(BSE: 500228 | NSE: JSWSTEEL | ISIN: INE019A01020)
JSW has acquired 90% stake in the US arm of Jindal Saw (JSAW). JSAW has a plate mill capacity of 1.2mtpa, Lsaw pipe capacity of 0.55mtpa and W-jointing capacity of 0.35mtpa. JSW has valued the US operations of JSAW at an EV of USD900mn. The existing shareholders will retain 10% stake, while JSW will acquire balance 90% stake through the LBO route with a cost of debt at LIBOR + 2.5%. The US operations posted EBITDA of USD75mn for the period July 2006-June 2007. However, the company has calculated proforma EBITDA of USD143.9mn after various notional adjustments to
arrive an EV/EBITDA of 6.25x for the acquisition. Although we believe the deal is expensive as compared to the cost of acquiring the assets, but the premium can be attributed to the fact that JSW has not only acquired the assets of the company, but also the facilities which are accredited by the customers that will take a long time to replicate. JSW currently has one million tonne excess slab, which it plans to ship to US thereby reducing the cost of production at its plate mill facility substantially. JSW has stated that the deal will be EPS accretive at the consolidated level in the first year of operations itself. We are positive on the deal. We will revise our earnings estimate post evaluation of the earnings accretion from the deal. We continue to maintain a buy on the stock with a target price of Rs790, which is 7x FY09 earnings prior to the deal.
The deal structure JSW will acquire 90% stake in the combined US operations of Jindal Saw. The entire funding for the deal will be through debt raised at various levels of holding.
Rationale for the acquisition JSW currently has a slab capacity of 3.8mtpa and rolling capacity of 2.8mtpa. The company intends to ship the surplus 1mtpa slab it currently has to the US operations and add value there to increase the realization. Currently the company is selling slabs at USD500-525/t. The pipes are likely to fetch around USD1,500-1,600/t in the current market scenario.
Why the US operations under JSAW not been satisfactory? The US operations of JSAW was primarily based on tolling agreement where the Jindal United Steel Corporation and Saw Pipes USA worked mainly on a tolling agreement leading to lower margins. Secondly, as per the management, the JSAW management have not incurred the maintenance capex which has lead to a significant increase in down time, thereby reducing the productivity of the mills. Lastly, but most importantly, the US operations have been badly hurt by irregular and poor quality slabs being supplied for rolling and finishing which increased the yield loss to 19% and scrap generation to the tune of 14%.
How does JSW plan to increase efficiency and reduce costs at JSAW JSW plans to ship slabs from the Vijaynagar facility sized as per exact requirement at the US facilities thereby eliminating the need for 31 employees who are currently utilized only for sizing the slabs. This action will itself reduce the yield loss from 19% to ~13% and also reduce scrap generation. Further, the company is planning to increase the production of saw pipes from 200,000t in FY07 to 350,000t in FY08 and further increase it to 500,000t in FY09. Similarly, JSW also plans to increase the plate mill production from 600,000t in FY07 to 850,000 in FY08 and further to 1,000,000t in FY09. JSW is also likely to incur additional capex of USD61mn for repairs and modernization of the mill which will further help reduce the downtime and thereby increasing productivity of the mill. Out of the total payout of USD810mn (excluding inventory value), we estimate the share of Mr. P.R. Jindal will be around USD466mn. In addition, Jindal SAW will continue to hold 10% in the new SPV, JSW US-Holding-SPV-2.
Valuations Although we believe the valuation of the target companies especially the Saw Mill appear to be stretched, the acquisition does make a business sense. JSW with its excess slab capacity will have the opportunity to tap into the lucrative oil and gas pipes market in US. Further the company will incur a capex of USD61mn for repairs and modernization of the pipe making facility, which will then utilize the in-house plate mill capacity to the fullest. We believe the deal is likely to be EPS accretive to JSW on a consolidated basis as there is no equity dilution and additional interest burden for funding will be close to USD80mn. The target companies had actual combined EBITDA of USD75mn in Jul-Jun2007 due to external slab supplies and other negative factors. We believe the EBITDA in financial year can improve significantly. We continue to remain positive on the long-term prospects of the company and its valuation at the current levels, excluding the deal. We continue to maintain a buy on the stock with a target price of Rs790, which is 7x FY09 earnings prior to the deal.
Key Risks Due to the current acquisition, the debt-equity of the company is likely to breach its target of 1x in the short run. The company expects the debt-equity to shoot to 1.4-1.5x in the current year. However, the ratio is expected to moderate as soon as the US operations are stabilized.
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