By Geetanjali Kedia

India's largest private steel-maker, Sajjan Jindal-led JSW Steel, announced the acquisition of around 40% stake in the ailing Mumbai-headquartered Ispat Industries, early this morning, for Rs. 2,157 crore. The deal, valuing Ispat Industries at EV per million tonne (mt) of Rs. 3,800 crore, comprises of a preferential allotment of 108.7 crore shares to JSW Steel at Rs. 19.85 per share. Subsequently, JSW will make a mandatory open offer for 20% stake to Ispat shareholders, at an expected price of around Rs. 20.70 per share, as calculated on last 2 weeks average share price of Ispat.

A comparison between the two companies, presented below, shows that the deal value is pretty much in-line, considering the current share price and the fact that Ispat Industries has been under Corporate Debt Restructuring (CDR).

* Expanded equity post allotment to JFE, Japan

The equity of Ispat Industries is likely to more than double from present Rs. 1,300 crore to Rs. 2,724 crore, post deal-completion:

Note: Debt conversion in future, by lenders (IDBI Bank, ICICI Bank, SBI and IFCI), may lead to further equity dilution.

JSW Steel will become the promoter of Ispat Industries. Besides 40% stake through preferential allotment and 20% through open offer, it may, in the future, acquire 50.28 crore equity shares (18.5% stake) held by the Mittal brothers. This will translate into, JSW holding 78.5% in Ispat, which may ultimately result in merging the target with itself, as was seen in the former's acquisition of Southern Iron Steel in 2007. Considering the current market price of Rs. 1,200 and Rs. 21.50 per share of JSW and Ispat respectively, the share swap ratio for merger could be around 1:60, resulting in fresh issue of 4.5 crore equity shares of JSW Steel, expanding its equity to Rs. 268 crore, going forward.

Although high concerns remain on Ispat's operations and profitability since 16% EBITDA margin for 15 months ended June 2010 slipped into the red in September 2010 quarter, JSW Steel's managerial abilities will come into play, to turnaround the target company, which should start getting reflected in its working, after 6-9 months, post effective control by JSW. Raw material sourcing will be another challenge, since both JSW and Ispat lack backward integration arrangements, unlike other majors like SAIL or Tata Steel.

Since JSW Steel is acquiring new capacity of 3.3 mt of Ispat Industries at an enterprise value much lower than its own existing EV of close to Rs. 5,500 crore, its equity dilution thus will also be lower. The deal will be EPS accretive, once turnaround is achieved, which may get partly reflected in combined financials of FY 12. Moreover, debt equity ratio of the combined entity will also remain at existing levels, as shown below:

* Assuming waiver of Rs. 1,000 crore as part of CDR package

Post-merger of Ispat Industries with itself, JSW Steel's debt equity ratio will rise marginally from current 1.79:1 to 1.83:1, which is quite comfortable. Thus, mounting debt concerns also gets addressed satisfactorily.

This deal is likely to make JSW Steel, India's largest steel-maker in next 6 months, taking into account its ongoing expansion, leaving behind PSU giant and present leader SAIL (13 mt). JSW's current expansion plan will raise its capacity to 11 mt, likely to be completed by March 2011; and adding Ispat's 3.3 mt, it will overtake SAIL by a good distance. Tata Steel will remain in the third position, with its 10 mt capacity, expected to be achieved by August 2011.

To conclude, JSW Steel seems to have acquired the might along with Ispat' Dolvi plant at Maharashtra. The deal is positive for JSW shareholders while Ispat share price will settle and rule at around 21 level, closer to its expected open offer price.

JSW Steel is a buy at present levels, while Ispat remains a sell.