Investigation: The Essar Steal A Deal

Whether or not Essar Steel is provided Rs 1,270 crore of fresh loans by the financial institutions, the manner in which the A.B. Vajpayee Administration has pushed through the package smacks of crony capitalism.

The phone rang. The Mentor came quickly to the point. "I believe these Businessmen are facing some problems" "Are they sitting with you, Sir?" asked the Advisor. "Yes." "Why don't you ask them to see me straightaway?"

A month later, the Advisor was spotted driving around Mumbai in a car that belonged to the Businessmen--and it wasn't a white Ambassador. Weeks later, the Advisor presided over a meeting in his room with a Bureaucrat, five Bankers, and the Businessmen, asking the former to help out the latter in any way they could.

Meeting over, all of them--including the Businessmen--went to call on the Bossman, which embarrassed the latter no end. He drew the Businessmen aside, pretended to chat with them over tea, and, later, came back to his table to be briefed before quickly terminating the discussion.

The word was out on the Hill. Someone was clearing a special deal for the Businessmen. Which the Advisor took the credit for, since he believed in the Cause, even at his birthday bash. "Inka kaam ho gaya (Their work is done)," he proudly declared, in public, to even their rivals.

There's a spreading stain on the Sultahe of Steel. Once again, the unmerciful glare of controversy is throwing harsh shadows of doubt on a financial deal swung by a business house in the twilight zone: the Rs 1,270-crore package conceived of by 3 financial institutions--with the explicit blessings of the A.B. Vajpayee Administration--for the Rs 2,652.45-crore Essar Steel, the flagship of the Essar Group. Caught in the crossfire of the charges of catalysing a sweet deal for their company are, obviously, brothers Shashi and Ravi Ruia, the powerful co-promoters of the group. Scam? Or no scam?

"THERE IS NO BAIL-OUT"

Prashant Ruia, 29, the young Director of Essar Steel, denies that his company is being favoured by the financial institutions. In a no-holds-barred interview with BT's Roshni Jayakar, a confident Ruia countered the charges hurled against the group. Excerpts:

Prashant Ruia ON THE PACKAGE. This is not a bail-out package. We requested the institutions to fund a commercially-viable project in the form of Essar Minerals' slurry pipeline, and for additional loans for the pelletisation project. As for the $250-million Floating Rate Note (FRN) redemption due in July, 1999, Essar Steel had intended to raise bonds in the US capital markets in May, 1998. The mandate was given to Chase Manhattan Bank. However, due to the sanctions imposed by the US Government, the transaction could not be completed. So, in July, 1998, we had approached the institutions for a proposal to re-finance the FRNs. In January, 1999, we made a presentation to the Union Finance Ministry to expedite the matter. We have a redemption due in July, 1999. We were in a hurry.

ON INSTITUTIONAL SUPPORT. The institutions are supporting us to the extent of Rs 378 crore of assistance to Essar Minerals, and Rs 350 crore for the residual capital expenditure of Essar Steel for the current year. The overall exposure of the institutions is not changing as the company is also repaying Rs 300 crore each in the current and the coming year. Net-net, the exposure remains the same. As far as the FRNs go, we are requesting for an export performance guarantee, which is linked to exports of $300 million of steel. We have tied up with a German firm, Thyssen Stahl Union, to provide us $300 million against an export performance guarantee provided by Indian banks. Yes, it is a fresh exposure, but it is a commercially-viable transaction that can stand on its own.

ON INSTITUTIONAL OVER-EXPOSURE. We strongly deny this. In the case of steel, institutional exposure to Essar Steel is among the lowest of all the projects financed by them. The institutions have provided only 29 per cent of the project cost. Even if you take the fresh funding into account, ours is the lowest: Rs 1,285 crore.

ON THE PROMOTERS' EQUITY INFUSION. We will bring in Rs 765 crore: around Rs 400 crore through the sale of Essar Steel's 41 per cent stake in Essar Power; Rs 200 crore as fresh equity; and Rs 166 crore from Essar Minerals, which will be spun off as a separate company by March 31, 1999.

ON MEETING DEBT COMMITMENTS. The break-up of the debt due in 1999-2000: frns: Rs 1,025 crore; the institutions' principal repayment: Rs 300 crore; and banks' securitisation: Rs 200 crore. In all, about Rs 1,600 crore. Of this, Rs 300 crore will be provided through fresh institutional funds, Rs 1,025 crore through an export performance guarantee, Rs 300 crore through the pellet-unit sale, and Rs 200 crore through operations. It is a problem of an asset-liability mismatch. The remaining debt is Rs 3,800 crore which, over a 8-year period, works out to Rs 300-400 crore per annum. This is equal to Essar Steel's depreciation. As long as we can meet depreciation, we can repay the debt in 8 years.

THE EXIT FROM DIVERSIFICATIONS. No, it is not a pre-condition by the institutions. These divestment proposals were made by us in 1996. Six months after the completion of the pipeline project, we will look for a strategic partner in Essar Minerals. The proposal to sell Essar Steel's stake in Essar Power has taken longer than expected because we expected a better price. But the sale should happen soon.

Sure, the Ruias claim that the financial institutions are only funding their projects in time; they aren't bailing them out. Claims Prashant Ruia, 29, Director, Essar Steel, who is the group's spokesperson: "Bail-out? What bail-out? There are no fresh loans, and the financial institutions are not even financing our Floating Rate Note repayments." However, the exit, with a bang, in February, 1999, of Mohan Guruswamy, the former advisor to Union Finance Minister Yashwant Sinha, who supported Essar Steel's cause--and, subsequently, that of the 11 other steel companies--only raised more sparks last month about whether the Ruias have swung a special deal, or merely concluded a restructuring of their financing.

That this has not been a run-of-the-mill issue is obvious from the fact that it needed the intervention of South and North Blocks, the involvement of the Finance Minister, and the interference of other senior functionaries in the Vajpayee Administration to bring it about. In fact, the government has publicly maintained that Guruswamy's exit was, primarily, caused by his role in pushing through the package. His rejoinder, as personally disclosed to BT, is that the real reason for his "sacking" was his ethical opposition to the numerous deals pushed by the politicians belonging to the Bharatiya Janata Party--such as a plan to sell the Unit Trust of India's (UTI's) holdings in ITC to bat Industries.

Then, Guruswamy also maintains that the same politicians in the ruling party were unhappy when he attacked the manner in which the financial institutions were going out of their way to help transnationals like Enron Corp. and GE Caps. Finally, he says he was fed up by the regular interference of the Prime Minister's Office (and House), as well as key ministers, in the decision-making process. For instance, Guruswamy alleges that it was the PMO that pushed through the coal-transportation contract for the Hinduja's 1,040-mw power unit at Visakhapatnam (Andhra Pradesh), and that a senior minister in the government wanted him to formulate an Essar-type package for the Mittal-promoted Ispat Industries too.

These controversies assumed a life of their own when the Opposition raised them in both the Lok Sabha and the Rajya Sabha. In an emotional outburst on March 5, 1999, Sinha offered to resign in case Guruswamy's charges were proved. "Agar mere ya sarkar ke khilaf ek ansh bhi sabit hua, to mein tatkal istifa doonga (Even if a part of the charges against me or the government are proved, I will resign immediately)." He added: "The issues raised by Guruswamy deserve to be dismissed with the contempt they deserve. I would say, with all the emphasis at my command, that there is absolutely nothing in this except the frustration of a man who has been sacked." That was not enough for the Opposition, which has been baying for the finance minister's blood.

Subsequently, Parliament has witnessed a series of discussions on the issues raised by Guruswamy--including the controversial Essar package. While the Vajpayee Administration maintains that Guruswamy exceeded his brief in the Essar imbroglio, the latter--with the help of the Ruias--defends the deal with the financial institutions (see interviews). While the Ruias maintain that politics had no role to play in the process, Guruswamy claims that Sinha was fully informed about the fact that North Block was orchestrating it--including the key meetings with the heads of financial institutions. Claims Guruswamy: "Yashwant Sinha was always informed about everything. Nothing was done without his knowledge."

Surely, there are economic truths--and lies--b lind the political lies and truths. Explains Prashant Ruia: "Our application is over 10 months old. In January, 1999, we made a presentation to the Union Finance Ministry, asking them to expedite the matter. We had a foreign repayment commitment, and we were in a hurry." Agrees Guruswamy, 50: "The package was designed for the entire steel sector. But Essar Steel was the first case to be taken up because of the risk that the company could default on its commitments in the international debt market." True, he conferred openly with the CEOs of the IDBI, the ICICI, the IFCI, the UTI, and the SBI, in the presence of the Ruia brothers, implying that this was no hush-hush deal.

On the other hand, BT learns that Guruswamy did not inform Union Finance Secretary Vijay Kelkar about it, which suggests that this was no routine affair. Tellingly, the IDBI, for one, has slapped stiff conditionalities on the package for Essar Steel. Explains G.P. Gupta, 58, Chairman & Managing Director, IDBI: "To protect our loans, we will ensure that the incomplete projects are completed as soon as possible." One interpretation of the strictness of the conditions: while the financial institutions may have had no choice but to follow North Block's orders, they could--and did--try to protect their assets. Of course, the controversy has ensured that Essar Steel will not get its resuscitation pill without a thorough scrutiny of the prescription.

It is a classic symbol of the financial institutions' belief that an unsafe loan becomes safe the moment the legal identity of the corporate borrower--but not the promoter--changes. To fulfil the pre-conditions set by the lenders, Essar Steel will have to lower its debt of Rs 4,800 crore which, on a net worth of Rs 2,414 crore, amounts to a gearing ratio of 2:1. Its first move: spin off its 3.30 million tonnes per annum (MTPA) pelletisation unit as a separate company, Essar Minerals, and earn Rs 997 crore from the transfer of the assets.

The structure of the deal is ingenious. Essar Steel will be allotted 33.40 crore shares (face value: Rs 10), amounting to 64 per cent of Essar Minerals' equity capital of Rs 518 crore. Significantly, the other shareholder in Essar Minerals will, probably, be the State-owned National Minerals Development Corp., which will hold a 36 per cent stake in the company. Thus, another Rs 184 crore will, for all intents and purposes, come with government sanction. However, the Ruias contend that the names of the strategic investors in Essar Minerals have not been decided--yet.

Of the remaining Rs 663 crore, Essar Minerals will take on Rs 143 crore of Essar Steel's debt incurred for this project onto its books. It will also pay Rs 520 crore in cash to Essar Steel, which will use a part of the money to pay back Rs 300 crore to the financial institutions. To complete the loop, Essar Minerals will borrow the Rs 520 crore from the same financial institutions--with the result that they will, effectively, be lending their money to Essar Steel to have their money returned to them. Officially, of course, the loans are to Essar Minerals, and not Essar Steel.

The only condition: the Ruias must also pump in an additional Rs 765 crore to pay back the financial institutions, as a result of which Essar Steel's debt will fall to Rs 3,687 crore. Of the promoters' contribution, Rs 450 crore must come from the sale of a 41 per cent equity stake in Essar Power, for which the Ruias are looking for a buyer. But then, the financial institutions will send the money right back to the Essar Group in the form of Rs 378 crore to Essar Steel for capital expenditure, and Rs 372 crore to partly bankroll Essar Minerals' Rs 1,553-crore 8-mtpa beneficiation unit and 8-mtpa slurry pipeline (although the latter may not materialise now that the IDBI's 4-member special sub-committee has come out against it).

Had the deal gone through as envisaged, the exposure of the financial institutions in the 2 companies would, actually, have increased by Rs 1,270 crore, with loans of Rs 378 crore to Essar Steel and Rs 892 crore to Essar Minerals. Of course, after the controversy surfaced, the financial institutions, supported by the PMO, imposed stiff conditions on the Ruias. Adds idbi's Gupta: "Any further assistance to steel companies, including Essar Steel, will be subject to pledging of shares, of upto 51 per cent, by the promoters in lieu of the loans. And, if the need arises, these shares will be sold to the highest bidder to bring about a change in management."

The other riders which may be attached to the latest package of loans sanctioned to the Essar Group--as revealed by a confidential IDBI Appraisal Memorandum (dated February 5, 1999) of Essar Minerals--include:

Clearly, the controversial financial package--even if it goes through--is in a form that may not be palatable to the Ruias. Which is what they may have been trying to side-step in the first place by calling in their political favours.

Essar Steel's financial problems stem from both the troubles plaguing the steel industry--which worked in its favour since the package could be justified as a sectoral, and not company-specific, initiative--and its own difficulties: low profitability, massive debt, stuck investments, and immediate repayments.

For one, profit-margins in the steel industry--specifically, Hot Rolled (HR) coils--have been squeezed by declining prices and over-optimistic demand estimates. Despite operating its hr coils unit at 90 per cent capacity, and a globally competitive cost-structure--$230 per tonne versus the global average of $250 per tonne--Essar Steel still has rusty margins. It posted net losses of Rs 226 crore in the first 3 quarters of 1998-99. Admits Jatinder Mehra, 60, Managing Director, Essar Steel: "The recession has hit all the players, in the business, but the worst-affected are new players like us."

Meanwhile, Essar Steel's debt burden is threatening to drag it under. Its interest outgo--at Rs 312.70 crore in the period between April and December, 1998--constituted 18 per cent of its sales. Besides, foreign exchange loans account for 40 per cent of the total, which have been bloated by the 35.64 per cent devaluation of the rupee in the last 54 months. And Essar Steel's urgent need for cash stems from its repayment commitments, such as the redemption of the 5-year $250-million FRNs in July, 1999.

However, the company's plan to extend maturities and even out cash-flows through a $300-million bond issue in the US in May, 1998, went awry because of the post-Pokhran-II sanctions imposed by the Clinton Administration. Explains Prashant Ruia: "We approached the institutions in July, 1998, to assist us in the refinancing of the FRN." Agrees Abhey Goel, 25, Assistant Manager (Corporate Advisory Services), Ernst & Young: "The package is necessary as the company doesn't have funds." Now, Essar Steel has tied up with the Germany-based Thyssen Stahl Union, which will provide $300 million against an export performance guarantee from the banks.

Unfortunately, the company has other commitments too. For starters, the Ruias must repay loans of Rs 1,751 crore in 1999-2000. There are also the liabilities on account of tax-dues (Rs 205.57 crore), future lease-rental payments (Rs 354.62 crore), and guarantees provided by the banks and the financial institutions to other companies in the group (Rs 1,892.31 crore). The situation is, indeed, grave. Why, Essar Steel had a negative cash-flow of Rs 319 crore in 1997-98, and incurred cash losses of Rs 17.05 crore in the first 3 quarters of 1998-99.

Actually, the Ruias' problems are of their own making. For one, they diverted money from their cash-cows like Essar Steel to pursue their other ambitions such as their entry into the power and refinery sectors. On March 31, 1998, the book value of the company's investments in the other companies in the group stood at Rs 281.55 crore besides loans and advances of Rs 804.67 crore. Points out Akash Deep Jyoti, 29, Senior Analyst, ICRA: "Although Essar Steel has reduced its exposure to the other companies in the group in the recent past, the figure should be reduced further." However, the promoters continued to expand although the danger-signals had been blinking.

For instance, the hr coils capacity was increased from 1.60 MTPA to 2 MTPA with an additional investment of Rs 811 crore. This was partially forced by Essar Steel's decision to commission the 3.30-mtpa pelletisation project to provide the raw materials for its sponge iron unit. Since Essar Steel will consume only 50 per cent of the pellets, the company will need other markets. Admits Prashant Ruia: "At present, the domestic consumption of pellets is 4 MTPA compared to a capacity of 5 MTPA. But we will be able to sell in Asia due to the $5 per tonne freight advantage we have over Latin American producers." Perhaps. Perhaps not, given the global glut.

States a confidential note dated January 25, 1999, written by Gupta to Guruswamy, detailing the assistance provided by the financial institutions to the steel sector: "Steel companies are likely to continue to operate in a difficult environment for the next 2 years or so. The recovery of domestic demand, and the consequent volumes growth, largely depends on economic recovery. However, increased supply will (still) restrict gains"

Agrees N. Krishnan, 32, Analyst, I-Sec: "Competition among domestic hr coil-producers will be intense. And companies that were talking of exports will find it difficult to increase sales since the US and Europe are lobbying hard to stall imports in their markets." If the floor-price on imported hr coils is, in fact, reduced from $302 to $280 per tonne under pressure from the users of the product--another controversy in itself--Essar Steel will only be in deeper trouble.

Given these conditions, is the financial institutions' money safe? "Yes," contends Prashant Ruia, adding, "the company's debt burden is not increasing. In fact, it will be reduced to the extent of the funds received from our divestment in Essar Power, and the spinning-off of the pellet complex into a separate company. The debt-equity ratio should fall to one of the lowest in the steel sector: from 2:1 to 1.34:1." He's right.

However, since its debt will initially drop to Rs 3,687 crore--and then go up to Rs 4,065 crore--a repayment tenure of 8 years for Essar Steel will mean an average annual repayment, besides interest, of just over Rs 500 crore. So, the company's cash-flows must be higher than that every year for the next 8 years for it not to go under. As per its projections--which, admits Prashant Ruia, "are more optimistic than the one given to the IDBI"--Essar Steels' net profits will increase from Rs 110.50 crore in 1999-2000 to Rs 1,283.50 crore in 2004-05.

Confirms a report prepared by the German consultancy company, Roland Berger, in May, 1998: "The competitiveness of any steel plant is largely determined by its steel-making costs. And the relative cost-position of Essar Steel in comparison to its domestic and foreign competitors is favourable." It reckons that the company's cash-flow will rise from Rs 642.50 crore in 1998-99 to Rs 1,079.50 crore by 2000-01. However, this pre-supposes, in addition to smooth sailing for the steel business, the group's exit from its other businesses. Reasons Prashant Ruia: "It has taken longer than expected to sell Essar Power because we expected a better price. But that should happen soon."

Obviously, its lenders are betting on a more focused Essar Group's ability to withstand any shocks. However, if the package is not eventually cleared--or if Essar Steel fails to make its repayment plans work--that will signal an end to the group's expansionist ambitions. Either ways, this controversy should teach the Essar Group a lesson that will stand them in good stead tomorrow: the old ways of doing business are dying. And what the Ruias need in order to survive in 2000 are no longer steely nerves, but steely strategy.

Researched & reported by
Roshni Jayakar, Alam Srinivas, Ranju Sarkar & Rakhi Mazumdar

"THE FM WAS ALWAYS KEPT INFORMED"

He was the man in the hot seat--until he opened his mouth. Mohan Guruswamy, 50, the former advisor to the Union Finance Minister, explains his role in l'affaire Essar Steel in an exclusive interview with
BT's Alam Srinivas:

Mohan Guruswamy ON WHETHER HE PUSHED THE ESSAR STEEL PACKAGE. I didn't push the Essar Steel package. It was the Finance Minister who And there was nothing called the Essar Steel package. Steel was one of the 6 core sectors facing problems. I participated in some of the meetings. I gave my inputs and views. But I didn't participate in the executive decision-making. For instance, the floor-price for imported Hot Rolled (hr) Coils was fixed by the Inter-Ministerial Committee. I only gave my inputs to the Finance Minister.

ON WHY ESSAR STEEL'S CASE WAS GIVEN SPECIAL CONSIDERATION. The Essar Steel case was not a bail-out because the company had no problems, and it did not want any money from the financial institutions. The only problem was its Floating Rate Note commitment in July, 1999. I realised that a default by a large corporate house in the international markets could have had ramifications for the Indian economy. So, we were trying to do something about that. That's all. You can call it a bail-out or a package, but that is all nonsense.

ON THE ROLE OF THE FINANCE MINISTER. The Finance Minister asked me to talk to the financial institutions and get the (package for the) steel sector going. He also said: "Let's have a meeting on the sector with the institutions." I said that the financial institutions say they cannot consider the steel sector as a whole in one meeting. One has to consider each group because each group has peculiar problems. Which is how, instead of the (entire) steel sector, one company was considered at a time. The meeting with the chiefs of the financial institutions to discuss Essar Steel was called by the Finance Minister, and it was held in his office. Yashwant Sinha was always informed about everything. Nothing was done without his knowledge.

ON WHETHER THE $302 PER TONNE FLOOR-PRICE ON HR COILS WAS JUSTIFIED CONSIDERING THE RECOMMENDATION OF $245. If you initiate anti-dumping measures to provide protection to indigenous steel producers, steel-users are hurt. But when you give reference-prices which are over $50 per tonne more than what was recommended by the Inter-Ministerial Committee, you give credence to what the critics are saying. A decision was called for. And I would have supported a decision which was based on the assumption that if $245 is the cost of production, then that should be the floor-price. But the mystery is over how this price went up. Which is why I too questioned the $50 difference.

ON HIS PROXIMITY TO THE RUIAS. I HAD NOT MET THE RUIAS TILL I CAME TO THE FINANCE MINISTRY. It was Yashwant Sinha who introduced the Ruias to me. My office was an open house. I didn't throw any tantrums, I didn't make any demands, I did not want any gifts.

ON L.K. ADVANI'S ROLE IN PUSHING THROUGH THE ESSAR STEEL PACKAGE. (L.K.) Advani had no role to play. Even if he had asked me to do it, I wouldn't have done it if I felt there was something wrong. Even Advani can't make me do things. For example, if Advani had asked me to support the sale of UTI's (Unit Trust of India's) stake in ITC to BAT Industries, I would never have done it. Period.