Profits in the pipeline

When in trouble, you can bet on your close ones to bail you out. That's exactly what Sajjan Jindal has done by buying out the US assets of Jindal Saw, owned by elder brother PR Jindal. But this also allows him to get a foothold in the promising US oil and gas pipelines market. JSW has acquired a 90 per cent stake in three companies that make plates and pipes for the oil and gas industry for an enterprise value of $900 million. ''There's tremendous synergy with JSW,'' says Sajjan Jindal, vice-chairman and MD of the Rs 9,080-crore JSW Group. ''We have one million tonnes of surplus slabs, the raw material for plates, which we can now ship to the US."

JSW has been exporting slabs at $500-520 per tonne; by converting them into pipes they can be sold for $1,650 per tonne. ''Even after providing for freight cost and conversion costs, we will make a conversion margin of $400-500 per tonne,'' explains JSW CFO Seshagiri Rao. The acquisition is in line with JSW's strategy of making basic steel at home and expanding its footprint by acquiring facilities for value-added steel abroad. But it's not going to be easy. The three firms have accumulated losses of $42 million, though in the last financial year they reported an operating profit of $75 million on revenues of $510 million.

The standalone units have been constrained by lack of slabs and working capital, which meant that the plants were running at half their capacity. "In the long run, availability of raw material for a standalone manufacturer is a problem and so is arranging finance. Nobody gives you raw material in the US on a 90-day credit and money can cost 7-8 per cent if you don't have a strong balance sheet,'' observes an industry watcher.

Luckily for Jindal, the demand for pipes in the US is strong with many new oil and gas pipelines being laid and others due for replacement. World Steel Dynamics, a steel information service provider, estimates that nearly 15,000 miles of new pipelines will be set up in the US by 2011 and another 10,000 miles are due for replacement. One would tend to think that a mature market like the US would already have adequate oil and gas infrastructure.''Many power plants in the US, which run on oil are shifting to gas to take advantage of the price arbitrage. Also, rising oil prices have made it viable for oil majors to drill deeper. But as you go deeper, the quality of the gas gets sour (it's not sweet gas)and that needs special pipes,'' says Jindal, explaining the spurt in pipeline activity.

American media reports say the US will spend $600 billion in the next ten years to revamp pipes more than 35 years old. Jindal feels the next boom in pipelines will come from hydrocarbon-rich Latin American companies and claims he will be well-positioned to tap into an upswing in demand. He plans to expand the pipe mill capacity from 0.5 to 1 million tonnes in line with the plate mill capacity.

But Jindal's peers are not impressed. ''It appears to be a family transaction and not driven by a business rationale. It could be a further division of assets between the brothers,'' says a senior executive with a steel major. "Jindal Saw enjoys a good marketshare in India and wants to concentrate on that,'' counters Jindal. The 43 per cent stake of the promoters in JSW is held jointly by the four Jindal brothers and other members of the family. ''There are no cross holdings in the manufacturing balance-sheet. We have gradually cleaned up,'' says Jindal," but the promoter stake in the companies is still jointly held by the family."

But peers believe he could have explored the synergies by simply shipping the slabs to the US rather than by making an expensive acquisition. ''We had considered that but fixing the price becomes a problem. I am running a much larger operation and have a much larger talent pool to quickly turn around the assets,'' claims Jindal.

The stock market isn't impressed. The JSW scrip was hammered by about 8 per cent after the deal was announced, though it later recovered to Rs 572. Rao says JSW will invest $60 million to ramp up capacity utilisation to 70 per cent, which should boost the turnover to $800 million. With better utilisation next year, revenues should climb further to $1.5 billion, making the business profitable. The strategy appears fine on paper. Now Jindal needs to prove he can do it.