Insolvency and Bankrupty Code in India and its Implications-3

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Insolvency and Bankrupty Code in India and its Implications-3

--BY KAMESH SUBRAMANIAM AND H SUCHANDRA MUNDUL
 
IBC – A Hit? Or a miss?
Like its predecessors, IBC has its own set of challenges and controversies.
• While Bhushan Steel has been successfully resolved under the IBC, the process was not the smooth flow that was expected.
• When Liberty Houses’ bid was rejected by the IRP, it moved to pause the bidding process stating that the only reason for rejecting the bid could not be late submission.
• Also some of the creditors of Bhushan Steel moved to be classified as secured creditor and objected to Tata Steel’s resolution plan, even though the IRP has accepted the same.
• The timelines mentioned in the IBC Act for implementation of resolution plan and completion of bidding process is not set in stone.
• Case in point is Essar Steel (Debt over INR 40,000 Crores), which hasn’t yet gone into liquidation despite the elapsing of 270 days since the admission of the insolvency petition against the company by NCLT.
• Eligibility of bidders is still a sore spot for the IBC process flow of Essar Steel. During the bidding process of Essar Steel, a new section was introduced - Section 29A - which barred promoters of defaulting companies and their related entities from the bidding process.
• Arcelor Mittal and Numetal emerged as the bidders for the company. Arcelor Mittal’s erstwhile subsidiary Uttam Galva had defaulted on payment of its debts, while one of the promoters of Essar Steel Rewant Ruia had a stake in Numetal.
• The IRP had rejected both the bids on the basis of provisions in Section 29(A). However, the appellate tribunal of NCLT had recently stayed the order of the IRP.
• The appellate tribunal dismissed the IRP order stating Section 30 (4), which gives 30 days to prospective bidders to clear their dues and become eligible to bid.
• It also declared that the 30 days litigation period would not be considered as a part of the 270-day timeline and thus extending it to 300 days effectively.
 
It is too early to comment on the effectiveness of the IBC process, even though Bhushan Steel and Electro steel Casting have seen a resolution. There are still a lot of grey areas concerning how the turnaround of these companies will happen, and that remains to be seen. It is great news for the market that the NPA crisis which was up until now brushed under the carpet is seeing stringent action. This gives a strong message to the industry that default will no longer be looked at kindly. In my opinion, the following questions still need answering before it can be concluded for sure that IBC is indeed a hit. 
 
1. Is there going to be significant change in the strategic intent and operating strategy of Bhushan Steel?
2. Has IBC considered how the intercompany loans are structured in the Tata Group for Bhushan Steel buy out? How deeply did the committee of creditors analyse the buyout structure before approving it?
3. What happens if Tata’s realise that Bhushan Steel was not just badly managed but a bad asset altogether for them? Will they try and pass it on to some other willing investor?
 
How was Bhushan Steel’s Buyout Structured?
Until now, the focus was on the IBC process and how IBC was implemented for Bhushan Steel. Now that Tata Steel has won the bid and received most of the clearances required, it is important to understand how Tata Steel has structured the funds required.  The acquisition was done through a special purpose vehicle (SPV) Bamnipal Steel (BNPL), a wholly-owned subsidiary of Tata Steel created for this deal. The entire consideration of INR 35,360 crores would be paid by Bamnipal Steel (BNPL). In addition BNPL would acquire a 72.6 percent stake in Bhushan Steel for a face value of INR 2 amounting to an aggregate of Rs 159 crore. There is also an article in Business Standard which had come out recently stating Tata Steel had been intending to increase its total shareholding in Bhushan Steel to 76 percent. The acquisition would be partly funded by debt, which Bamnipal Steel would acquire on its books. A report from ICRA has given the proposed debt structure as:
 
Commercial papers – INR 5,000 Crores
Short term borrowing program – INR 13,000 Crores
Total – INR 18,000 Crores
 
ICRA has also assigned a provisional rating of [ICRA] A1+(S) to these proposed debt instruments of Bamnipal Steel. Tata Steel has issued a letter of comfort for the debts to be raised by Bamnipal Steel. It is owing to this that the Symbol S has been placed in front of the rating. There will also be some amount of Inter corporate loans – the exact figures are still not known- out of which INR 9,000 crores will be an option that can be converted into equity. The whole idea behind structuring the buyout as an SPV was to keep the operations of Bhushan Steel separate in order to closely monitor the day to day activities of Bhushan Steel. 
 
Post buyout, Bhushan Steel has effectively become a debt free company and Tata Steel intends to transfer this debt on to the balance sheet of Bhushan Steel. The next obvious question would be how would Tata Steel achieve that? Is it that they would borrow on the books of Bhushan Steel i.e. Bhushan Steel would raise the debt from the market and repay Tata/Bamnipal Steel? At this juncture, there isn’t enough supporting data to draw conclusions on that. Another case in point is also where would that leave Bhushan Steel’s cash flow and how would Bhushan Steel’s cash requirements be met? Since the takeover process is still in nascent stages, only time will tell how finally Bhushan Steel performs.
 
We are now attempting to answer the questions that we had raised earlier regarding the strategic intent and inter-company loan structuring.
1. Is there going to be significant change in the strategic intent and operating strategy of Bhushan Steel?
In all the research that we have come across so far on Tata Steel’s acquisition of Bhushan Steel, nowhere is the concern raised about how this is going to affect Bhushan Steel on a strategic level. By that we mean will there be a significant diversion from the company’s existing Vision/Mission/Operating Policy? From whatever data we could gather, we are of the opinion that at least in the near future there are no plans of changing the core values that drive the company’s operations. The reason for this conclusion is based on the following plants:
i. Bhushan Steel’s latest expansion in Odisha is close to many of Tata Steel’s captive Iron mines; which means Tata Steel will easily be able to ramp up capacity in the Odisha Plant.
ii. An ET Markets research has already stated that Bhushan steel does have profit making plants at Ghaziabad and Khopoli that are value added manufacturing. It is very active in the automotive sector as well as other value-added products. 
iii. Tata Steel has already factored in various operating synergies apart from increasing capacity utilization such as: this acquisition making it the market leader in terms of total capacity. (13MTPA to 24MTPA including Tata Steel’s expansion at Kalinganagar)
 
 
This leads us back to the discussion on what led Bhushan Steel to a position where it was unable to service its debts. If Tata Steel finds operational synergies with its existing operations and firmly believes that a turnaround will happen shortly, then what stopped the erstwhile Bhushan Steel Management from doing the same? One answer could be limited access to raw materials, especially after the Supreme Court order of banning mining and the capping of how much could be mined. The second and in our opinion more critical was the way the capacity expansion of the Odisha Plant was funded. 
 
The valuation model that we have done earlier shows that the cash conversion ratio of the company was very low compared to industry standards. Which leads us to the conclusion that the company had no choice but to go for additional borrowing. Here we would like to also bring out the point that the additional capex that Tata Steel had taken on for its capacity expansion is much lower than that of Bhushan Steel. The interest burden is also significantly lower for Tata Steel’s India operations.
 
While it is normal for a company to have a debt equity ratio as high as 2.33:1 for capital-intensive infrastructure projects, for Bhushan Steel it wasn’t the ideal mix. The company was over leveraged. What the promoters should have done here was bring in additional capital in the form of promoter funding. If they did not have deep enough pockets, then they should have gone for private placement of equity with investors with healthy risk appetites, who would be willing to invest.
 
2. What happens if Tata’s realise that Bhushan Steel was not just badly managed but a bad asset all together for them? Will they try and pass it on to some other willing investor?
 
We have taken a close look at the Bhushan Steel balance sheet and the articles/news items available regarding the buyout. We believe that Bhushan Steel was not badly managed from an operational perspective. It was just not able to manage its debt burden effectively post the capacity expansion at its Odisha Plant. Our attempt here is to use a set of assumptions to project the EBDITA figures for the next two years and figure out what value does Tata Steel find in Bhushan Steel. The idea here is to use the basic valuation method to see how Bhushan Steel’s EBDITA figures will contribute to the consolidated earnings.
 
Assumptions used in the valuation:
1. The projections are on the base year of FY 18 i.e. From April 2017 to December 2017. Data for January – March 2018 is not yet available.
2. The sales volume for Bhushan Steel has been projected to grow at 6 percent, which is the industry growth rate for the steel industry for FY 2019. We have assumed a growth rate of 7 percent in FY 2020 by keeping macro-economic factors like Global Market outlook being positive, political stability in India and no major global market negative events as constant.
3. Given that Global Steel prices are showing an upward trend this year i.e. FY 18 -19, and with all the anti-dumping duties and laws, we personally expect the steel prices to continue on the upturn. We have assumed a YOY growth rate of 5 percent on the conservative side.
4. The multiplier used in calculating the Enterprise value for Bhushan Steel is the average of the EV/EBDITA multiples of Tata and JSW steel. The multiplier comes up to 8.
 
 
The Valuation Model
Based on these assumptions, we have the following EBDITA and Enterprise value figures for Bhushan Steel:
The above model shows the estimated figures of Bhushan Steel if the growth rates were applied on YOY basis. However, having applied the expected assumed growth rate, we find that Bhushan Steel is falling far short of the INR 35,360 Crore value that Tata Steel has paid to acquire it. So we have also done a goal seek setting EV to INR 35,200 crores to figure out what will be the required MTPA to be sold, which came to 5.1, close to the number, which Tata Steel declared as expected. 
 
On this basis, we have set the tonnes as constant to 5.1 and done a goal seek on the CAGR to achieve this number. The figure comes to a whopping 20.8 percent. We are using these figures to answer the question that we had raised that whether Tata Steel has over paid for Bhushan Steel and if they would suddenly realize that Bhushan Steel was a bad asset all together. The answer is, if Tata Steel is able to make Bhushan Steel reach a capacity utilization of about 90 -95 percent then they have just purchased an asset which would be their ticket to market domination. We would like to add here, this acquisition is definitely a very well thought out and deeply deliberated action by Tata Steel as they now have first-hand experience of what can go wrong with their Corus Steel acquisition and subsequent turnaround.
 
3. Has IBC considered how the intercompany loans are structured in the Tata Group for Bhushan Steel buy out? How deeply did the committee of creditors analyse the buyout structure before approving it?
 
When we speak about IBC, we have to understand the major player in the process is the committee of creditors. This committee of creditors is generally banks and other financial creditors. Their primary concern is to recover whatever possible of the NPA and somewhat minimise the losses. So they are not truly concerned about how the highest bidder is funding the buyout. This is a significant loophole in the IBC process, although previous defaulters have been banned from the bidding process. There is no provision in the IBC to scrutinise the financing of the buyout structure at any of the stages. In this regard, to answer the question we had raised, IBC did not analyse how the inter-company loans were structured and neither did the committee of creditors thoroughly investigate the buyout structure. When compared to other bidders, Tata Steel’s bid was the highest and on an overall, the buyout structure seemed to have synergies with the existing operations of Bhushan Steel. However, without more information on how the implementation of the buyout is happening and what kind of changes Tata Steel will make, it is hard to comment on whether the decision of the committee of creditors is viable in the long run. 
 
Kamesh Subramaniam, CA, CFA is Senior Manager at Standard Chartered GBS and H Suchundra Mundul, MBA Finance, is Associate Manager at Standard Chartered GBS.
 
Note: This is the last of a Three part article. - Editor
                                               

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