JSW Steel: Analysts concerned over Italian acquisition

Observers note Lucchini is loss-making and running at low capacity for years; say big discount to replacement value is vital to avoid drain on earnings

Sajjan Jindal’s JSW Steel, in the final stage of buying losing Italian steel maker Lucchini, will get a toehold in the European market by doing so but analysts warn this could pull down the parent company’s earnings. Unless the company gets a massive discount.

Lucchini, with a production capacity of 2.5 million tonnes (mt) a year, is likely to be valued around $400 million. As the company is insolvent and for sale since four years, analysts say JSW might be able to negotiate a good discount.

Founded in 1908, Lucchini’s mill and blast furnace in Piombino is the main asset. The plant is managed by a special commissioner appointed by the Italian government. Apart from JSW, L N Mittal's ArcelorMittal and Naveen Jindal's Jindal Steel had also bid for the company.
 

PUZZLING DEAL

• $400 mn The valuation of Lucchini with a production capacity of 2.5 mtpa of steel
• The plant is managed by a special commissioner appointed by the Italian government
• L N Mittal's ArcelorMittal and Naveen Jindal's Jindal Steel had also bid for the company
• Analysts are negative on the deal because Europe does not look the right market now
• They also say it will be difficult to derive  much benefit from a mere 2.5-million tonne plant
• The Jindals had, in 2007, taken over a steel plate mill in the USA, but has failed to make money yet

“This deal makes no sense for JSW. First, Europe is not the right market to get into at this point. Second, the capacity of the plant is only 2.5 mt. Even if we take the long term perspective, it will be difficult to derive much benefit from a 2.5 mt plant,” said an analyst with a foreign brokerage, asking not to be named. “Had it been an integrated plant it makes much more sense but a rolling mill which has no special technology is not a big deal. They (JSW) can (as well) set up a plant here (in India).”
 

Lucchini will be the second big foreign takeover of Mumbai-based Jindal. In 2007, he took over a steel plate mill in America and it turned out to be a disaster for the group. Even after seven years, JSW has failed to make money out of the acquisition. It tried to sell the US plant but did not find any takers.

Examples of other Indian steel companies to have lost money in acquisitions abroad are Tata’s acquisition of Corus and Essar’s acquisition of Algoma Steel in the US. Both have failed to meet the expectations of investors, as well as of the management.

“The company (Lucchini) is, after all, insolvent. If the valuation is more, then this acquisition is going to be like the US plates and pipes mill for JSW Steel, acquired for almost a billion dollars few years ago and which still runs at 20 per cent capacity, nothing compared to the investment made,” the analyst added.

JSW has not officially talked about the transaction but insiders say an announcement on a takeover is imminent. The JSW Steel stock is trading at Rs 1,172 a share, up 15 per cent since January this year (see chart).

According to Giriraj Daga, senior analyst with Nirmal Bang Securities, JSW Steel is only interested in the technology the Lucchini plant is offering. “I think the company is creating a downstream facility for itself, since this plant has rolling mills that make bars, wire rods and rails. It makes logical sense to take the steel produced in India and then export it to the Italy plant to make the finished product,” he said. “With this acquisition, the company is fixing its downstream facility of the total chain that the group is planning, as it intends to create 40 mt capacity by 2025, from acquiring mines to making finished steel products,” said Daga.

He recommends that if JSW goes ahead with the deal, it should be on a slump-sale, where the asset comes to the buyer but the liability of the company remains with the holder. “JSW should buy it for 40-50 per cent lower than replacement value, still higher than the usual 70 per cent lower than replacement value in the industry right now. But we do not know what, apart from the rolling mill, is the company looking at in the plant, so the buy price should be at least 40-50 per cent lower than replacement value,” he says.

The replacement value could be almost $1 billion to set up a 1 mt plant, say analysts.