Not a steal

Investors will start looking at the Tata Steel stock positively once the benefits of the Corus purchase become evident.

Tata Steel's acquisition of Anglo-Dutch steelmaker Corus has not gone down well with the market: the stock was hammered and lost ten per cent the day the announcement was made. It is yet to recover. The reasons are not hard to fathom.

While the combined entity will have tremendous scale""24 million tonne per annum""and many synergies, the market is not willing to wait for the benefits to come through.

Besides, at an EV/EBITDA (enterprise value/earnings before interest, tax and depreciation) of more than 8 times CY06 financials on consensus estimates and a replacement value of $679 per tonne, analysts believe the transaction valuation is stretched.

In the Mittal Steel-Arcelor deal, the EV/EBITDA was 6.2 times. In terms of EV/tonne too, Tata Steel's price, at $700-710 per tonne is higher than what Arcelor commanded at $586 per tonne.

Also, in case of Mittal Steel-Arcelor, the deal involved a share swap along with cash. Tata Steel will have to shell out hard cash for Corus.

And that means not just more debt on the Tata Steel balance sheet, but also an equity dilution. The company 's gearing is low at around 0.26:1, so it is in a position to take on debt of around Rs 8,000 crore, without the debt-equity ratio going out of whack.

As for the equity dilution, Tata Steel has issued warrants to Tata Sons""in July 2006, Tata Sons was issued 2.7 crore shares of Rs 10 each at a price of Rs 516 per share aggregating Rs 1,393 crore.

In addition, Tata Sons was issued 2.85 crore warrants where each warrant would entitle it to subscribe to one share of Tata steel against payment in cash. There will be a further dilution since Tata Sons will be infusing more funds into Tata Steel.

At the current price of Rs 463, the stock trades at 5.5 times estimated FY08 earnings and 4.1 EV/EBITDA on a stand-alone basis. While it is not unreasonably valued, the stock is likely to be a market performer till some benefits from the integration become evident.