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MOSL: TATA STEEL (Neutral)-Strategic bids for Bhushan may drag stock performance-However, it is a long-term positive

TATA STEEL: Strategic bids for Bhushan may drag stock performance; However, it is a long-term positive. Maintain Neutral
(TATA IN, Mkt Cap USD9.7b, CMP INR641, TP INR778, 21% Upside, Neutral)

Sketchy picture of likely acquisitions
According to media reports, Tata Steel (TATA) has emerged as the top bidder in the recent IRP (Insolvency Resolution Professional)-administered auction of two steel assets, i.e., Bhushan Steel Ltd (BSL), the listed entity promoted by Neeraj Singhal, and Bhushan Power and Steel (BPS), the unlisted entity promoted by Sanjay Singhal. Although details of the deals are still sketchy, it appears that TATA will own a 74% stake in the debt-laden (though reduced to INR362b) BSL and an 88% stake in BPS (INR182b debt), with commitment to bring additional capital (not sure if equity or debt or preference share) toward working capital and pending capex. On consolidation, net debt will increase by INR544b (or more) at the end of FY20, assuming that additional capital requirement for working capital and capex will be met from internal accruals once the interest burden comes down on refinancing.

Valuations may appear expensive, but are in line with replacement cost
BSL and BPS are essentially non-integrated flat steel product producers. We believe that these assets can produce 7-8mt saleable steel with current facilities. The business models are similar to JSW Steel. Operating cost for JSW Steel is lower as its furnaces are much larger, while it pays slightly more for iron ore due to its location. JSW Steel pays less outward freight due to proximity to market. Therefore, we believe BSL and BPS' EBTIDA per ton are likely to be either same or a tad lower than JSW Steel's margins of INR7,000-9,000/t across cycle. Assuming INR8,000 average EBITDA/t across the cycle for BSL and BPS, the valuation of INR544b is at ~8.5xEV/EBITDA (or more expensive) after factoring in FCF of the target for two years. Naturally, this appears expensive compared to sector average EV/EBITDA valuation multiple of 6 to 7x, and this acquisition is likely to drag the stock performance over the near-to-medium term. According to our calculations, the target price may get eroded by 13% to INR677, based on 6.5xEV/EBTIDA and book value for CWIP. Peak debt will be INR920-1,000b in FY20E (excluding European business).