What is the cost of a bad acquisition?

What is the Cost of a Bad Acquisition?

Let’s understand by looking at one of the most profitable steel companies in the world.

Tata Steel Standalone business.

The Operating margins (OPM) of Tata Steel standalone have hovered between 20% and 40% over the past 12 years, numbers unheard in the sector.

But Tata Steel Consolidated numbers tell a very different story. Consolidated OPM have moved between -1% to 25% over the last 12 years.

Why the difference?

Tata Steel acquired Corus Steel in 2007, in a leveraged buyout, which involved taking up a huge debt.

Corus Steel was loss-making, and was 4 times the size of Tata Steel India at that point.

Result – years of pain in managing an inefficient business.

Average Profits over the past 12 years
Tata Steel Standalone : Rs 8900 crore
Tata Steel Consolidated : Rs 6700 crore

The subsidiaries on average lost Rs 2200 crore over this period. Average extra interest paid each year by subsidiaries was nearly Rs 3000 crore.

Extra 35000 crore interest over 10 years! That is the cost of bad acquisitions. Not even considering the opportunity cost.

Tata Steel stock price before the acquisition was Rs 90 (adjusted for the recent stock split) – in 2007. It crossed that recently in 2021. Nearly 13 years of no returns, trying to turn around a loss making company.

Image Source: Screener

Of course to be fair to the company we have hindsight bias now, and this was not known before the acquisition. But this is why leveraged buyouts are tricky. If they fail, they can become a massive drag on existing profitable businesses as well.