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Essar Gujarat - A Strategy Case
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The case was written by Namit Mehta, Satyendra Kumar, Vishal Karanwal, Vivek Gupta

The Essar Group: Diversify to Doom

All the major business newspaper headlines in India on 21 July 1999 were screaming, "Essar creates history, defaults on FRN $250 million". Essar group had defaulted on its loan repayment of $250million of floating rate notes in international markets. It became the first Indian Company to default in International market raising fears in Indian corporate sector regarding future fund raising capabilities in the international market.

For last one year, it had been frantically trying to avoid the unavoidable, and in the process, rolling itself in many controversies. During 1998, steel consumers had accused Government of India in media of creating import barriers to favour and bail out Essar. This created a political controversy and caused embarrassment to the government. Essar became an untouchable for government controlled financial institutions. The financial institutions, which had major exposure in Essar, backed off and left Essar in the lurch when it came to disburse sanctioned loans for the ongoing projects of Essar. It was not only a financially disastrous year for the group but its public image also suffered a major setback.

Ruia brothers, Shashi, 55 and Ravi, 50 who had stunned Indian corporate sector with their vision and daring entrepreneurship were today in a quagmire of their own making. While on diversification spree, entering one business after another, they were obviously not aware that very soon the group would become a case study at the management school.

Today Essar group is considering various options to consolidate, sell companies that it had nurtured with heavy debt exposure in past few years. Its major companies are in core infrastructure areas with strict regulations, controls and major government role and interventions. Essar is wondering what went wrong in its dreams and their executions. Was it fate, Pokhran nuclear tests in 1998, continuing recession in Indian and world market, stock market depression in India or was it structured to doom.

Group Profile

Nand Kishore Ruia, a marwari businessmen settled in Madras in 1956, founded the Essar Group. Essar started off by exporting iron ore. In 1966, it acquired a stevedoring contract for bringing iron from the mine heads and loading it onto sheds. His sons; Shashi (ESS) and Ravi (AR) diversified from family business of trading and ventured into shipping in 1969. After shipping Essar moved into construction activity and then into the supply of critical support services for the oil and gas sector. Their major breakthrough came in the form of a drilling contract awarded by ONGC. From these successful medium-sized businesses in marine and port construction, oil-drilling, and shipping, Essar first took the opportunity provided by the gas pipeline to start a very successful sponge iron business.

It has been the entrepreneurial sprit and opportunism that has been driving the group from a Rs. 150 crore shipping company to a Rs. 4000 crore conglomerate. The group was slowly adding one business after another until late eighties.

In 1990s, Government of India started economic liberalisation programme that promised growth and vision of catching up with late industrialising economies of Southeast. Capital markets were opened up and raising finances became much easier and it became a prime facilitator of rapid growth. The incredible rate of growth of Essar group during this period saw them in virtually all the core sectors.

Ruia brothers had a resplendent vision of creating a huge empire and they exploited every opportunity that came their way and created many new avenues to realise their vision. Mr. Shashi Ruia engineered Essarís conquests and they were well capitalised by his younger brother Ravi. Essar restructured itself in 1994 to include senior professional managers from leading public sector undertakings to manage their growing, diversified businesses. These professionals were given free hand for running independent units. Mr. Shashi Ruia kept the groupís external environment & business development activities with himself. Ravi Ruia was given charge of the operations & overseas businesses. The second generation also started making their way in family business. Today Prashant Ruia is the director-in-charge of Essar's Power, Oil & Steel businesses along with communications and personnel. Anshuman Ruia looks after Shipping.

Essar group entered in global business by commissioning a $90 million cold rolled steel plant, Essar Dhananjaya (ED), in Indonesia in 1994 of 150,000 tonnes capacity fed by HRC from Essar Gujarat Limited in a joint venture with the Garama group of Indonesia. ED was to import hot rolled coils from Essar Gujarat's steel plant in India. During that period Ruias had been working up on setting more such ventures in Bangladesh, Saudi Arabia or Pakistan. The focus for such expansions was to beat possible downturns in domestic demand. Essar also acquired a three-year-old textile mill Woventex Ltd in Mauritius. Through this they wanted to move in Africa which they believed would soon see an economic upsurge.

On Essar new business strategy Shashi Ruia commented, "We will get into any new business that will make us more money".

Ravi Ruia commented on Essarís global strategy in 1994, "We are looking at impact of globalisation on existing businesses in country. Next we are looking for opportunities opening up overseas. Not just those with synergies with our existing operations, but also those that have potential for us". Commenting on new opportunities he said, "Today the canvas is wide open. We must have an open mind. We should have basic synergies with what we do, but we must not miss a major opportunity just because it does not fit in with our basic operations".

According to Prashant Ruia, Chairman of ESSMCO for reasons of fast acquisitions by Essar shipping limited is "Öbuying ships has become easier now; it takes less time and the access to funds is easier".

This philosophy became their prime motivator for a rapid expansion and acquisition. Their strategy hinged on a simple premise - one project will nurture another project & so on. In mid 90's, the joke at the corporate headquarters of Essar group at Essar House, Mumbai used to be that which new company has the group opened today.

Essar group wanted to increase its assets to Rs. 31,300 crore, income to Rs. 19,400 crore and gross profit to Rs. 7,500 crore by the year 2001-02. In this process they went on an expansion spree even at high cost debt to reap benefits from the post liberalisation growth in India. However the economy growth which they envisaged didnít last long. Their steel project was delayed. It was plague and then floods in Surat, Gujarat (their plant location) that took their toll on project. But major factors were their planning and project management skills. They had changed the project plan and basic technology number of times. Because of this they could not exploit the price boom in steel sector and could not repay the loans to the financial institutions. When they came on stream with steel plant, Indian economy started cooling off, Southeast Asian crises happened, overcapacity in steel sector led to a global glut and price recession in steel, all working against their risky debt strategy.

Today, it has assets worth Rs. 14,530 crore, income of Rs. 4,030 crore and gross profit of Rs. 1,150 crore. Essar is one of Indiaís leading business groups and has phenomenal presence in Steel, Shipping, Oil & Gas, Power, Telecom and few financial services companies besides other small businesses. Steel accounts for 70.30 percent of the group's turnover, while shipping accounts for 17.30 percent. The portfolio is rather diverse with very little synergy amongst them, except that all big companies core industries.

The financial performance of the Group Companies is indicated in Exhibit # 1 - 4. The equity pattern and liquidity ratio of all Group Companies is shown in Exhibit # 5. The Group Structure is shown in Exhibit # 6.

Essar Steel Limited (Erstwhile Essar Gujarat Limited)

Essar first took the opportunity provided by the gas pipeline to start a very successful sponge iron business and then, with the gradual opening up of the steel sector, had the vision to set up a world-class integrated steel plant. Essar established its flagship company named Essar Gujarat Limited which was later rechristened to Essar Steel Limited (EStL). It manufactures hot- briquette iron (HBI) which is a superior variant of sponge iron and hot-rolled coils (HRC) using the electric are furnace method at Hazira near Surat in Gujarat. EGS was the first in India to set up the world's largest gas-based sponge iron plant. Its Rs800 crore HBI project was planned with a capacity of 1.32 mtpa, which was later increased, to 1.76 mtpa.

EGL was initially planned as 100% EOU with an 8 lakh-tpa plant. Later on Ruias decided to expand the capacity to 10 lakh tonnes when the government allowed EOUs to set up large capacities. Again, when the government deregulated the steel industry in the wake of liberalisation, the plant capacity was doubled to cater also to the domestic market. Currently HRC unit has a capacity of 2 mtpa. The project was delayed, which increased the cost by 109% from Rs. 3350 crore in 1992 to Rs. 6,998 crore. ESL set-up iron ore pelletisation plant at Vizag with a 3.3-mtpa capacity to become a world class fully integrated steel company. The plant was scheduled to be operational by the end of 1995, with a 240-kilometer slurry pipeline to pump iron ore fines in the form of slurry from Bailladilla of Vizag, where it was to be palletized. However, the Rs775 crore project was commissioned in Vishakapatnam in 1996 and commenced production in November 1997.It was planned to supply 1 mtpa high grade iron ore pellets to EGL and the surplus was to be sold in the domestic and international markets. But later on it increased it supplies to 60 percent of its production to the Hazira plant. Essar Steel (EStL) planned to increase its pelletisation capacity by 4.7 million tonnes at the cost of Rs500 crore.

Essar Steel's hot rolled (HR) coils plant project cost increased by 109 percent to Rs 6,998 crore from the earlier estimate of Rs3,350 crore in 1992. The cost increased due to additions like a pellet plant and delay in completing the project. EStL planned to set up a mini blast furnace and use the hot metal for energy conservation. This work is currently under progress in mid 1999. EStL invested Rs340 crore in 11 companies that were expected to buy 40 percent HRC output of EStL. It set up downstream facilities to produce value-added products. A downstream complex with a plate line capacity of 400,000 tonnes was commissioned.

EStL is highly quality conscious so rejections are quite minimal. It has the highest operating margins and cash margins in the Indian steel industry. Its labour costs (according to Paribas Asia Equity) are $5 per tonne as compared to $49 per tonne for SAIL and $ 76 per tonne for TISCO, and its energy costs per tonne are half that of SAIL and TISCO. EStLís variable cost of production has been found to be amongst the lowest 17-percentile cost of production in the world as confirmed by Beddows & Co. report. This makes it one of the lowest cost producers of steel in the world. This is possible due to the high level of integration leading to high value addition and utilisation of the most efficient technology and international management practices.

The group faced severe cash crunch in 1995-96. ES had invested Rs. 217 crore in greenfield power and oil projects. Later on ESL spun off its 100 percent subsidiary, Essar Power (EP), which involved an outlay of Rs1, 845 crore to Prime Hazira Ltd. of Mauritius. This was done after it successfully closed the power purchase agreement with the Gujarat State Electricity Board, which would draw 300 MW of EP's 515 MW capacity. Essar Investments had acquired Sterling Computers for Rs213 crore through ES' loan of Rs255 crore.

The paid up capital of the Company on March 31, 1998 was Rs. 330.35 Crore and the net worth stands at Rs. 2414.09 crore. The company had a total outstanding debt of Rs. 5114 crore of which $250 million was due for repayment in July 1999.

Essar also acquired a 32% stake for $ 80million in Sesa Goa Ltd's (SGL) parent company Ilva Laminati Piani (ILP) manufacturing cold rolled steel. The Ruias had tried to acquire SGL earlier in 1990s but failed to do so. Essar will run SGL and also develop the Southeast Asian markets for Riva a 52% partner in ILP.

Essar Power

When government of India liberalised the power sector and encouraged private sector to bridge the huge demand-supply gap of electric power in the country, Essar took this opportunity to set up a 215 MW captive power plant for its steel unit in Hazira. There was an element of synergy in the above move because Electric Arc Furnace technology used in HRC steel project was highly dependent on consistent and cheap power supply. Later on Essar decided to increase the planned power plant capacity to 515 MW for selling surplus power to GSEB. With the successful commissioning of the power plant in 1995, Essar became the 1st Independent Power Producer. Essar Power Ltd (EPL) finally achieved financial closure in March 1998. EPL had a cost overrun of Rs469.89 crore due to the delay, taking the final cost of the project to Rs2314.89 crore. The cost overrun has been partly financed by the promoters through unsecured loans of Rs244.87 crore and bank loans of Rs150 crore. Repayment on the rupee term loans, which was to have started by April 1, 1998, started from April 1, 1999.

Essar used liquid Naphtha as the fuel for its plant. The power plant was 1st of its kind in the world to use liquid naphtha as the fuel. The choice of using liquid naphtha was prudent because of its surplus availability. It was also daring on the part of Essar because never before this type of technology was used anywhere in the world.

In line with their corporate vision Ruias planned an aggressive expansion strategy for power sector. Their objective was to have "2000 MW by Year 2000". Essar purchased equity in new upcoming power projects and also decided to set up Rs1, 350 crore 330 megawatt unit at Bhander in MP and a captive power plant with a capacity of 600 mw for their oil refinery in Vadinar. However, the groups worsening fortunes had a toll on their power plans. Essar suffered a severe cash crisis and Bhander project could not take off. The captive project at Vadinar is in a very bad shape. Ruias started to negotiate for selling their power company to American Marathon group in June.

The company was then floated as a separate company with Prime Hazira of Mauritius, a privately held concern of Ruias, as its main promoter and shareholder with 49% equity. This hiving off of power plant raised controversy about Ruias intentions of shareholder value. The Ruias generated the funds from internal resources and later on diverted them to companies in which they had substantial holding. This sullied the Ruias reputation as an investor friendly transparent group.

Essar Oil

Incorporated in 1989, Essar Oil was started as a fully owned subsidiary of Essar Gujarat limited. Essar oil Limited (EOL) was later hived off as a separate company. EOL has three main divisions - energy, offshore exploration and petroleum products, in addition to the new refinery being set up at Jamnagar. Its offshore division undertakes construction related to the oil industry for extraction of oil and gas reserves.

EOL decided to set up world's largest 9 million TPA grassroots refinery at Vadinar in Gujarat. The refinery is designed to process crude oil from the Middle East and a variety of other crudes to manufacture petroleum products. Essar will also have access to the Kandla-Bhatinda pipeline, which is under implementation by IOC. The company will derive synergy through Essar Shipping's fleet of tankers, the largest in the Indian private sector.

The initial project cost of Rs. 5,350 crore was to be financed with a debt-equity ratio of 1:1. The project was to be financed by Rs. 2,900 crore equity and Rs. 2,430 crore debt. The promoters' including Essar Shipping, SISCO, Essar Steel Ltd and the Chandarias have a stake of 45 percent at present while public holds remaining 45 percent. The promoters' contribution to equity is Rs. 600 crore. Essar Oil refinery project in Gujarat faced cost overruns of Rs465 crores to Rs5815 crores. . The project financial structure then had a debt component of Rs3, 531 crore and equity component of Rs2, 284 crore. The project capacity was increased from 9 M tonnes/y to 10.5 M tonnes/y to increase profitability at an investment of Rs1, 000 crore. Due to loans taken from financial institutions during 1996- 97, the interest coverage ratio stood at 3.35.

The oil division owned 12 rigs with a drilling ship 'Essar Discoverer. When government of India allowed the private sector to exploit developed minor oilfields and explore new ones, Essar, by then one of the largest drilling contractors in the Gulf, was quick to bid. EOL signed production-sharing contracts with 2 exploration blocks in Rajasthan and 1 in offshore Saurashtra. Essar has got approval for the development contract for the Ratna and R-Series oil fields.

Essar Shipping

In 1969, the Ruias established a shipping company under the name of Essar-Bulk Cargo Carriers (EBCL). The company exported iron ore from Madras. This company was later merged with Karnataka Shipping Corporation in 1983. In December 1984, the company was rechristened Essar Shipping Limited (ESL). ESL's main business is ship chartering and ship trading.

ESL's capacity increased to dead wt .394 million tonnes by 1987. After 1987, when government liberalised shipping, Essar went on aggressively expanding its fleet. By 1992 Essar shipping had a turnover Rs 355 crores and a dead wt capacity of 1.24 million tonne (314% increase since 1987). Essar made an open offer for South India Shipping Corporation (SISCO), and acquired it in 1992. SISCO's merger with Essar began by establishing ESSMCO (Essar -SISCO Ship management co.), managed by Prashant Ruia. In 1992, SISCO owned 14 ships.

Industry reacted differently to Essar's aggressive buying spree because of fundamental cyclic nature of shipping business. A Bombay based researcher commented "In a business characterised by a cyclical pattern of troughs and crests that could lead to serious problems". Essar had borrowed heavily to finance its purchases. ESL's gearing was high as reflected in its debt to equity ratio as stood on 31st March 1993, at 3.6:1. Ruias however underplayed the suggestions given by industry and justified their business as insulated from market conditions. ESSMCO's managing director Prashant said "India's international business is already growing and we have to be ready for the opportunities".

However Essar started consolidating its shipping business and merged SISCO in ESL in 1996. ESL applied brakes on its buying spree and started selling. Essar made a considerable amount of money by buying ships when the prices were low and selling them when they were in demand following standard international practices. Its fleet size was reduced from a high of 52 ships to 38 by 1999. The debt to equity ratio of ESL came down to 0.69:1 in 1998. In 1999 ESL is the second largest shipping company in terms of capacity (38 vessels, 1.42 million tonnes dwt). Essar has a diversified shipping fleet consisting of bulk carriers, tankers, multisport activities and offshore support activities. Tankers account for more than 70% of ESL tonnage and contribute a major portion of the revenue. It also owns several bulk carriers; most of the mini bulk carriers are employed mainly on coastal transport in both Indian and international waters. The fleet is the youngest in India, with an average age of seven years. A majority of the vessels are employed on long-and medium-term time charters, enabling stability of revenue generation even during the shipping downcycle. Essar had a comfortable position in the oil tanker cargo because of deployment on a cost plus basis. However with the disbanding of Administered Price mechanism (APM) in the oil sector, the cost-plus formula for crude tankers on Indian sector was withdrawn from 1st April 1998.

Essar Shipping has negotiated a $97-million loan from GE capital corporation (GECC), USA, one of the largest and with the longest maturity periods ever raised in the Indian shipping industry. In fact, the second tranche of the loan was disbursed recently after Essar Steel defaulted on its FRNS, testifying to the soundness of its shipping business.

Essar Telecom

When government opened up telecommunication in 1994 with new telecom policy, Essar saw a great opportunity and bid for various circles for providing basic and cellular services. In January 1995 the Essar entered into joint venture with Bell Atlantic, USA to bid for both cellular and basic services tenders floated by the Department of Telecommunications (DoT). Essar Gujarat group entered into an alliance with Sterling Cellular Limited, cellular licensee of Delhi in May 1995 and used their brand name Essar Cellphone to promote SCL's service. The Essar Group then launched its Essar Cellphone services in Rajasthan, Haryana and Uttar Pradesh (East) telecom circles.

In January 1996, Essar Telecom planned to tie up with JT Mobile Telecom Ltd, which had licences to operate cellular service in Punjab, Andhra Pradesh and Karnataka. Essar bagged the licences to operate basic telephone service in Punjab and the alliance was done to provide the synergy in operating both the basic and cellular services together.

In October 1996 Essar Cellphone planned to invest US$457.14 million in its cellular ventures in India and expand its subscriber base to one million by the year 2002. "Our plans are quite simply focused on becoming north India's leading cellular network," Essar Cellphone's CEO Jan Erik Boers said.

In October 1997, Essar Cellphone (EC) planned to launch an overseas debt offering of $240 million. In February 1998, The Essar Group floated a special purpose vehicle (SPV); a new investment company named Asia Pacific Infrastructure Ltd (APIL) in Mauritius, to route foreign equity investments into Essar Commvision Ltd (ECL).

In January 1998, The Foreign Investment Promotion Board (FIPB) approved Ruias' bid to sell 24 percent stake in Sterling Computers (SC) in favour of a group of overseas corporate bodies. In March 1998, Swiss Telecom (Swisscom) acquired 49 percent stake in Sterling Cellular, its Indian joint venture. It also planned a financial restructuring programme for the joint venture.

Tamilnadu Mercantile Bank

Essar group had mastered the art of diverting funds, and did not limit itself to the manufacturing or trading activities. They had a long association with Tamil Nadu and had been eyeing acquisition of Tamil Nadu Mercantile Bank, a Tuticorin-based leading bank. During 1994, Essar group acquired 71 percent stake controlling stake in TNMB, at a cost of Rs70 crore. TMB is bank run by Nadar community of Tamil Nadu. The Nadar's held 80 percent of the bank's Rs1044.04 crore deposits.

The takeover however entered into controversy when Nadar community protested against the transfer. There was an 18-month long tussle to gain control of the TNMB. RBI initially rejected the share transfer but later on the Company Law Board approved it. The Nadar community, which promoted the bank, tried to ensure that the control of the bank did not pass out of its hands. The community floated the Nadar Mahajan Bank Share Investors Forum and tried to buy back Essar's stake through its Share Retrieval Trust. The fight starting from RBI, CLB finally went to Supreme Court of India. Essar demanded Rs. 90 crore from Nadar community for buyback of shares in an out of court settlement. The Essar group by then had given up its hopes to acquire the Tamilnadu Mercantile Bank Ltd. (TNMB). Nadar community could not muster the much needed funds to buyback the shares. Essar then sold its stake for Rs130 crore to Mr. C Sivasankaran, an NRI businessman. The group achieved good returns on its investments of Rs. 70 crore made in TNMB to acquire majority stake two years ago.

Besides all these companies Essar holdings included two financial companies and investments of $50 million in Afro-Asian Satellite Company. There are numerous companies and ventures where Essar holds equity shares and future participation strategy.

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