Edelweiss-JSW Steel - Ispat acquisition(22.12.10)

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Acquires 41% stake and management control in Ispat for INR 21.6 bn

JSW Steel (JSW) to acquire 41.3% equity in Ispat Industries (Ispat) by investing INR 21.57 bn, implying an enterprise value of INR 123 bn (including preference capital) and equity valuation of INR 52 bn. Ispat has HRC and downstream flats capacity of 3.3 mtpa and ~0.5 mtpa, respectively. For 12mFY10, Ispat posted revenue, EBITDA and PBT of USD 1,733 mn, USD 308 mn and USD (-60 mn), respectively, with sales volume of 2.6 mt.

Operational improvement and synergy benefits crucial for turnaround

Ispat achieved EBITDA/t of USD 118 in 12mFY10. We expect a combination of cost savings, better realisations and cyclical improvement in steel margins to lead to EBITDA/t and EBITDA of USD 175 and USD 525 mn, respectively, by FY13E. Such a turnaround would imply EV/EBITDA of 5.2x which is fair but not cheap. Potential cost savings include those on freight, power, VAT and raw material (leveraging JSW’s existing supplier base and upcoming pellet capacity).

Debt refinancing planned for Ispat; interest cost could be down 200bps 

The effective cost of Ispat’s term debt, aggregating INR 67.8 bn, is ~12.5%. JSW proposes to refinance this by September 2011, which will bring down interest costs by 200-250bps.

Ispat to undertake capex of INR 31.4 bn over next two years

Ispat is planning capex of INR 31.4 bn over the next two years, which includes setting up a 110 MW CPP, 3 mtpa pellet plant, 1 mtpa coke plant and capacity expansion to 4.0 mtpa from the existing 3.3 mtpa. So far, it has spent INR 4 bn. Of the equity infusion of INR 21.57 bn into Ispat, INR 7-8 bn will be the required equity capital for this capex; the remaining capex is likely to be funded through fresh debt of ~INR 20 bn over the next two years.

Outlook and valuations: Turnaround is key; maintain ‘BUY’

This acquisition will enable JSW to emerge as India’s largest steel player, at 14.3 mtpa, by early FY12. We believe JSW has the financial strength and operational capabilities to effect the turnaround as mentioned above. However, the issue of increased debt of INR 94 bn would act as a drag. Hence, we do not see upside to our fair valuation of INR 1,372/share. We maintain ‘BUY/Sector Outperformer’ on the stock.