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MOSL: TATA STEEL (Neutral)-Signs definitive agreement for Europe JV with TK-Marginal dilution in valuations

TATA STEEL: Signs definitive agreement for Europe JV with TK; Marginal dilution in valuations; maintain Neutral

(TATA IN, Mkt Cap USD10.6b, CMP INR568, TP INR634, 11% Upside, Neutral)

 

Tata Steel (TATA) has signed a definitive agreement with ThyssenKrupp (TK) to spin off its European steel assets into a 50:50 joint venture (JV). This clears the uncertainty around valuations. The entity will be called ThyssenKrupp Tata Steel BV (TKTS). The terms of the agreement might be a little different from the MoU signed in September 2017. TKTS will be managed by a two-tier board structure (management and supervisory) with equal representation. TATA will move EUR2.5b of debt and TK will move EUR4b of unfunded pension liabilities into TKTS as decided earlier. However, TK will now have higher economic interest of 55% in case the JV decides for an IPO. The additional 10% economic interest will be monetized by TK in the IPO so that the commitment to maintain equal holding for six years is not breached. Now, they will start seeking regulatory approvals for the merger. TATA maintains timeline of December 2018, while TK expects 12-18 months for completion of the transaction.

 Debt reduction is positive, but don’t expect much equity value in JV

• We believe it is a good deal for both TATA and TK, as they expect to realize synergies of EUR400-500m in sales, procurement, administrative and logistics efforts. These should be realized over 2-3 years after formal integration.
• TATA will benefit from debt reduction of EUR2.5b from its consolidated balance sheet, but we don’t expect much equity value for TATA’s 45% economic interest because these assets haven’t generated free cash flow even on debt-free basis. All of TATA’s subsidiaries together had negative FCF of INR40.5b even after generating INR61b EBITDA in a good year like FY18 (Exhibit 2). TKTS will now have additional burden of EUR6.5-7b. EBITDA of TKTS is expected to fluctuate around EUR1.5b depending on market conditions, while sustenance capex will be EUR900m-1b and finance cost will be EUR250-300m irrespective of market conditions.