud on the deal comes from an activist investor. Elliott Management Corp. has asked Thyssenkrupp to negotiate a better deal, saying that Tata Steel’s performance has deteriorated since the deal was first proposed, according to a Bloomberg report.
When the memorandum of understanding was signed in September 2017, both companies’ European steel businesses had a near identical Ebitda (earnings before interest, tax, depreciation and amortization) margin, with Thyssenkrupp’s at 10.1% and Tata Steel Europe’s at 9.5%. While Thyssenkrupp’s profit margins have remained around those levels, Tata Steel Europe’s have dropped to around 7%.
The last four quarters show Tata Steel Europe’s Ebitda on a declining trend. Tata Steel Europe started FY18 with the first quarter Ebitda decline sequentially, which it attributed chiefly to higher coking coal prices negating the effect of higher product prices. The second quarter saw selling prices decline sequentially, even as costs increased and volume declined. The third quarter was a seasonally weak one due to planned shutdowns, but here Ebitda stabilized as costs were lower. In the fourth quarter, production recovered, which along with higher selling prices offset higher costs and Ebitda gained. Thyssenkrupp has said that its Ebitda benefited from higher selling prices but also from cost efficiency.
This divergence in performance is why a few investors believe there is a case for better terms for Thyssenkrupp. Eventually, that depends on whether the underlying reasons are permanent or temporary in nature. Even while keeping the equity stake at 50% the two companies can negotiate other terms in a manner that allows concessions for the divergence in performance.
Fortunately, the companies don’t seem to be having second thoughts about the transaction. Certainly, tough opposition from institutional investors cannot be ruled out, but even if they force a recast that is still better for Tata Steel when compared to the deal falling through. Its acquisition of Bhushan Steel Ltd and the likely acquisition of other distressed steel assets will increase the strain on its balance sheet. Moving the Europe steel business off its books not only makes its balance sheet healthier, but should also improve profitability at the consolidated level.