Tata Steel decides to go for follow-on

The Indian steel manufacturer will offer new shares at a 2% to 4.6% discount versus Friday's closing price, allowing it to raise up to $766 million.

Indian steel producer Tata Steel has decided to raise money through a follow-on public offering (FPO) and over the weekend set a price range that will allow it to raise between Rs33.86 billion and Rs34.77 billion ($746 million to $766 million). A portion of the deal (15%) will be available for potential anchor investors today and the subscription period for other investors will run from Wednesday until Friday.

Initially the company was thinking about issuing global depositary receipts (GDRs), or even non-voting shares. However, investors were not particularly keen on the latter and, after plans of the former leaked to the Indian press in the first week of January and the share price started to trend lower, the former became all but impossible to do. The reason is that GDRs have to adhere to a minimum floor price based on the average closing price over the previous two weeks and when the share price is on a downward trend the floor price is typically above the market price, making it impossible to issue the GDRs at a discount.

Based on Tata Steel’s 14-day moving average as of last Friday, the floor price would have been around Rs665, while the closing price on the National Stock Exchange of India on that day was Rs622.45. The floor price rule also applies to qualified institutional placements (QIPs), which are targeted only to institutional investors, but not to FPOs, making this an obvious choice for the company.

FPOs are structured more like an IPO with a portion earmarked for retail investors and a three-day online bookbuilding. They also allow for an anchor tranche, which is welcomed by institutional investors since it gives them a chance to buy a more meaningful stake, which is allocated in proportion to the order size. According to sources, there is huge interest from both international and domestic investors to participate as anchor investors in the Tata deal – to the extent that the entire deal could be covered by these orders alone.

The fact that Tata Steel is the seventh largest steel producer in the world following its acquisition in 2007 of UK’s Corus Group and one of the largest players in India where demand for steel continues to grow, is obviously a key attraction. And in spite of some concerns about interest rate hikes in India that has resulted in the local stock markets underperforming their regional peers so far this year, investors are mostly positive about cyclical industries in Asia right now. The deal is also likely to be treated as a liquidity event, offering investors an opportunity to put in sizeable orders without the risk of moving the share price.

Retail investors are also expected to be interested, given that this is the first offering from the Tata group in years that is available to the retail public.

Most of the anchor demand was said to be price insensitive, suggesting that the anchor tranche is likely to price at the top of the range.

The shares are offered in a range between Rs594 and Rs610, which translates into a discount between 2% and 4.6% versus Friday’s close. While quite tight at first glance, Tata Steel’s share price has fallen 11.8% since January 3, which marked a 12-month high and was the last close before news of the fundraising appeared in the Indian press. And, as one banker noted, it would be tough for the company to accept a steep discount on top of that stock skid. Indeed, the size of the offering has already come down from the early plans for a $1 billion deal two weeks ago, via talk of an $850 million transaction last week to the $746 million to $766 million sale that is now in the works.

The share price fell 0.23% yesterday after the price range was fixed, finishing the day at Rs621 and reducing the discount versus the market price by another few basis points.

Tata Steel is looking to sell 57 million new shares, which represent 6.3% of the existing share capital and some eight days’ worth of trading, based on the average daily turnover in the past three months. Of the total, 1.5 million shares have been set aside for company employees, leaving 55.5 million shares to be sold to public investors. Of that public portion, 50% will be offered to qualified institutional bidders, 35% to retail investors and 15% to high-net-worth individuals. The 8.3 million shares targeted at the anchor investors will come out of the QIB tranche.

The company is planning to use about half the money raised from the share sale, or Rs18.75 billion, towards the expansion of its main steel works in the Indian state of Jahrkhand. The plant currently has a crude steel production capacity of 6.8 million tonnes per annum, which it plans to increase to 9.7 mtpa. The total cost for this expansion is estimated at Rs163.72 billion and most of the additions are expected to come into operation in the financial year ending March 2012.

The rest of the money raised will be used to redeem non-convertible debentures and for general corporate purposes.

As with most Indian deals, Tata Steel has mandated a large number of bookrunners to help it arrange the transaction. In this case, the honours are shared by seven banks: Citi, Deutsche Bank, HSBC, Kotak Mahindra, Royal Bank of Scotland, SBI Capital Markets and Standard Chartered.

According to a report in the Indian press yesterday, four of these banks – Deutsche, HSBC, Kotak and SBI – have come under criticism by the government for getting involved in the Tata Steel transaction despite already being mandated for a follow-on by state-owned rival Steel Authority of India Limited, better known as SAIL. The latter isn’t expected to hit the market until mid-February at least, so it is a bit difficult to see that there would be much of a conflict of interest, but steel minister Virbhadra Singh reportedly referred to the presence of these banks in both deals as “unethical” and indicated that the government is contemplating taking action against them, potentially to the extent that it would remove them from the SAIL transaction.

Clearly the last word has not yet been voiced on this issue and it will be interesting to see how it pans out as any restrictions (explicit or implicit) imposed by the government on who can work on its privatisations and sell-downs could end up having implications for other deals as well – both with regard to the bookrunner line-up and the timing.

SAIL could raise as much as Rs80 billion ($1.7 billion) as the government is looking to sell a 5% stake and the company may offer the same amount through new shares. Except for the four mentioned banks, Enam Securities and J.P. Morgan are also mandated for the transaction.

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