Deals of steel

Published: 18 August 2008

Acquisition of SJK Steel stake highlights Gerdau's metal

The steel industry is one of India's most dynamic success stories, and several of the country's leading producers have expanded from regional presence to global prominence in recent years. That growth has been driven principally by demand from emerging markets.

While America, Europe and Japan will increase their collective steel demand by 29 million tonnes to 457 million tonnes by 2013, globally, demand is expected to climb by 478 million tonnes to 1677 million tonnes.

With prices expected to fall and supply to rise, the Indian steel industry will continue to play a key role as a supplier to the global market.

India opened its capital markets to foreign investors fifteen years ago. Since then, the government has continued its market reforms to enable and encourage further investment.

Banks are no longer required to get prior approval from the Reserve Bank of India (RBI) for large loans, giving investors greater freedom to operate, while strict rules on capital adequacy make for greater strength and stability in the financial system.

In 2007, HSBC acted as sole financial adviser to Brazil-based steelmaker Gerdau SA in its acquisition of a 45 per cent stake in India's SJK Steel Plant Limited.. With this acquisition, Gerdau became an equal partner with Indian steelmaker Kalyani Steels, the controlling shareholder of SJK Steel.

Gerdau SA is among the world's top fifteen steel producers. As of June 2008, the company operated in 14 countries.

The SJK Steel plant in Tadipatri, in Andhra Pradesh, has a production capacity of 275,000 tonnes per year. Gerdau and Kalyani plan to expand production at the plant to 1.6 million tonnes, while upgrading the facilities with value-added features including the installation of new rolling mills.

The deal, which marked the first brownfield entry of a global steel player into the Indian market, highlights HSBC's ability to advise multinational clients in Indian investment and close complex corporate and financial restructuring transactions.

HSBC's partnership with Gerdau started in January 2007 and negotiations with the target company took about six months to complete. When Gerdau first approached HSBC for advice, the company already had a fair knowledge of potential Indian steel producers with whom it wanted to strike an investment deal, said Bhanu Singhal, an executive banker who was involved in the initial discussions. "Representatives of Gerdau in fact named Kalyani Steels when they first visited the London office of HSBC seeking advice on Indian investment opportunities," Mr Singhal said.

At the time of the investment, SJK Steel had reached its full production capacity, but outstanding debts meant additional investment was necessary to finance its expansion, explained HSBC investment banker Sumit Jain, who was closely involved in the deal. The agreement with Kalyani Steels relating to the SJK steel plant involved a Corporate Debt Restructuring (CDR) scheme, under which part of the the plant's debt was waived, with the rest to be paid as per the terms of the scheme.

It takes confidence for a foreign company and first-time investor, who may be unfamiliar with India's regulatory environment, to invest in a financially distressed business, Mr Jain said.

"HSBC played an important role here in advising Gerdau on the background to the restructuring plan, its formalities and the Indian legal structure," said Mr Jain.

However, the established reputation of parent company Kalyani Steels in the Indian steel industry helped the negotiations. "By the time the agreement was signed, the client was well aware of the financial status of SJK Steel and in the end Gerdau got this asset at a valuation that they were agreeable to," said Mr Jain.

"The bank had to make sure that all documentation, all processes and all the formalities were completed for the court to approve the CDR scheme, and that all the parties agreed. These were preconditions that had to be fulfilled before Gerdau could complete the deal."

Breaking new ground for global investors

"This deal is special for India, as prior to this, there had not been any steel major that had come to India and bought an existing operational steel asset. There are other major international steel players who have big plans for India, but they are doing it on their own on a greenfield basis. So in terms of a brownfield acquisition of a steel company in India, this was the first acquisition of its kind," explained Mr Jain.

HSBC with its emerging markets identity once again proved its capability in advising and facilitating a cross-border deal between players from two emerging markets. "Among the key challenges involved with the deal were a complex valuation exercise, complexities involved with a CDR package and negotiations with a hard-to-please Indian target company", Mr Jain said.