Jeremy Warner's Outlook: Winner's curse threatens Tata as Indian steel maker risks all to pay top dollar for Corus

F&C/New Star: what a contrast; Interest rate rises are beginning to bite
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The Independent Online

Ratan Tata, chairman of Tata Steel, has let his heart rule his head in bidding so much for Corus. The Tata camp was said to be "overjoyed" at its victory yesterday while Mr Tata himself described it as "a moment of great fulfilment for India".

Yet the bottom line is that at £6.7bn he has been forced to pay a third more than what the Corus board originally agreed was a full and fair offer for the Anglo-Dutch steel maker.

Well done the hedge funds, and well done, too, David Cummings, head of UK equities at Standard Life Investments. Their judgement proved rather more reliable than that of the Corus board in thinking Corus would go for at least £6 a share.

Yet in meeting their expectations, Tata Steel has shown an element of hubris which puts both its own and Corus's future in jeopardy. This is really far too much to be paying for a business as operationally geared as Corus.

The great bulk of the outlay will come from the debt markets, with the borrowings secured against the cash flows of both Corus and Tata. The upshot is that, come the next downturn, Corus will struggle to service its debts and may even go under in the ensuing capacity shakeout.

With its much lower cost base, Tata will no doubt survive, but it is unlikely to be left unscathed. Ambitious expansion plans in India may have to be curtailed.

Mr Tata described the 11 per cent collapse in his share price yesterday as "harsh", yet it may if anything have been an underreaction. Rarely has the expression "winner's curse" seemed so apposite. In allowing himself to be bid up so far by his Brazilian rivals, CSN, Mr Tata seems to have forgotten the extreme cyclicality of Corus's history, where the company would be riding high one moment and be on the verge of bankruptcy the next. This is not a business which can safely take on so much debt.

Philippe Varin, the Corus chief executive, claims to have put the company on a more sustainable footing with his restructuring of the last three years. Forgive my scepticism, but I've heard the same script too many times before in the long and troubled history of British Steel for this to be at all credible. Come what may, the European steel market faces a future of steady decline. Its steel makers, what's more, face a still more uncertain future of growing competition from the low-cost producers of the developing world.

Is not this just the Tatas trying to keep up with the Mittals? In its literal sense, this may be a somewhat unfair way of looking at it. Tata is a very different type of business dynasty to that of Mittal. It's much older, for a start, and with extraordinarily diverse interests. Furthermore, it is controlled not by family but by a charitable foundation. Mr Tata, though a descendent of the founder, is not the owner of the business as such, but just a salaried employee.

Even so, there is an element of truth in the observation that this is all about keeping up with the Joneses. When Mittal Steel bought Arcelor, it fundamentally changed the game in global steel making. Both Tata and CSN took the view that they had to bulk up with assets in rich, developed markets if they were not to be trodden on by Mittal. Ambitious expansion plans in their own, fast-growing, home markets would not of themselves be enough.

One of the reasons why Corus has gone for so much is that it is one of the few remaining assets of this type which it is still possible to buy. A company where chronic overcapacity used to be the defining story suddenly, and somewhat unbelievably, found that it had scarcity value. What's more, there are a number of perfectly good reasons for believing the steel cycle permanently shifted on to a higher level. Rapid economic growth and demand in the emerging markets of Asia, Russia and Latin America has quite plainly changed the dynamics of demand.

In any case, that is what Mr Tata is banking on. If the industry reverts to the old pattern of boom and bust, then he's in trouble. As it is, he's paying a lot more for Corus - around 7 times 2005 earnings before interest, taxation, depreciation and amortisation - than at 5.7 times Mittal paid for Arcelor. He's also paying exclusively in cash. He has none of the equity cushion that Lakshmi Mittal applied with Arcelor.

The multiple is reduced a bit by the $350m of synergies Tata expects to derive from the deal. However, these may be harder to achieve in practice than Tata thinks. Very little of this is expected to come from cost-cutting. Rather, it is to do mainly with purchasing, supply and growth synergies, which are invariably much more difficult to achieve.

Tata is paying top dollar for the supposed strategic advantages of being one of the big five world steel producers. In so doing, Mr Tata claims to be playing the long game. He'd better just pray that the short term doesn't catch up with him in the meantime. India's "moment of fulfilment" may yet become Tata's nemesis.

F&C/New Star: what a contrast

Further evidence that mergers in people-based businesses such as fund management don't work comes in the shape of a disastrous update from F&C Asset Management which knocked nearly 18 per cent off the share price yesterday. F&C lost an astonishing 20 per cent of its assets under management last year.

Given that markets rose strongly, this actually rather understates the true size of the outflow. Despite remedial action, it hasn't stopped yet. Additional institutional withdrawals of £5.2bn have since been notified. So serious has the position become that the board is being forced to consider what it delicately refers to as a "rebasing" of the dividend. For which read a swingeing cut.

Part of the outflow is down to changing trends in the fund management industry, with many institutions shying away from traditional "balanced" investment mandates in favour of more specialist ones which F&C is ill-equipped to provide. There has also been growing interest in alternative asset classes, such as hedge funds and private equity.

Yet directors are paid to keep ahead of such trends. F&C, whose investment performance has in any case been quite poor, has singularly failed to do so. Part of the explanation is undoubtedly the distraction of the merger with Isis, the fund management arm of the life assurer Friends Provident. This is self-evidently not yet working. They rarely do in fund management, an industry littered with examples of failed mergers.

Clash of ego, culture and style all too frequently leads to loss of performance and standards as infighting takes hold. Many of the best people will vote with their feet and leave. The contrast with John Duffield's start-up asset management business, New Star Asset Management, could hardly be greater.

He's now doing so well he's promising a £300m return of capital, worth around £1 a share, to investors in a business only quite recently floated on the Alternative Investment Market. This is not to be a share buy-back, mind, the preferred capital repayment mechanism of most big companies.

Buy-backs, much touted as the only sensible form of capital return by investment bankers, seem to do nothing for the share price and are quickly forgotten by investors. No, this will be real, cash in hand for all shareholders, of whom a large number are still the staff. Moreover, since New Star is AIM-listed, the capital distribution will carry taper relief of just 10 per cent capital gains tax. F&C investors can only look on and weep.

Interest rate rises are beginning to bite

Repossessions are rising sharply again, bringing back memories of the housing market crash of the early 1990s. Fortunately, this is not back to the future quite yet. The level of repossessions, though rising, remains small compared to back then, and, in any case, house prices are still rising. Even so, there is now clear evidence that higher interest rates are beginning to bite. The Bank of England may be able to get away with another rate rise yet. Any more would risk turning a likely soft landing in the housing market into a hard one.

j.warner@independent.co.uk

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