Hard times

Benefits from the Novelis acquisition will start flowing in only in the long term.

It's the second biggest acquisition overseas by an Indian company and co-incidentally, it's in the metals space.

Barely a fortnight after Tata Steel outbid competitors to buy the Anglo-Dutch steelmaker Corus for $12.1 billion, the Rs 11,396 crore Hindalco snapped up the Canada-based Novelis at an enterprise value of $5.95 billion in an all-cash deal.

Both the Indian firms bought out companies much bigger than themselves---Novelis (nine months CY06 revenues $7.37 billion) is approximately two and a half times bigger than Hindalco (nine months FY07 revenues $3.05 billion).

Corus makes four times the amount of steel that Tata Steel does. At an EV/EBITDA of 12.4 times for 2007, however, the Hindalco-Novelis deal is one of the most expensive ever. Tata Steel paid a lower valuation multiple of close to 8 times for Corus.

The rationale for Hindalco's acquisition is to marry Novelis' high-margin rolled products business (CY 05 revenues $8.36billion) with its business of primary metal.

"If any company has tied up both front end and back-end operations, it completes the value chain and that makes a whole lot of sense, "observes Sanjeev Krishan, executive director, PricewaterhouseCoopers.

In the process, Hindalco can be shielded from the vagaries and volatility of commodity cycles. "We would be LME-proof as the volatile prices will impact the combined entity to a much smaller extent," says Kumar Mangalam Birla, chairman, Hindalco.

Besides, Novelis, which makes high end rolled products for users like Jaguar and Coca Cola, can use aluminium made by Hindalco. How much and when though is the question.

Analysts point out that even if Hindalco ships out its entire production of primary metal of 160,000-220,000 tonne over FY08-09, it would amount to less than 10 per cent of Novelis' needs. According to Sunirmal Talukdar, CFO, after 2010 Hindalco should be able to supply 1.5 million tonne of metal to Novelis.

In that sense, the synergies, industry watchers say, are more apparent for the Tata-Corus combine. Corus needs slabs to make finished steel which Tata Steel plans to supply from its plant in Kalinganagar, Orissa. Also Tata Steel already makes value-added products and can therefore make more meaningful use of Corus' technology. "True synergies for the consolidated entity are limited, "says an industry watcher, pointing out that even if Hindalco were to move up the value chain with technology from Novelis, the benefits don't appear to be significant. "In Tata Steel's case, the company makes a higher share of value-added products, so it can upgrade technology much faster," observes an analyst.

It's not going to be easy to make Novelis profitable. Part of the world's largest producer of high-end rolled products' problems ""it posted a loss of $168 million for the nine months ended September,2006-- lie in fixed price contracts that it has negotiated with buyers-- nearly 20 per cent of sales---that can't be renewed on fresh terms for a while. While Corus is not in the pink of health, its profitability can improve quickly because all it needs is access to cheap slabs.

However, both Tata Steel and Hindalco are going to have to leverage themselves to the hilt to pay for their purchases""Hindalco's net debt to equity ratio could go up to over 1, so could Tata Steel's.

"There will be some impact on Hindalco's balance sheet," admits Debu Bhattacharya, managing director, Hindalco.

The stakes are definitely high: Hindalco is effectively making an investment that amounts to 80 per cent of its market capitalisation in an asset that it is unlikely to yield returns for some time.

Moreover, if things don't work out, Hindalco will have to cough up $2.8 billion that it is borrowing to pay for Novelis. Tata Steel is somewhat better off because the debt it is taking on is"without recourse" to the company.

But neither deal has gone down too well with the stock market""Hindalco lost nearly Rs 3,000 crore in market capitalisation post the announcement. The Tata Steel stock was meted out similar treatment. After all, the magnitude of the challenge before both companies is no different. Both have an uphill task ahead of them.

Buying Novelis

Forward integration for Hindalco

Hedge against fall in aluminium prices

Deal expensive at EV/EBITDA of 12.4

Debt of $3.1bn could strain Hindalco's balance sheet

Synergies will take time to come through