Case study Economic times article

Corus buy: Tatas may go for leveraged buyout

TNN Oct 11, 2006, 01.21am IST MUMBAI: Tata Steel is likely to follow in the footsteps of Tata Tea. India's largest private steel company is mulling a leveraged buyout (LBO) of Corus, where it will raise debt on the strength of the Anglo-Dutch steelmaker's balance sheet. The Jamshedpur-based steel company had earlier in the week said it's reviewing a number of global acquisition opportunities that also included Corus. According to investment banking sources, Tata Steel could raise debt of about $6.5bn to finance the $8-10bn needed for acquiring Corus. In '01, Tata Tea had used the LBO route to buy the UKbased Tetley. Ads by Google

QuickBooks OnlineMust Have Tool for Business Owners. Access Anywhere. Try it for Free! quickbooksonline.in HDFC Life Term PlanPremium Starts@Just 2000/yr. 30 Years Life Cover* Buy Online Now www.buyhdfcslonline.com

"Tata Steel will use a special purpose vehicle to oversee the LBO," said the sources. As was reported earlier in ET, Tata Steel is expected to set up the SPV with participation from holding company, Tata Sons, and financial institutions. LBOs became famous in the 1980s when private equity funds such as Kohlberg Kravis and Roberts (KKR) popularised it. The most famous LBO was the contentious takeover of RJR Nabisco immortalised in the book 'Barbarians at the Gate'. Purnendu Chatterjee had tried to adopt this route in his abortive bid for Basell Polyolefins. In an LBO, the acquirer raises high-yield debt based on the cash-flow of the target. After the acquisition, the debt is paid down by using the cash flows. Its supporters say that LBOs help a company become leaner and more efficient as non-core, unnecessary assets are disposed off. Corus, as on August 30, '06, had net debt of $2.5bn and an EBITDA (operating profit) of $800m. "The Tatas can raise debts against the future profitability and balance sheet of Corus. Other specific instruments like mix of external commercial borrowings and bullet repayment debts can be used," explained the sources. The LBO-route is a standard option used in acquisitions across the globe.

Tata Steel, which through its plans on Corus, has led to a revival of interest in steel shares, has about four weeks to announce a formal offer to the shareholders of Corus. Thereafter the company, according to UK's City Code on Takeovers and Mergers, will have 28 days to post offer letters to the British steelmaker's shareholders. The development comes after the UK Takeover Panel, which foresees merger and acquisition activities in the UK, put Corus in 'offer period'. Tata Steel had last week stated at London Stock Exchange that it is reviewing a number of global opportunities, including Corus. "The announcement by Tata Steel put Corus in the offer period. While the time frame varies, the Indian company now has about four weeks to make the formal announcement," said legal experts. "In other words," they added, "Tata Steel will have to opt either for the 'put up or shut up' clause to make or decline to make an offer within these four weeks." While sources close to the development said that the Indian major may make an offer "much before that," British media speculated that it may wait until Corus has paid its interim dividend on October 16. On the other hand, guidelines provided by the City Code can stretch the acquisition for more than three months. "But that depends on the companies involved. Unlike the hostile bid by Mittal Steel on Arcelor, Corus has stated that it is looking out for suitors. The Tata group is already recognised among the general investors in the UK, after the Tetley acquisition," added the experts.

. FLOW OF PRESENTATION Introduction Tetley Tale of Tata Tea LBO Structure of the Deal Synergies Pre-Post Merger 2. INTRODUCTION One of the most important milestones in the Indian corporate history. In the Year 2000, Tata Tea acquired the iconic Tetley Brand in a 450 m. $ deal from Schroeder Ventures and PPM ventures. Tata Tea managed to fend off bids from Sara Lee and Nestle At the time of acquisition, Tata Teas net worth was only $ 114 m. It was also the largest cross-border acquisition by an Indian company at that time. This was also the first ever leveraged buy-out by an Indian Company. 3. TETLEY Established by Joseph and Edward Tetley in 1837 in Yorkshire, England. An Iconic brand, Tetley is considered to be the inventor of teabags At the time of acquisition, Tetley was the Second largest tea company in the World In India, Tata and Tetley Tea entered into a joint venture to produce tea bags in the Year 1992 4. THE TALE OF TATA TEA Incorporated in 1962 as Tata Finlay Limited Tea factory in Munnar(Kerala) and blending/packaging unit in Banglore In 1982, renamed Tata Tea ltd. after Tata Industries Ltd. bought out the entire stake of James Finlay and co. Set up Tata tea Inc in Florida to meet the demands of US market In order to meet the needs of Japan market entered into JV with Hitachi to form Tata Hitachi Sales Limited 5. In 1984, set up R&D facility in Munnar In 1989, bought 52% stake in Consolidate coffee limited of Karnataka By 1994 bought 64.5% stake in Asian Coffee to consolidate its position in the coffee industry 6. WHY THE DEAL MADE SENSE? Complementary specializations. Readymade access to the European and North American market. Financial setbacks for Tetley in

recent years. Acquisition enabled Tetley to reduce its debt- equity ratio. Integration structure. 7. LEVERAGE BUY-OUT Acquisition of a company through a combination of equity and debt Jerome Kohlberg, Jr. and Henry Kravis coined the term Formation of SPV Stock Purchase Format Asset Purchase Format Management Buyout Future Cash Flows or the Assets of the company as security Increased Debt Equity ratio 8. ADVANTAGES OF LBO: Heavy Interest & principal forces management to improve performance & operating efficiencies such as Cost improvisation cost reduction Divesting non-core business Investing in technological upgrades Significant reduction in agency cost Tax shield 9. DISADVANTAGES OF LBO Financial distress uncertainties Increased fixed costs associated with debt financing can worn out the effect in case of downturn in business cycles. In Leveraged acquisition, banks have a say in what is being done. 10. LARGEST ACQUISITIONS BY INDIAN COMPANIES 11. STRUCTURE OF THE DEAL Special Purpose Vehicle - Tata Tea(Great Britain) To acquire all the assets of Tetley To ensure that Tata Teas balance sheet does not suffer additional funding costs Will be merged into Tata Tea Ltd, once it has paid its debt obligations 12. SPV 100% TATA TEA TATA TEA INC subsidiary (15 mn) GDR Issue (45 mn) SPV (10 mn) TATA TEA GREAT BRITAIN (70 mn) 13. SPV The SPV leveraged the 70 mn equity 3.36 times to raise a debt of 235 mn to finance the deal Entire debt amount of 235 mn comprised 4 tranches A, B, C and D whose tenure varied from 7 to 9.5 years Coupon rate of around 9% (LIBOR + 424 bps) Where did it go? Tetley Acquisition 271 mn Legal, Banking and Advisory services 9 mn Tetleys WC requirements - 25 mn 14. Netherland based RABOBANK - 185mn Intermediate Capital Group - 30 mn Venture capital funds Mezzanine - 10 mn Schroders - 10 mn Debt raised against Tetleys brands and physical assets Valuation on the basis of future cash flows 15. DEBT REPAYMENT STRUCTURE A B C DAmount 110 mn 25 mn 10 mn 20mnLoan Type Long Term Long Term Long Term RevolvingPurpose Funding Funding CAPEX WC Acquisition AcquisitionYear of 2007 2007 2008 2007MaturityPay Back Semi Annual 2 instalments 2 instalments Cessation ofMethod Installments in 07-08 in 07-08 Credit 16. TATA TEA SCHRODER TATA TEA MEZZANINE S INC 10 mn 10 mn GDR 15 mn INTERMEDIA 45 mn TE CAPITAL GROUP 30 mn 10 mn TATA TEA GB RADO BANK 185 mn EQUITY DEBT 70 MN 235 MN 271 mn 9 mn 25 mn TETLEY LEGAL AND ACQUISITIO BANK TETLEY WC N CHARGES 17. MERGER - THE PROCESS In structured finance the word tranche refers to one of several related securitized bonds that are offered as part of the same deal. They are called tranches since each bond is a slice of the deals risk. All the tranches together make up what is referred to as the deals capital structure or liability structure 18. STRUCTURED FINANCE. Tailored financing solutions Financing with hybrid securities Asset-backed securitization Leveraged and acquisition finance Uses of structured finance: aligning securities to investor needs - term, credit risk, prepayment risk, interest rate risk, etc

19. CONCEPT OF SPV - EXPLAINED Tata Tea (GB) and SPV was created as a part of securitization process. Securitization is the process of pooling and repackaging of homogenous illiquid financial assets into marketable securities, that can be sold to investors. Tata Tea (GB) took over all the properties of Tetley 20. CONCEPT OF SPV - EXPLAINED Tata Tea originated Assets of Tetley through receivables, leases, any other form of debts and funded the same on its BS. ( Originator) Portfolio of Tetley assets were then sold to Tata Tea (GB) SPV for funding the assets. 21. CONCEPT OF SPV - EXPLAINED Tata Tea (GB) issues debts and purchased the assets from Tata Tea. Tata Tea (GB) was owned by Tata Tea Debts issued by Tata Tea are secured by assets acquired from Tetley ( Obligor). Tata Tea (GB) subcontracts the administration of assets back to Tata Tea. 22. CONCEPT OF SPV - EXPLAINED Tata Tea (GB) issued tradable securities tranches to fund the purchase of assets. The performances of these tranches were directly linked to the performance of the assets RaboBank, Prudential Mezzanine Capital, Schroder Ventures and Intermediate Capital Group purchased the securities offered by Tata Tea (GB). 23. CONCEPT OF SPV - EXPLAINED They all invested because they were confident that the securities would be paid in full and on time from the cash flows that is made available from the asset pool. Money collected by Tata Tea (GB) was paid to Tata Tea. As cash flow arises on the assets, Tata Tea (GB) used for repaying funds to the investors in the securities. 24. SECURITIZATION THE PROCESSAdvisor of the program- Financial Advisor Receivables- Legal Advisor Originator Obligors- Tax/Accounting Advisor Sales of pool Third parties of assets Transaction Servicer Transaction Administrator Corporate AdministratorCredit Enhancement SPV Bondholders Representative Credit Enhancer Paying Agent Liquidity Provider ABS Credit Rating Agency etc. Issuance Underwriter(s) Investors 25. SECURITIZATION THE PROCESS Tetley Ancillary Service Obligor Provider Sale of Assets Issue of Securities Tata Tea Tata Tea ( GB ) Investors Originator Special Purpose Vehicle Consideration Subscription of securities for Assets purchased 26. SECURITIZATION THE PROCESS Originator Tata Tea Sell/transfer the right to receive future cash flows (receivables) due under certain contracts to SPV (I) Special Purpose Vehicle (SPV) Tata Tea (GB) Purchase the right to receive future cash flow (I) Enter into contracts with originator, third parties and others relating to the transaction (I) Issue ABS to investors, ABS repayment relies on future cash flow due under contracts (I) 27. SECURITIZATION THE PROCESS In traditional methods of corporate finance, a corporation raises equity/obligations to own assets. In securitization, a corporation creates and securitizes assets - that is, transfers assets in form of securities. The claim is on assets, and not on the entity, hence, asset-based funding Asset backed funding lies in reducing the equity, and increasing the leverage 28. SECURITIZATION THE PROCESS SPV are used in securitization transactions as devices of hiving off assets and converting assets into securities. SPV are not

companies in substantive operations; they do not have any business except acting as a legal instrumentality. This is necessary to ensure asset- backed securities 29. SYNERGIES Tetley Access to Tata Teas gardens and production base Access to Indian market Tata Tea Tetleys premium brands and global distribution network 2nd largest in India to 2nd largest in the world Tetleys technical expertise Upgrade product portfolio and increase 30. POST MERGERTetley was expected to bring TTL volumes in theshort term and greater opportunities in the longtermTata and Tetley formed several groups teaprocurement group, geographic expansion group,R&D sharingLegal merger took time as Tetley D/E ratio was toohigh and it needed to come down to 1:1Initial Cultural differences 31. Acquisition contributed to significant increase in salesvolume Rs. 6870 mn before acquisition to Rs. 67256 mnin FY12 (CAGR of 18% approx.)As of FY12, Tetley brand contributes to 40% of TataGlobal Beverages revenueAs of FY12, Tetley is the only brand under Tata GlobalBeverages stable with presence across the globe 32. THANK YOU 33. EFFECT OF LEVERAGE ON ACQUISITION.Mr. A bought house on 31Dec 2003 costing Rs.7,50,000 at down payment of Rs. 75,000 10%For balance amount he took bank loan Rs. 6,75,000@ 7.5%. Mr. A will get rental income from this houseRs. 2,50,000 p.a. He will incur Rs. 10,000 towardshouse tax and additionally would require Rs. 50,000for maintenance p.a. All cash flows accrue at year end, and also rental remains fixed for next 5 years. Freecash flows of each year is used to repay debt. 34. Income Statement of Mr. A for 2003 2008 2003 2004 2005 2006 2007 2008Rental - 2,50,000 2,50,000 2,50,000 2,50,000 2,50,000LessMaintenance - 50,000 50,000 50,000 50,000 50,000House Tax - 10,000 10,000 10,000 10,000 10,000Rental Income 1,90,000 1,90,000 1,90,000 1,90,000 1,90,000Interest - 50,625 40,172 28,935 16,855 3,869Free Cash Flow - 1,39,375 1,49,828 1,61,065 1,73,145 1,86,131 35. Income Statement of Mr. A for 2003 2008 2003 2004 2005 2006 2007 2008Loan Amount 6,75,000 6,75,000 5,35,625 3,85,797 2,24,732 51,587PaymentsFree Cash flows - 1,39,375 1,49,828 1,61,065 1,73,145 51,587 - Free Cash flow as calculated earlier from rental income after expenses & interest.Closing Bal. 6,75,000 5,35,625 3,85,797 2,24,732 51,587 0Interest -- 50,625 40,172 28,935 16,855 3,869- Closing bal = (opening bal free cash flow ) Interest is calculated on closing bal.Debt 6,75,000 5,35,625 3,85,797 2,24,732 51,587 0Equity 75,000 2,14,375 3,64,203 5,25,268 6,98,413 7,50,000RatioDebt 90% 71.4% 51.4% 30% 6.9% 0%Equity 10% 28.6% 48.6% 70% 93.1% 100% 36. LBO - INFERENCES Thus it is evident from Equity ownership as % of total capitalization increases from 10% to 100%. We can conclude that advantage of leverage in financing enable to own an asset of relatively significant equity value with regards to amount of initial equity investment.