JSW Steel - Ispat Merger To Raise Leverage

JSW Steel, an integrated steel manufacturing firm, announced on Monday the share swap ratio for the merger of JSW Ispat with JSW Steel which has been fixed at 1:72. This means that JSW Ispat shareholders will get one share of JSW Steel for every 72 shares held in the company.

JSW Steel has 11 MTPA steel producing capacity and post the merger the total capacity will increase to 14.3 MTPA, thus making it the largest steel producing company in India. The downstream facilities of JSW Steel at Vasind, Tarapur and Kamleshwar with a combined capacity of 1.2 MTPA will be spun off into a wholly-owned subsidiary so that the VAT benefits available to Dolvi HSM (erstwhile JSW Ispat) can still be enjoyed.

In the post merger equity share capital, the promoters of JSW Steel will own 35.12 per cent in the merged entity while 14.92 per cent shall be held by JFE Steel International Europe BV (JFE Holdings) and the remaining 49.96 per cent will be held by the public shareholders.

Benefits Of The Merger
The merger will allow JSW Steel to have tax benefits from the accumulated Rs 9,700 crore losses of JSW Ispat and a reduction in interest rate for the latter. As per the income tax calculations, at the end of June 2012 JSW Ispat’s losses stood at Rs 9,700 crore compared to Rs 4,300 crore as per the reported numbers. It means that JSW Steel can generate tax benefits near to Rs 3,200 crore.

JSW Steel plans to leverage the infrastructure of its Dolvi unit to add another 3-4 MTPA of capacity through brownfield expansion. The Dolvi unit has the required land to increase the capacity by 3-4 million tonnes. Hence, post the merger JSW Steel can increase its steel making capacity at the Dolvi plant via brownfield expansion which requires lower capex as compared to greenfield projects.

The merger will result in synergies of operations, taxes and interest costs. The Dolvi unit`s infrastructure and its proximity to ports will help in sea-borne imports. Further, as per JSW Steel’s  management, the merger will also provide cost savings of Rs 350-500 crore per  year due to lower interest cost, better raw material sourcing and lower selling and administrative cost.

Concerns
The one major concern post the merger is the total debt level of JSW Steel, which will increase from Rs 18,000 crore to Rs 25,000 crore as on June 2012. And if we take acceptances of the merged entity the debt will increase to Rs 33,376 crore from the current JSW Steel’s debt of Rs 24,100 crore as on June 2012. The merged entity’s net debt to equity (including acceptances) would stand at 2.2x.

The merger will increase JSW’s share of Ispat losses and debt levels. The company’s margins should remain under pressure due to fall in steel prices, increase in the interest expense and limited gains from lower coking coal and iron ore prices in the international markets.

We believe in the near term there will be some negative impact on JSW Steel’s financials, especially due to higher interest costs, but JSW Steel will also benefit from JSW Ispat’s accumulated losses that will bring down its tax incidence later. However if Situation for the steel industry get worse in terms of demand and fall in the steel prices then we can see pressure on the margins. Given the bleak picture for the steel prices there is a risk that JSW may not get the benefit of lower international iron ore prices even after the opening of mines due to the adverse iron ore demand-supply situation in Karnataka in the near term. JSW steel is purchasing ore through E auction route from NMDC which has recently increased Iron ore prices by 8-13% which worsens margin outlook. Therefore In the near term there will be negative impact on JSW Steel’s financials, especially due to higher interest costs and weak steel scenario.