A Dream Crumbles

What moths are to fire, the Ruias are to controversy. A sebi inquiry into the Essar Oil public issue, corruption charges in Essar Construction tenders, cheques bouncing on Digvijay Cement and the customs department, accusations of using political connections to profit ESL, suspicions of diverting public funds into personal bank accounts abroad, and now the inability to repay investors against $250 million worth of five-year floating rate notes (frns) that Essar Steel raised and which fell due on July 20. The Ruias had hoped that Indian financial institutions like idbi, uti and lic would bail them out, but at the last moment, the FIs, which already have lent Rs 8,100 crore to the group, pulled the plug.

As a result, the Ruias' supergroup dream lies in shambles. To save ESL, they will have to sell almost everything else they own.

Detractors claim this is the culmination of an inadequately planned expansion spree into seemingly-unrelated businesses through the '90s, as Essar got into one capital-intensive area after the other, pursuing a dream to become a massive industrial house that would rival the Ambanis of Reliance in sweep and power. Not so, says Ruia. 'We are a serious player in the serious business of mining, steel, refining, shipping and telecom. We did not randomly walk into these sectors. In less than a decade, we have created assets worth Rs 19,000 crore on the ground. How many companies can stake that claim?' he asks. 'A smear campaign has been unleashed against us ever since we got into the oil business,' he hints darkly.

So what did happen? To give the Ruias their due, ESL is fundamentally a sound proposition. Its 2 million tonnes per annum (tpa) capacity hot-rolled (HR) coil plant makes a product range comparable with the world's best in terms of quality and operating costs. It is India's largest sponge iron producer and the world's largest hot-briquetted iron producer. The debt-equity ratio is a reasonable 2:1 and its capital cost per tonne compares favourably with other private steel producers like Ispat and Jindal. Product demand could soar, considering that per capita consumption of HR coils in India stands at only 22 kg as compared to 250 kg in the US or even neighbouring China. The export potential is reflected in $400 million of exports in the last four years and a 23-per-cent growth in 1998-99. Doesn't quite sound like a company on the edge, does it?

Three things happened in the last two years to spoil the pretty picture. First, the steel market turned all calculations on their head. Global prices crashed to what experts called 'the death valley''between $180 and $200 a tonne. Domestic demand slumped on the back of an industrial recession and foreign firms started dumping cheap steel.

Second, the global appetite for Indian paper dried up, making it harder for firms to access global funds. Simultaneously, the primary and secondary markets in India took a nosedive. Third, Pokhran II and the resultant sanctions jeopardised the prospects of Indian companies scouting for debt.

Ruia's defence, therefore, runs something like this:

Borrowings mismatch: The Ruias proudly proclaim that they are into capital-intensive, long-gestation, core sector projects. How is it then that no long-term finances were tied up? In '93, ESL raised Euro Convertible Bonds for $75 million of three years' maturity. It expected the bonds to be converted into equity. But subscribers preferred to redeem instead. So ESL was forced to raise a short-term loan of $40 million that fell due in March '99. In the meantime, it also issued the five-year frn for $250 million in '94. So the Ruias were borrowing short-term and investing long-term. A recipe for the disaster. Which finally struck last fortnight.

Bad markets: The Ruias claim that since the overseas debt market had just opened for Indian corporates, there was no appetite for long-term Indian paper. Hence, the short-term loans. But companies like icici, Spic and telco have been able to sell paper with maturities of 10 to 15 years. In fact, in '97, Reliance raised $405 million from international investors in three days, $150 million being Yankee bonds with a 30-year maturity period.

Integration loop: Even as ESL was being implemented, the Ruias decided to set up a 3.3 million tpa pelletisation plant at Vizag to supply to ESL, an iron ore plant in Bailadila in Madhya Pradesh and then a slurry pipeline project to transport the ore from Bailadila to Vizag. By '98, ESL had spent Rs 856 crore on Vizag, Rs 151 crore on the other projects while borrowing Rs 143 crore from the State Bank of India and three other banks. Sure, these expenses would reduce costs in the long run, but it spread ESL money thinly at a time when it was borrowing at high interest. And more importantly, when it had not even secured the right term-financing for itself.

Power trap: The Ruias also floated Essar Power to get electricity at a cheaper price than charged by the state electricity board. In 1997-98, ESL provided equity of Rs 247 crore as unsecured loans and provided guarantees to the extent of Rs 1,342 crore. The following year, it loaned an additional Rs 98 crore while upping the guarantees to a whopping Rs 1,800 crore. The result: steel shareholders and lenders exposed to high credit risk and debt liabilities, cutting their return on investments.

Today, the list of lenders chasing ESL reads like a who's who of the financial world'the idbis and lics apart, there's ing Bank, Stanchart, Societe Generale, Barclays... Many of them now want out. On December 31, '98, overdue interest was above Rs 17 crore. The Ruias obviously failed to financially structure and steer the company properly. And the blame game is likely to gain them nothing.

Even the FIs, traditionally lenient on defaulters, are now playing hardball. Indeed, many analysts see this as a welcome sign. 'The FIs have finally come into their own. Earlier, they would only talk of pulling the plug but lacked the courage. Now when their own bottomline and market credibility is under scrutiny, they are speaking the commercial lingo. Don't forget that they are also players in the debt and equity markets and their shareholders are beginning to ask questions,' says a top official of an infrastructure finance company. If it also signals a weakening of the politics-business nexus, it's a bonus.

Meanwhile, the Ruias are trying to absorb the shock with a debt rescheduling plan, and selling some of their dream projects. Hiving off the pellet plant to Essar Minerals and bringing in a new partner could eventually reduce ESL's debt by Rs 660 crore. Essar Power would be sold to US-based Marathon Power, that's a Rs 500-crore cash inflow to ESL. A 26-per-cent stake is being offered to Bharat Petroleum in the half-finished refinery project. Some more money there. There's the bleeding Essar Telecom too, which Essar's partner Swiss Telecom quit in disgust some time back, and the Ruias are considering selling it as well.

However, till all this happens, ESL's woes will remain. And remember, the Ruias will have to sell cheap. Where does that leave the group in the new millennium? Basically with Essar Steel and Essar Shipping. It's the price the group has had to pay for its obsession with growing bigger at the cost of getting better.