Let the bidding begin

The revival or, rather, survival of the debt-ridden Bhushan Steel, founded in 1989 by Brij Bhushan Singal, now hinges on the hopes of a takeover. Nearly 75% of the company’s market cap has been wiped out since the arrest in early August of Bhushan Steel’s promoters on bribery charges. The question on everyone’s mind now is whether the company can serve as an ideal takeover target.

Though the promoters hold about 65% stake in the company, 75% of this is pledged with banks and financial institutions. Post correction in share prices, the lenders are sitting on huge losses. In this situation, most market experts believe that though it is too early to take a call, any takeover at this stage will be tricky given the ownership of its promoters and the role of banks and regulators. The central bank has put the ₹40,000-crore exposure of banks under the corrective action plan (CAP) — the first case since RBI devised such a mechanism as part of its ‘framework for revitalising distressed assets in the economy’. Though a mechanism like the corporate debt restructuring currently exists, it’s not clear how the CAP is going to speed up things in this case. 

Out of control

A majority of promoters' shareholding is pledged with lenders 

For now, all eyes are on how the lenders are looking to deal with the situation and whether the promoters will be in a position to meet their obligations. With about 5 million tonne capacity and good assets in its portfolio, Bhushan Steel is considered to be one of the leading players in the market. The integrated company manufactures automotive and white goods steel, a market that enjoys higher margins. In fact, thanks to the company’s exposure to value-added products, Bhushan Steel’s blended gross steel realisation — at ₹54,000 per tonne in Q4FY14 — is one of the highest in the industry. 

“Today, to establish a million tonne-capacity integrated steel plant, the company will need about $1 billion [₹6,000 crore],” says Goutam Chakraborty, who tracks the steel sector at Emkay Global Financial Services. Going by the replacement value theory, Bhushan Steel’s current steel manufacturing capacity of about 5 million tonne is valued at about ₹30,000 crore. Add to this another ₹5,000 crore from ongoing projects and the total value of these assets can be estimated to be in the region of about ₹35,000 crore. “We believe that since the replacement cost (around ₹35,000 crore) is lower than the market valuations at about ₹41,000 crore to ₹42,000 crore, including the debt and current market captialisation of the company at about ₹3,000 crore, the buyer or acquirer will only follow suit at a lower share price,” says an independent market expert.

The way out?

Pricing of such assets will be crucial as, on the one hand, the financial institutions that hold pledged shares of the company would want to sell the shares at higher rates, while on the other hand, buyers will be looking for lower prices. Independent market analyst Satish Ramanathan says, “The likes of ArcelorMittal and JSW would want to buy the stock at a discounted price rather than the market price. But there is nothing preventing these buyers from paying over the assets, given the time value of money they save in doing so.” Of the three players, JSW has been the most active, carrying out a spate of acquisitions that include Ispat Industries and Welspun Maxsteel.

Analysts believe that putting up a 5 million tonne plant in and around the user industry and acquiring land could be an uphill task and could take a few years. For instance, a plant costing ₹35,000 crore today could actually cost ₹46,500 crore if the interest cost at 10% is accounted for during the gestation period, assuming that the commissioning happens within three years. In this case, even after accounting for (deducting) the debt, the company’s assets could actually have good value left for shareholders. Meanwhile, only time will tell who has the bargaining power, particularly in the light of the company’s lenders looking to exit and the company being in deep trouble.

In the recent past, Bhushan Steel has been featured in the news for all the wrong reasons. From mounting debt, piling losses and high interest and depreciation costs to the shutting down of its Dhenekanal plant by the Odisha State Pollution Control Board and the subsequent arrest of company officials, the steel maker has found itself floundering in a mess of its own making. And a bribery scandal involving managing director and vice-chairman Neeraj Singhal, followed by his subsequent arrest, allegedly on charges of paying a ₹50-lakh bribe to SK Jain, CMD of Syndicate Bank, has certainly not helped matters.

The problems started to mount from the last fiscal, as the company started to witness declining volumes hitting revenue and profits. In FY14, its sales volumes fell to 1.98 million tonne, compared with 2.3 million tonne in FY13. This had a negative impact on operating profits and the problems were further compounded thanks to the interest costs it incurred on borrowed funds for existing and ongoing projects. To put this in perspective, in FY14, it incurred an interest cost of ₹1,663 crore, compared with ₹1,287 crore in FY13, which was almost half of its operating profit. This indicates that on the top of the unfavorable business cycle, a large part of the company’s profits were used for servicing debt.

The reason behind this was that in Q2FY14, as compared with the previous six months, long-term debt ballooned sharply by ₹4,000 crore. This was primarily due to the fact that the company went on a capacity-augmenting spree, going in for a brownfield expansion in Tarapur by setting up a plant there and augmenting capacity at its plant in Dhenekal. The capacity was ramped up to 4.4 million metric tonne for flat products and 1.7 million metric tonne for long products. 

As such, Bhushan Steel today is overleveraged, with a debt-equity ratio of 3.5, and this has proved to be the Achilles’ heel for India’s sixth-largest steel-maker as it is reeling under a pile of debt. An equity infusion of ₹6,000 crore is required today to pare the company’s debt. Such an infusion can help bring debt levels down to ₹30,000 crore and bring down the debt-equity ratio to a still-high 3.1, but getting that is difficult following the arrest of its promoters. 

 Arrested development 

Following Singhal’s arrest on August 6, the stock plummeted to a 52-week low of ₹305 per share, a drop of nearly 20%. To ensure that the company’s debt burden is not declared an NPA, a consortium of lenders led by the State Bank of India, Punjab National Bank and others — who have a total combined exposure of ₹40,000 crore in the company — decided to take over the reins by appointing three independent directors to its board to monitor operations. An independent non-executive director, VK Mehrotra, has resigned from the 11-member board citing “failing health” as the reason. 

Melting point

The share price has more than halved since the scandal broke out

As per the CAP, a decision agreed upon by a minimum of 75% of creditors by value and 60% of creditors by number would be considered the basis for proceeding with the restructuring or recovery action of the account, and will be binding on the lenders under the terms of the inter-creditor agreement. But getting a consensus won’t be easy. Take the case of United Bank of India, which is also a lender to the company.

Executive director Sanjay Arya was quoted in a newspaper report as saying, “A promoter-director of Bhushan has been arrested for activities they were doing in their individual capacities but it isn’t [connected to] the operations of the company or its performance. The account is still standard and nowhere is it an NPA.” The bankers’ apprehension is not entirely unfounded, considering that the daily working of the company is still in the hands of its top management. A forensic audit of Bhushan Steel’s books has been ordered and the promoters have been directed to infuse equity to deleverage the firm. However, an equity infusion may be hard to come by and may take a while, which is why the banks have ordered Bhushan to sell its non-core assets as a stopgap measure. 

“Currently, margins are under pressure because of the high cost of iron ore. But if iron ore mining resumes and the company is able to operate at full capacity for the next two to three quarters, operating margins should be stable and we could expect a sharp uptick soon after. In the coming quarters, margins may be around 20% and could reach 30% at an operating profit level once the situation improves,” says a market source who did not wish to be named.

If the company is not able to bring down its debt burden, it could well be on the block for an acquisition. Bhushan needs a cash infusion in order to repay its debt, of which nearly ₹2,300 crore is due in the current fiscal. Given the current mess, it is highly unlikely that any entity will be willing to put in equity into the company and an external investor has to come in to keep it afloat. In the absence of an investor, if the banks decide to sell the assets, there are plenty of domestic players who would be interested in augmenting their capacity and taking over the business. 

“Bhushan is overleveraged. Also, given that the share price has eroded so rapidly, the company’s ability to attract capital is questionable. And that is the key requirement today. Having said that, it produces high-quality products and delivers the products its customers need. So, there is no business risk here, just a financial liability,” sums up Ramanathan.