Tata rides the recession

THE past few weeks have been trying times for the Tata group. In the midst of a crisis in which credit has been difficult to come by, Indias leading business house has been engaged in a troublesome effort at refinancing the large volumes of debt it had raised to finance partly the expensive acquisitions of the Anglo-Dutch steel major Corus and luxury automobile brands Jaguar and Land Rover (JLR).

At the time of their acquisition by group companies Tata Steel and Tata Motors respectively, there were some who called for caution. They pointed out that the price being paid for Corus, after a nationalistic bidding war against Brazils CSN, was too high and that buying into an automobile major when the market for automobiles was set for a downturn might not reflect good business sense.

Moreover, post acquisition, debt at the level of both parent and the United Kingdom subsidiaries in the Tata group was slated to rise sharply. This made the group vulnerable when markets shrank or credit conditions tightened. According to an estimate by Kotak Institutional Equities Research, reported by Joe Leahy of Financial Times (March 23), who has been tracking the Tata predicament closely, the debt accumulated by the Tata group will exceed Rs.1,000 billion in 2009, as a result of a Rs.300 billion increase over the previous year.

Clearly this accumulation of debt by the parent was warranted only in two circumstances. First, the returns to the acquirer from the acquired companies had to be large enough to service this debt and amortise it over time. Second, in the interim, the burden of debt should not weaken and threaten the viability of the acquiring firm. While there is no evidence that the debt is undermining the viability of a large and diversified group with a long history such as the Tatas, expectations of reasonable returns from Corus and JLR have been belied. In fact, they have suffered losses, and the parent has had to infuse additional capital into these ventures. The debt, therefore, remains and needs to be refinanced.

Those who expressed reservations when the Tata group resorted to these acquisitions in quick succession would, of course, feel vindicated. Their words of caution were then dismissed by Tata executives as being voiced by misinformed observers who were incapable of understanding the changed global market circumstances and Tatas inherent strengths. Their arguments were also ignored by the media and the government, which in fact were celebrating Indias arrival on the world stage through these and similar acquisitions of global majors by Indian business houses (for instance, the acquisition of Novelis by the Aditya Birla group).

In fact, there were signs that the government, emboldened by the large foreign exchange reserves the country had accumulated, was backing the leveraged overseas forays of Indias business groups. This was one form in which India Inc. or a growing collaboration between state and private capital in the country after liberalisation was being crystallised.

Unfortunately for the Tatas, the worst fears of the sceptics have come to pass. Within months of these acquisitions, the world witnessed the onset of a financial crisis that triggered a credit crunch and precipitated a real economy recession. Industries such as automobiles and steel were among the worst affected. This had two implications.

First, sales and revenues of Corus and JLR were far short of expectations, making it difficult for these companies to meet commitments on their debt and reduce the degree of leverage. Second, with much of this debt being of a bridge loan kind, loans that mature and cannot be repaid have to be refinanced and rolled over to prevent default. Given the current circumstances, this is difficult, as Tata discovered this May, when the $3 billion it had borrowed to finance Tata Motors acquisition of JLR and another $4.5 billion it had borrowed for Tata Steels acquisition of Corus were due for refinancing.

What is remarkable is that the Tata group has been able to ride the waves and come ashore safely this time as well. Negotiations on the volume of the loans that would be refinanced and the terms at which that would be done continued until the last week before the loans were due for repayment, triggering criticism that the Tatas were indulging in brinkmanship. It was clear that the U.K. government was under pressure to prevent closure of plants in the steel or automobile industries. Using this vulnerability, the Tatas initially tried bulldozing the U.K. government into giving it support. Tata Motors was reportedly lobbying for state guarantees for about 500 million in loans from U.K. clearing banks and a 340 million European Investment Bank (EIB) loan.

The government, it was reported, was willing to guarantee only 175 million of the EIB loan for just six months, in return for a 15 per cent premium. What is more, the government had demanded the right to choose the chairman of JLR and to veto redundancies for this minimal support. Tata reportedly refused, but whatever support it got did not come easy or cheap.

While the debt owed by Tata Steel did not result in a similar run-in with the U.K. government, the Tatas were hard put to deal with that burden as well. Tata Steel-U.K. had to negotiate a resetting of the terms of the near 3-billion debt it had taken on to acquire Corus, by offering to repay around 200 million of that amount, with funding from its Indian parent. The steel company too has been beset by a host of problems. It had been the target of a ratings downgrade by credit rating agency Moodys in March because of the impact of the recession on its operating performance and the recognition that the company would once again have to turn to its parent for financial support.

To make matters worse, a consortium of companies (consisting of Marcegaglia of Italy, Dongkuk Steel Mills of South Korea, Duferco, an Italian-Swiss company, and Argentinean firm Terniums subsidiary Alvory) decided, unilaterally, to suspend midway a 10-year supply contract that gave Corus Teesside plant in the U.K. a secure market for its products. As a result Corus had to contemplate selling or shutting down its plant at Teesside.

All this meant that unless the parent was capable of and willing to provide substantial additional support, Corus creditors would have been unwilling to roll over any debt the firm was unable to repay. The fact of the matter is that they finally did oblige the Tata group. But this was because the Indian parent offered substantially large sums of money to its subsidiaries. In the case of JLR alone, the parent has reportedly infused anywhere between $1.25 billion and $1.4 billion to cover the losses incurred since its takeover of these companies when they were profitable.

Thus the strain of the adjustment forced on its overleveraged U.K. operations falls directly on the Tata group in India. So the second question is the way in which the Indian parent has been able to shoulder this burden with no visible signs of vulnerability, as yet. There are a number of ways in which the group appears to have financed this burden. To start with, it has tapped its own brand strengths and the resources of its shareholders to reduce its exposure to debt.

Thus Tata Motors returned $1.11 billion of its original bridge loan by mobilising funds through a rights issue, launching a fixed deposit scheme and by selling the shares of Tata Steel it held. Second, the Tata group has mobilised the support of the Indian government. Even when the group embarked on its ambitious overseas acquisition strategy, there was evidence that it had the backing of the Indian government, which too was seeking to build India itself as a global brand. On the eve of the Corus acquisition, then Finance Minister P. Chidambaram declared that the government will be ready to help Tatas, if they have any request, to complete the Corus transaction, though he qualified his statement by saying that it would only be general help in the nature of facilitating clearances or approvals or permissions within the country.

But since then there has been more to this support than first declared. When the difficulty of restructuring its acquisition-related debt increased, the Tata group sought and won the support of Indias public sector banking industry, which is unlikely to have acted without the approval of the Finance Ministry.

Even recently, when faced with a credit crunch abroad, the group turned to the bond market in India to mobilise funds to partly finance its multiple commitments. This was facilitated by the government-owned State Bank of India, which led a syndicate of 10 other banks to guarantee the bond issue, allowing the Tatas to mobilise Rs.42 billion on rather easy terms. This not only helped Tata Motors medium-term cash flow but helped generate the confidence required among a group of 27 international banks to persuade them to roll over $1.05 billion of the bridge financing it had obtained for the JLR acquisition.

There is also speculation that the government may step in to help the Tatas more directly. Rajiv Dube, president of Tata Motors, is reportedly in talks with the Defence establishment to obtain secure orders for the Land Rover brand. They [Land Rover] have been used very widely by the armed forces around the world, so they see this also as a market of opportunity, he is reported to have said (Financial Times, May 29).

Finally, the Tatas have used innovation to obtain support from the Indian public for its U.K. operations. After some hiccups, Tata Motors launched its version of the peoples car, the low-priced Nano, in April and called for bookings. When the 16-day booking period ended on April 25, the company claimed that it had received 203,000 orders, the advance deposits against which were placed at Rs.25 billion. This money was in essence a loan from the public at large.

Tata Motors is only committed to deliver 100,000 Nanos by the end of 2010. The 103,000 customers who are not successful in the lottery too will have to wait until 2011 and beyond to drive their Nanos. In the interim they will, of course, be paid interest at an attractive rate. But the fact that Tata has been able to leverage the domestic market to maintain an overextended order book in the middle of the recession means that these customers are unintended creditors of the company. That money too has been crucial to the Tatas survival strategy.

In sum, despite its grievous errors in the form of the crisis-eve, debt-financed acquisitions of Corus and JLR, the Tata group has escaped a group-wide crisis by leveraging its brand, the Indian government and the Indian public. That is indeed remarkable, even if fortuitous to some degree.