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Tuesday, May 10, 2016

Tata’s Exit from UK: What it Teaches

When the going gets tough, it makes great sense to chip off the dead wood.

Speaking to Bloomberg, Koushik Chatterjee, ED of Tata Group, tracing the facts, viz., “Given the over-capacity issues [in steel industry], and given how trade movements are happening across borders, … countries with open borders being more vulnerable as compared to others that are not … muted demand profile of steel industry [across the continent], very volatile currency… high-cost geography …particularly the dim prospects for a change in these factors in the near future…,”  said that all these have cumulatively made the management team engaged in handling the UK operations of Tata Steel realize that the transformation plan, which has already eaten up huge capital over the last nine years— acquisition cost of £6.2 bn plus around £3 bn that was infused into its operations — is no longer doable, and hence the call to quit from UK’s steel operations. 

Intriguingly, while answering the last question of the interviewer, Chatterjee, who is known as a “calm, composed, and down-to-earth person”, observed: “going forward we will have to be a lean and competitive organization and keep doing the right things from the process and product point of view.” This is a pretty interesting comment made by the executive who as the then VP – Finance, Tata Steel, had actively been associated with the bidding process of Corus from the control room set in Taj Mahal Palace, Mumbai, on that fateful night of January 31, 2007.

This revelation has for obvious reasons raised quite a few eyebrows. And to better appreciate this candid revelation, we must first understand what mergers and acquisitions are essentially meant for: they are resorted to attain greater market share, acquire additional brands, cannibalize competing brands, realize improved infrastructure, create new synergies, capitalize on efficiencies and economies of scale, globalize in shorter span of time, etc. And it is commonsensical to expect mergers to result in more efficiency and the productivity of the combined firm must increase through the “economies of scale”. And there are two theories that explain the philosophy behind this expectation: One, the “theory of differential efficiency”, according to which, if the management of Tata Steel is more efficient than the management of the Corus, then acquisition of Corus by Tata pulls up the efficiency of Corus to its level; and, the second is the “synergy theory”, according to which, when Tata and Corus combine, they should be able to produce a greater effect together than what the two operating independently could—a phenomenon of two plus two becoming five. Again, this synergy could be “financial synergy” or “operating synergy”.

Thus, a merger of two firms should always and invariably result in a “positive”: the positive could be by way of increased volume of revenue from the combined sales—either due to “economies of scale”:  cost-based economies of scale, or revenue-based economies of scale; or “economies of scope”: Cost-based economies of scope, revenue-based economies of scope, or diversification-based economies of scope—or decreased operating cost or decreased investment requirements. And it is needless to say here that if the combined effects are neutral or negative, the whole labor of merger exercise would go waste, and precisely that is what appears to have happened in the case of Corus acquisition by the Tata Steel.

This phenomenon highlights two learning points: one,  although M&As as a strategy sound
theoretically pretty good, their success demands ample ingenuity in their execution, and two, as a seasoned analyst once said, “A larger part of what makes a [merger] deal successful after you complete it, is what you do before you complete it”. And this observation fires a pertinent question: “Does the failure of the merger [Tata-Corus deal] the outcome of the current market conditions mostly defined by China factor, or poor estimates of the merger outcome?”

The answer is obvious, and not necessarily on the hindsight: first, the acquisition was at the peak of the commodity cycle; second, the acquisition price itself was dubbed by some analysts then as above the‘comfort zone’ and that Ratan Tata had put the company in jeopardy in the process;  third, over it, the deal was an all-cash that too financed by debt; fourth, Corus was never a turnaround case nor did it exhibit any growth opportunity, for, steel making in UK being costlier owing to high energy costs and government’s unwillingness to subsidize it; and lastly, Corus was all through managed by Tatas as an independent unit, that too headed by the same old CEO for the first two years, and  thus nothing appears to be favorably fashioned for the merger to turn positive. It could be just that the overall market dynamics might have, at the most, hastened the whole process.

The whole episode also teaches another important lesson: As Chatterjee bravely admitted,  when the acquired assets turn impaired even after making the best effort, both in terms of managerial acumen and infusion of fresh capital, and as the mounting losses become less and less absorbable by the acquirer, it becomes imperative for the parent company to contain its future risk by offloading the acquired assets without getting much bogged down by the valuation, for, it would alone facilitate its safe journey forward.


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