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Acquisition Risks: How Market Fluctuations Can Impact Acquisition Dynamics
High energy costs for energy-intensive businesses like steel production, extra cost imposed by climate change policies and fall in international demand has made steel manufacturing challenging in the UK
Photo Credit : Reuters
The Tata Steel's announcement that it is examining options to sell its UK steel operation is reflective of classic acquisition risk where the acquirer cannot predict future market trends which can reverse the acquisition dynamics. The reason for this announcement are not hard to fathom. UK's steel industry has been dominating news headlines for the past few months. It has been facing severe problems primarily due to structural factors including global oversupply of steel resulting in slump in global steel prices, significant increase in third country exports into Europe, high manufacturing costs, continued weakness in domestic market demand in steel and a volatile currency.
High energy costs for energy-intensive businesses like steel production, extra cost imposed by climate change policies and fall in international demand has made steel manufacturing challenging in the UK.
Tata Steel's decision can also be seen as part of a wider trend that is playing out in the UK and where other acquirers in steel business failed to read market trends in UK. Earlier, in September, 2015, Sahaviriya Steel Industries (SSI) announced that it would be "mothballing" its major steel making plant in Redcar on Teesside in the North East of England. The Redcar plant included the second largest blast furnace in Europe. The company, a unit of Thailand's largest steelmaker, went into liquidation resulting in about 2,200 job losses. SSI had been struggling with increasing losses at the plant and reportedly had accumulated debts worth $1.4 billion.
In October, 2015 certain businesses within Caparo Industries group went into administration. Caparo Indsutries is part of a global network of businesses under the Caparo name, with operations in China, India and the US. Out of the approximately 20 individual businesses which were active in UK about 16 went into administration in October, 2015.
Given this trend, it becomes even more crucial to analyse the factors that has led to steel-making become unsustainable in the UK. China, which has been one of the key drivers in the global steel market, saw dramatic economic growth since liberalisation started in 1979.In 2005, Beijing designated steel as a pillar industry for the Chinese economy. This was done by the government primarily to support its plans for rapid modernization of its economy, construction, infrastructure and manufacturing industries. Even then, China accounted for 27 per cent of global production. That year, China suddenly transformed itself from a net steel importer to a net steel exporter. In 2006, China became the world's largest steel exporter by volume, up from the fifth largest in 2005. Today it remains the world's largest producer of steel, accounting for approximately 50 per cent of global production. China has, within a very short period of time, made astonishing gains in steel production and today manages to sell steel at a rate cheaper than the rest of the world. China's oversupply triggered steel prices to crash from about $600 a tonne to $300 and lower.
While Chinese oversupply has impacted the steel industry globally, trading conditions in UK have been especially challenging. Decades of underinvestment and a long-term decline in UK steel's international competitiveness has also played a significant role in UK steel's present position. The strong pound was one of the crucial factors for the decline in the industry. In the summer of 2015, sterling reached a seven-year high against a basket of currencies.
Another acquisition risk is to not factor in impact of cost dynamics. Many of acquirers in UK steel industry faced cost disadvantage at every stage of production relative to close competitors including high labour costs.
It is not always possible to predict market trends in an acquisition and these present an unforeseen risk that cannot identified through diligence or analysis. It would be realistic to make an early exit if the market trends post-acquisition are not favorable to limit continuous exposure.
Tata Steel's decision is in line with this principle and additionally to take advantage of the restructuring phase of South East Asia region. India is definitely offering a more favorable business environment with the announcement of minimum import price (MIP).
Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.