Business India, July 26-August 8, 1999
A group that became one of the icons os entrepreneurship in the early 1990s has suffered a setback. Will it learn from its mistakes and fight its way out of the corner?
It is a great view from the top of Essar House, an ornate structure bordering on the opulent. The Ruias manage their conglomerate, the Essar Group, encompassing steel, power, oil, telecommunications, and shipping, from their offices on the 19th and 20th storeys. From the glass-and-marble tower you have a bird’s eye view of the famous Royal Western India Turf Club, commonly known as Mahalaxmi Race Course, where fortunes are sometimes made but most often lost. Turning left, you see businessmen and executives sharpening their swings and putts with their irons on the golf course at Willingdon Club. Straight ahead is the panoramic expanse of the Arabian Sea and, if the weather's good, a clear horizon. Today, however, the monsoon has made the seas choppy. In the midst of their packed schedules with international bankers, as the Ruias cast glances at the turbulent waters, they must find the sight rather symbolic.
They have had many firsts in several businesses, of which they are proud of, but today they don't relish the new first: they became the first Indian corporate group to have defaulted on a foreign financial obligation by failing to redeem their floating rate notes (FRNS) worth $250 million on 20 July 1999.
What has gone wrong?
What will they do next? Are they going under? Will they survive this setback and bounce back? Do they have a credible plan for the same? These are several questions that Business India investigated. To put things in perspective and not be carried away by the down cycles in commodities, the more appropriate question to start with is: What did they do right?
If there was any proof needed that liberalisation would unleash true entrepreneurship in India, then Essar's growth in the last 10 years could be cited as one of the handful of examples. From 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 and then, with the gradual opening up of the steel sector, had the vision to set up a world-class integrated steel plant.
For Indians used to outdated steel technology in public sector mills, and the old works at Jamshedpur, Essar provided the first glimpse of world-class steel manufacturing, setting up a mill that produces two million tonnes of steel and hot-rolled coils with less than 2,000 employees. When many thought that India could be competitive because of cheap labour, Essar thought otherwise. Today 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.
Since an assured and cheap power supply is essential, they first went in for a 215 MW captive power plant and then, when the opportunity arose for independent power producers, expanded it to 515 MW. This power plant is run by a total of 38 people.
It is well known that Bailadila in Orissa produces the best iron ore in the world. However, lumps of iron ore are exported, while the fines or tailings mount up into ugly mountains at the rate of 8-9 million tonnes per year. In the monsoons a large part of these fines actually flow into the rivers, polluting the water. So Essar came up with a plan to convert them into pellets that can be fed directly into sponge iron plants as feedstock. Until now the South Americans had a monopoly over this product (DR-grade pellets). So Essar set up a modern pellet plant at Visakhapatnam (run by 75 people, including administration) producing 3.5 Mtpy of pellets. Since rail transport of fines costs about Rs400 per tonne, it planned a beneficiation plant that would upgrade the fines, and a slurry pipeline that would reduce the cost of transportation to Rsl00 per tonne. Essar designed it to carry 7 million tonnes, giving themselves enough scope to double capacity whenever required.
Essar had already built up expertise in shipping and port construction, thus building the required infrastructure at Hazira and Vizag was no problem. In fact, it actually gave them the flexibility to use pellets internally as well as export pellets from Vizag and steel or sponge iron from Hazira.
Similarly, when the government 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. When government took great time to carryon in this direction but opened up oil refining, Essar was one of the first out with a proposal to build a refinery. Since then, even though dozens of proposals were submitted by various industrial houses and public sector oil companies, the only ones under implementation are Reliance Petroleum (27 Mtpy) and Essar Oil (10.5 Mtpy with a provision to reach 24 Mtpy later). Reliance has announced the commissioning of its refinery, while Essar's is in an advanced stage awaiting commissioning in the second half of next year.
Restructuring a reputation
While financially restructuring the conglomerate, the Essar group is faced with an even more difficult task of changing public perception about itself. The problems with refinancing its floating rate notes (FRNS) leading to default have been accompanied by a large number of negative reporting in the media, which Essar claims is based on fiction rather than the facts. As a result, while Shashi and Ravi Ruia are talking to bankers, young Prashant Ruia is taking time off from hectic debottlenecking activities in the steel plant at Hazira. Important improvements are being made in manufacturing technology at Hazira which might soon take Essar Steel into the elite top tenth percentile of lowest-cost steel producers in the world. After all, with his costs down, if signs of another upcycle in steel prove to be true he might just start making some 24-carat gold at Hazira rather than "24carat steel" as the ad campaign says.
But today Prashant is courting the fourth estate. He has already met senior editorial teams of several newspapers and magazines and is telling others that he can meet them any time on their turf. The format of these meetings has varied from formal presentations and Q&A to free for all "court-martial". Prashant is not expecting remarkable immediate benefits from this communication exercise, but acknowledges that, if he had done enough of this earlier, maybe the media's perception would have been different by now. Nevertheless, armed with tons of documents, and his informal, amiable nature, he is chugging on. Clearly, he's hoping that, like the commodity cycles that he speaks so much about, there is also a cycle of a non-commodity called public perception.
However, Prashant Ruia also claims that negative public perception is not only a result of bad communication but also downright disinformation. One such example, he points out, is a forged document being circulated in media circles as 'Highlights of Heads of Financial institutions Meeting held in Delhi on 24 June'. Among other things the 'document' says, "The heads of financial institutions unanimously decided that the Ruias should be replaced from the management of the following companies at the earliest to ensure viability of any attempt to revive these companies: Essar Steel, Essar Oil, Essar Mineral, and Essar Telecom." When Business India tried to verify the authenticity of this document, we were told by a spokesman of IDBI, “Please be advised that the purported copy of the minutes of HIM (officialese for heads-of-institutions meeting) is not true and does not reflect the discussion held at the HIM."
In this atmosphere, some common allegations the Ruias are trying to refute are:
•’’Essar has diverted funds from publicly listed companies into family-owned ones. For example, from steel, oil, shipping, and power into telecom”
Essar Steel, Essar Power, Essar Shipping, and Essar Oil have not invested in Essar's telecom business as inter-corporate deposits, as secured or unsecured debt, or as equity. Ruias are ready to provide certificates from the elite top six audit firms, some of which have been vetting every financial move in Essar group as a part of implementing a code of corporate governance.
• "By floating a family owned entity 'Prime Hazira' and taking a minority stake in Essar Power, the family will make money in the current sale of Essar Power to Marathon”
Prime Hazira was set up as a special purpose vehicle in Mauritius to channel international funds into an independent power project. Accordingly, UBS lent it $75 million, which was used to bring equity into Essar Power. Prime Hazira's entry was with the knowledge and approval of the FIS and an undertaking that any future profit made by Prime Hazira by selling its stake would flow back to Essar Steel. JM Morgan stanley and Donaldson, Luffkins &: Jernette (DLJ) have structured the deal with Marathon for the 100 per cent sale of Essar Power. They were mandated to not only consult the lenders while maximising value for existing shareholders, but also make sure that the sale of Prime Hazira's holding was not to the detriment of Essar Steel and Essar Oil.
• "Funds from listed companies were diverted for the building of Essar House as a family property”
Essar House was built with family funds from the sale of real estate owned by the family in Maker Towers, Nariman Point, and elsewhere, and borrowings from HDFC. No funds from any of the listed companies were utilised in any manner for the same. Even now the listed companies pay rents and deposits to Essar House based on rates fixed by an independent real estate valuer.
• "Cost overruns and project padding are used by Ruias to siphon funds from projects”
Essar's capex per tonne of manufacturing capacity created in steel, oil, and power (per MW) are among the lowest not only in India but in the rest of Asia as well (see tables). These comparative figures are available in project appraisals done by financial institutions and other documents as well.
• "The FRNs have been bought by the Ruias at a discount and they are waiting for the FIs to refinance the notes so that they can make money”
According to a letter written by Chase Securities Inc on 18 June 1999, "to our knowledge, neither the Ruia family nor other affiliates of Essar own any material amount of the notes."
• "The Ruia family's international holdings are a mystery"
These are transparent and strategic investments. Acquiring the holding in ILVA Italy (one of the largest integrated steel producers in Europe) was financed by Essar Global, a family-owned company, with the full knowledge of the Government of India. Actually, Essar Steel wanted to pick up the stake in ILVA but RBI rules did not permit the same. The required money was raised as acquisition financing by Essar Global and repaid after partial divestment in favour of the Riva family. "The investment has bought considerable technological support for Essar Steel during its start-up phase (nearly 50 ILVA personnel were at Hazira), as a result of which we were able to achieve quality and ramp up capacity very fast. Now it provides a good source of understanding of the European steel market." With regard to P.T. Essar Dhananjaya in Indonesia, the promoters are Essar Steel, Essar Global, and the local Dhananjaya group. This cold-rolling unit is a major importer of Essar Steel's hotrolled coils and has done well even during the Southeast Asian crisis. Essar Global has also invested $23 million in the AfroAsian Satellite project - the first by the Indian private sector - promoted by Subhash Chandra.
The fact that such questions are being asked of this group are testimony to one of its weaknesses - the lack of an aggressive communication policy that is both reactive and proactive, a must for all modern corporations. But it is to be admitted that we as a nation are not known for objectivity. One day we hail them - "They can do no wrong" - and the next we condemn them - "They can do no right". Reliance, another business group which has risen fast, periodically suffers the same plunges in public perception. We can appropriately name this the "Azharuddin syndrome" after our cricket captain, who must know this phenomenon better than anybody else.
Jamnagar was the natural choice for both Essar and Reliance, because the Gulf of Kutch allows for all-season import of crude and is the shortest distance away from wells in the Middle East. Not only that - since refinery products are in great demand in north and central India and since a product pipeline already exists between Kandla and Bhatinda, a small extension from Vadinar to Kandla can evacuate the products to the north, while a central Indian pipeline is being planned by Petronet from J amnagar to Itarsi and Gwalior. Essar's own project engineers, who number about 800, are playing an important role in building, debottlenecking, and detail-engineering many of their projects.
When the government liberalised shipping, Essar expanded furiously and is today the second largest in terms of capacity (38 vessels, 1.42 million tonnes dwt). It owns six of the most modern double-hull, doublebottomed Suezmax tankers, which operate in international waters. It also owns several bulk carriers which operate 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 down cycle. 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 makes a considerable amount of money by buying ships when the prices are low and selling them when they are in demand following standard international practices.
When the government opened up telecommunication Essar, like 23 other business groups in India, saw a great opportunity and bid for various circles. With an astute plan it acquired the licences for basic services in Punjab and cellular services in Delhi, Punjab, Haryana, Rajasthan, and eastern UP through vendor and acquisition financing. "Big vendors like Nokia, Motorola, Ericsson, Siemens, and others have built huge capacities to supply telecom equipment and are facing a downturn in their business, so besides investment bankers, vendors too are aggressively funding acquisitions. The idea is that one pledges the shares to these companies and either borrows from them or gives them a certain equity stake with a clause to buy back later with a certain mark-up. Then, once the service is rolled out and a subscriber base built up, that is value is built into the business, one sells the whole or part of one's equity and repays the loans," explains Ravi Ruia. In effect, the licence-holder puts in very little of his own money.
This has become a standard method of funding telecom projects the world over. In fact, the entire telecom financing in China has been done this way. Though Essar faced problems in paying its licence fees to DoT recently, the new telecom policy has encouraged several banks and institutions to come forward with funds now. "The key fact is that we own cellular licences to most of north India and, with appropriate strategic alliances in Gujarat and Mumbai, we can harness the long-distance traffic between Delhi and Mumbai, where the cream of STD traffic lies," says Hemanth Luthra, CEO of Essar Telecom. Now that Swisscom, its foreign partner, wants to exit from its Asian businesses and focus on the new action in European telecoms, and Shivasankaran, the other minority partner, also wants an exit, Essar is seriously engaged in raising funds for acquiring the remaining 49 per cent in Sterling Cellular. It is also keen on bringing in a new strategic partner.
If it is such a rah-rah story, then what went wrong? The Jamnagar refinery is literally lying in pieces at various points on a massive 15-sq km plot, making for a truly tragic sight. Over Rs5,000 crore worth of equipment has already been purchased and Rs4,219 crore been paid to suppliers and contractors. But 15,000 labourers who were working day and night to finish the work have been sent home since March 1999. Many ABB Lummus crest engineers who had the responsibility to execute the project within the stipulated time and budget have gone home on a "short vacation". The damage and delay caused by the cyclone to the refinery's seawater intake and tank farm were being set right after filing for insurance claims, but all that is at a standstill. The reason for this paralysis: institutions are not disbursing sanctioned loans worth about Rs800 crore, ostensibly because Essar has not brought in Rs585 crore as additional equity through the Euro Convertible Bond route. For that, however, the present market conditions are entirely to blame.
Meanwhile, the Ruias are diluting their equity in the refinery project through fresh infusion of equity by a strategic partner. In the process they will reduce their own holdings to 26 per cent from the present 44 per cent, the partner will hold another 26 per cent, and the public the rest - the pattern adopted by MRPL. In this regard two oil companies - BPCL and Oman Oil- are carrying on simultaneous due diligence of the project, which is an attractive potential strategic acquisition for both - the former is short of refining capacity and the latter, an oil producer, is looking for capacity. The process, however, will take several months. Meanwhile ABB Lummus crest is putting in Rs200 crore as subordinate debt (treated as quasiequity) to keep the work going. But will the FIS now relent and release the already sanctioned loans and stop this colossal waste? It has been reported that MRPL is in a similar bind and has been unable to bring in Rs671 crore as equity because of the adverse market conditions. However, in its case, the FIS have been "sympathetic" and offered to take up Rs400 crore as equity while MRPL brings in another Rs271 crore thraugh internal accruals. When Business India asked ICICI whether this report was true and, if it was, why the discrimination, we received no reply. Similar was the official response from lOBI. Asked about the FRNS, everybody was either" too busy or travelling".
Whose money is it anyway? If the institutions have come to the conclusion that the Ruias are incompetent, they should remove them from management and take over the project instead of paralysing it. The point is not that the Essar Group has not made mistakes, but that it is well on the way to restructuring its finances with the full knowledge of its bankers and institutional lenders. The group is not asking for a "bailout" either, but simply disbursal of sanctioned loans to complete the project while the restructuring is on. Everybody who is trying to buy or sell a small house knows that it cannot be done in a jiffy, leave alone deals involving assets worth thousands of crores of rupees.
The Essar Group is selling its power plant to Marathon of the US, however painful it may be to part with a moneyspinner. The sale will reduce its debt exposure by Rs1,550 crore and return Rs 130 crore worth of unsecured loans to Essar Steel. The sale of equity will bring in $ 71.4 million into Essar Steel's and $15.3 million into Essar Oil's reserves.
It has spun off its pelletisation plant in Vizag as a separate company Essar Minerals on the advice of institutions. The FIS have assessed its Vizag assets at Rs1,OOO crore - about Rs400 crore in equity and Rs600 crare in debt. Stemcor, a large international trading house, wants to acquire 51 per cent of the equity in Essar Minerals. Essar Steel is diluting its holding by issuing fresh equity worth Rs180 crore to Stemcor, thereby giving it about 30 per cent. This fresh equity infusion will go into the completion of the pipeline and beneficiation project. Whatever stock Stemcor buys from Essar Steel later to gain a majority within the Rs580-crore total equity will go to Essar Steel. This divestment will also lead to the transfer of Rs500 crore in debt from Essar Steel to Essar Minerals.
By acquiring a majority stake in Essar Minerals, Stem cor will get an assured source of DR-grade pellets for supply to China, Southeast Asia, Iran, Qatar, etc. "The slurry pipeline has already been bought. The beneficiation plant has also been bought and both are lying in Vizag. Stemcor's money will help us complete it.
We have decided that we are not going to invest any more in the project. Whatever more money is required to complete the pipeline and later build the second plant will be brought in by Stemcor,” says Prashant Ruia. “However, as in the sale of Essar power, we have made sure that Essar Steel will get an assured supply, in this case of DR-grade pellets,“ adds Ravi Ruia. The total equity of the project as it stands will be about Rs600 crore and debt Rs900 crore. The additional Rs300 odd-crore in debt will be arranged by Stemcor. Trading houses Internationally are acquiring assets like this for assured supplied. Instead of doing spot trading they want long-term supplied, which helps them moderate the cyclicals. Similarly, another trading house called Deferco has bought steel mills in Russia and the US, and is emerging as a large investor.
Riding out of death valley
These two moves themselves will remove over Rs2,l 00 crore in debt from Essar Steel's books, since Rs1,550 crore is being taken over by Marathon and Rs600 crore transferred to Essar Minerals, in which Essar Steel will have a minority stake. This will reduce the debt-equity ratio from the current 2:1 to 1.34:1. It should be noted that the debt-equity ratios for two other major steel projects - Ispat and Jindal- stand at 3.51:1 and 2.88:1 respectively. Already Essar's cost of production is $230 per tonne and hectic efforts are on at Hazira to reduce this by another $ 7-10 using hot sponge iron for steel, a pioneering effort in many ways. Phase II of debottlenecking is in progress to increase the capacity of the plant to 2.4 Mt with no new investments. In short, Essar Steel will be raring to go in the expected upcycle in steel. A 22 June report by World Steel Dynamics Inc predicts that the international steel market has crossed the "death valley" of $185-240 a tonne - the lowest in the last 20 years. In fact, Essar has already started booking orders at $250-260 a tonne for exports," says]. Mehra, managing director of Essar Steel. "It is clear that commodities need branding as well, and that is why we are on a major marketing and market development campaign to highlight the quality of our product, for which people are ready to pay a premium,” says Prashant Ruia.
The default by Essar Steel on the redemption of its FRNs worth $250 million also has an interesting backgroungd. The FRNS were raised in the international market in 1994 with a maturity period o five years. The event itself was a first for an Indian company. The steel sector internationally has access to long-term loans extending anywhere from 12-15 years. However, at that time, such long-term mony was not available for Indian steel compnies. Today, steel manufacturers can raise money which will mature after 12 years. Since this debt was part of the project as appraised by financial institutions and not outside of it, Essar Steel assumed that the FIS would refinance it to meet the new 12-year norm. Meanwhile, not willing to rely on them, since the PIS were already heavily exposed to the group (though within their prudential norms), Essar tried to raise the money to refinance the FRNS in the international market more than a year before redemption. In fact, lead manager Lehman Brothers Securities Asia Ltd had prepared a prospectus for an issue of $200 million notes due AD 2008 and $200 million notes due AD 2018 in early 1998. However, Pokhran-II buried all hopes for the issue. Since the finance minister had promised in Parliament that no Indian company would suffer as a result of the sanctions, and so on, Essar assumed that Indian banks and financial institutions would now refinance the FRNS and that too on merit and not as a favour. However, these hopes were belied when they advised them to seek a roll-over from the noteholders. Rollover is a euphemism for default. Essar hoped against hope till the last moment and finally wrote a letter to all the noteholders through Chase Securities, trustee to the issue. "The company is currently examining the possibility of refinancing the notes or seeking an extension of the maturity of the notes. The company intends to present a comprehensive plan within 90 days of the scheduled redemption date. The company proposes to pay the interest due on the FRNS shortly," the letter said.
"They are not Real Value (remember the Vacumizer?). After all, how many business groups in India have built up assets of about Rs15,000 crore in the last 10 or even 20 years?" asks R. Sankaran, chairman of IndGlobal Trust, the only banker who was willing to go on record, which points to the prevailing atmosphere. "They have my sympathy. They started the project when there was 140 per cent duty protection on imports of steel and interest rates were 17-18 percent. By the time they came up with the project, duties were down to 25-30 per cent. Under these circumstances, how do you put up global capacities and be competitive?" Warming up to the subject, Sankaran says, "As far as the fRNS are concerned, the issue is very simple. IDBI and other institutions should be asked what they were doing all this time. SBI had also said it would finance it. Where are they? Everybody knew that the notes were coming to maturity. Six months back they were quoted at a 40 per cent discount. The institutions could have saved the country $100 million by buying the notes from the market at that time and extinguishing them, and then asking Essar to pay up the $250-million loan.
A top SBI official acknowledged, "The rolling-over of the FRNS is viewed as a technical default in India. But in the international markets it is done quite often even by reputed corporates and MNCS. There is nothing wrong with the Essar Group. It miscalculated its strategy and the current imbroglio is the price it had had to pay. But the group still has steam left in it and is restructuring its businesses. Indian banks and DFIS will not increase their support to Essar because they have reached their lending limits and because it has become a politically sensitive issue. But I am sure Essar will raise the money from some bank overseas." A large number of people we met in the financial community expressed similar views and were similarly averse to going on record.
The attitude, however understandable, cannot be justified. After all, a banker is a trustee of public money. Other than matters that govern fiduciary confidentiality, his opinion on an important corporate issue, whether it is favourable to the company or not, is a matter of public interest. Remember, it is these very gentlemen who, in endless streams of appraisal notes, assure their boards that, in the present globalising economy, these mega projects are not only viable but, indeed, desirable. Of course, if a promoter, however well intentioned, has proved to be incompetent, the bankers who have put public money into the company have every right to remove him from management control and bring in their own team, which is the international practice.
"In the last 15 days I have learnt what I couldn't have in 15 years," says young Prashant Ruia. The major mistake Essar made is that, while launching its global-sized projects in steel and oil, it did not fully comprehend the ramifications of the term 'financial closure'. But that is all in hindsight. After all, till Enron made the term popular, how many of us knew it or how many companies understood it? Today, of course, it is as sacred as "motherhood" in Essar House. "By nature I am loath to borrowing money. After nearly 20 years as a successful entrepreneur I raised my first loan for the sponge iron plant," says Shashi Ruia. Who knows, after the shock of default wears off, he might still come up with some surprises and remove this blemish.
Today, looking out of his office at Essar House towards Mahalaxmi race course, he hasn't the stomach for further financial gambles of any sort. "Financial closure first," he says. A bit uncharacteristic for a man who became a legend for his risk-taking in Indian ports from Kakinada to Tuticorin, from Goa to Mangalore and Chennai to Mumbai, and succeeding when he was barely in his 20s. But that is what tempering is all about - it means moderation and steeling. He could retire, handing the business over to the younger ones, and take to golf at Willing don and improve his present handicap. But he will have none of it - his eyes are set on the choppy Arabian Sea and, like a true shipper, he assures you that the rough seas will pass. He would rather engage in an animated discussion about the latest telecom technologies than wallow in the memories of the good old days in the docks. With that kind of determination, it should surprise nobody if the tempered Ruias bounce back in the not-too-distant future. After all another group, Reliance, went through similar rough seas in the 1980s and fought their way back.