Bulking Up

After suffering a prolonged slump earlier this decade, the global steel industry has bounced back. The improving worldwide economy, combined with a surge in mergers and acquisitions, has created a dynamo of an industry.

As the price of steel has climbed, so has the level of merger and acquisition activity. The trend began, especially in the United States, with some firms snapping up companies that were either in or had just emerged from bankruptcy protection.

Mike Locker of Locker Associates, based in New York City, says the steel industry is in the middle of a boom that will send steel prices to record highs.

The most recent figures from Locker Associates forecast steel shipments throughout the next three years will be as strong as they were in 2006.

"Steel Industry Update," a newsletter produced by Locker Associates, notes that supplies at domestic service centers are thinning, forcing key buyers to increase their orders before prices increase. After a fourth quarter surge, imports to the U.S. are less competitive in light of the declining dollar, higher freight rates and higher world prices.

MOVING TARGETS. The flurry of acquisitions has shifted the dynamics of the global steel industry. Companies such as Mittal, Arcelor, Corus and others grew their businesses through strategic purchases. For Mittal, some of the purchases were in locations far removed from the traditional steelmaking hotbeds of North America and Western Europe.

The possible culmination of the recent wave of mergers was Mittal’s purchase of Arcelor. This deal resulted in spreading operations to multiple continents, signaling other steel companies to take offensive moves to also grow their businesses or to adopt defensive moves to prevent a takeover.

Steel industry analyst Charles Bradford of Bradford Research, New York, has said that there were perhaps more than one dozen additional steel companies in North America that could be acquisition targets, either by other North American steel producers or companies outside the continent.

The consolidation trend also is being driven by the expectation that a stronger steel market will continue in spite of patches of weakness in a number of sectors.

Leo Larkin, a senior metals and mining analyst with Standard & Poor’s Equity Research, says he foresees additional steel mergers.

As more than one steel industry executive has noted, with the recent merger of Arcelor and Mittal, everyone is in play. Cognizant that the fractured steel industry still has room for further consolidation, many companies are looking for ways to grow their businesses by acquiring other steel operations that can fill holes in their portfolios.

Further consolidation among European steel companies appears to be somewhat of a challenge in light of the European Union’s concern about anti-trust issues. Larkin says that most of the big mergers and acquisitions will likely be done in the United States. However, opportunities abound in other regions of the world. One area of growing interest is the South American market, notably Brazil, where Arcelor is the largest steel producer.

Several analysts say they feel that two possible scenarios could take place in South America. The first could be the formation of a large national steel company in Brazil that would include companies such as Gerdau, CSN, Usiminas or some other Brazilian company. The second scenario could be a Brazilian firm partnering with an international operation, possibly China-based Baosteel or Japan-based Nippon Steel.

One factor driving the merger mania in the steel industry is that many of the same steel companies that struggled with the economic downturn earlier this decade are now flush with cash. These steel companies are confronted with three possibilities for their money: They can pay it to their shareholders (assuming the company is publicly traded); they can modernize their existing equipment for incremental increases in capacity; or they could build or acquire another operation.

Bradford says acquiring an existing facility is almost always offers a company a better opportunity than building a new plant.

However, when buying a steel mill, boosting capacity isn’t the only issue.

Bradford says that a deal also needs to make sense from an operational standpoint. And, with few exceptions, the mergers in North America will likely be capped in light of potential anti-trust issues. However, smaller deals could take place, especially if smaller steel mills opt to band together to get the scale needed to compete in the global market. However, with many of the top line steel companies already advanced in their consolidation efforts, some consultants say that to truly gain sway in the market, steel companies will have to achieve capacity rates of nearly 50 million tons.

According to a report from London-based SBB Insight, the merger between Arcelor and Mittal has resulted in all steel companies having to take a position. The report notes that Harvey Gordon of EuroStrategy Consultants thinks there will be some mergers yielding about 100 million tons of capacity and a few yielding roughly 50 million tons. At the turn of the decade, the world’s largest steel company had about 30 million tons of capacity.

World Steel Dynamics, a steel consulting firm based in Englewood Cliffs, N.J., anticipates that steelmakers will consolidate into one of two categories—global players operating on a high-value, high-tonnage basis with a lot of annual contract business and domestic players mostly selling lower-value products in smaller volumes primarily at spot prices.

UP AND DOWN THE CHAIN. While mergers between steel mills in the United States may become more difficult to execute, some mills are making strategic acquisitions in downstream and upstream portions of the business.

A classic example of this strategy is Nucor Steel, Charlotte, N.C. After absorbing Birmingham Steel, Nucor has continued to make acquisitions, targeting corollary businesses, such as fabricators and distributors.

Commercial Metals Co., Irving, Texas, also has taken this tack, with several of its recent purchases including some fabrication plants.

In addition to purchasing downstream businesses, some steel companies are seeking joint ventures or partnerships, especially for supplying their operations with raw material. Nucor and Fort Wayne-based Steel Dynamics, which both operate steel mini-mills, have made investments in scrap alternatives. According to Larkin, Nucor is paying close attention to its own internally produced scrap alternatives to feed its EAFs.

ON THE RISE. Larkin forecasts an up year for steel in 2007, though not as strong as in 2006. In an equity report released by S&P earlier this year, the group forecasts that a number of factors contribute to the expected decline in the demand for steel in 2007, including the slower growth of the U.S. economy; a 2 percent to 3 percent decrease in demand from the U.S. auto industry (versus an estimated 9 percent gain in 2006); and a decline in shipments to distributors and OEMs (compared to a projected 4 percent gain in 2006).

"Many of the steel industry’s clients are sitting on excess inventory that will take a good portion of the first half of the year to work through. Additionally, the industry is highly leveraged to the U.S. automotive manufacturers, several of which may cut production. When you factor all of this together, it adds up to our negative outlook on the industry," Larkin says.

"The lone bright spot for the industry is non-residential construction, but that one market won’t be able to offset weakness in other markets in 2007," he adds.

More recent figures from the consulting group World Steel Dynamics show that even with the recent rash of acquisitions, worldwide there still is room for a number of additional large-scale mergers and acquisitions that could result in an additional five to 10 companies reaching the 50 million-plus-ton production level by the end of this decade.

While the increased mergers canplay a prominent role in keeping steel finished product prices more stable, another possible benefit to the larger steel companies is the opportunity to strengthen their pricing power when buying their raw material, whether that would be iron ore or scrap metal.

EFFECT ON SUPPLIERS. For scrap recycling companies, which also have been in the midst of several significant acquisitions, the move toward fewer steel producing companies has not yet had a noticeable impact on their industry. Despite the many mergers, there have not been visible signs of downward pressure on ferrous scrap prices, which have been soaring throughout the past several months in light of strong demand.

Iron ore producers, however, could see a more concentrated attempt at keeping a lid on prices. At present, a small number of companies own an overwhelming majority of the open iron ore business. Along with the strengthening in the world steel markets throughout the past several years, iron ore producers have been busily pushing through increased prices.

Even though the scrap metal side of the industry is far more fragmented, the overall trend in steel demand has driven prices of ferrous scrap upward.

With the higher raw material prices tightening margins for some steel companies, larger operations may have a greater interest in and a greater ability to diversify their raw material intake.

Another advantage that a more consolidated steel industry holds is the ability to control production levels. In the past, when prices declined, a flood of supply on the market would exacerbate the situation, driving the prices down even further.

However, with fewer companies each having more capacity in their control, the ability to adjust production schedules worked to lessen the decline in prices.

According to one report, in 2005, when steel prices began to dip, a number of the larger steel mills were able to cut production, which worked to keep prices from declining even further.

WHERE WILL CONSOLIDATION GO? While large-scale mergers and acquisitions will be more challenging in Western Europe and the United States, China may be a fertile area for some multinationals to spread. Although the Chinese central government has a major stake in steel producers, the Chinese government is seeking more consolidation from its own steel mills. According to World Steel Dynamics, around one third of China’s steel production comes from its top 10 steel producers. However, the government is pushing for a 50 percent share for the top 10 in the market.

Mike Mytton, an analyst with Global Steel Consultants, a U.K.-based steel consulting firm, says that consolidation in the steel industry still has a ways to go. He says he feels that an area where consolidation could increase significantly is in China as well as in marrying Chinese operations with those outside of the country.

Other combinations that could take place, Mytton says, would be between low cost commodity producers and high-cost, but high-tech companies.

While some steel companies are attempting to diversify their operations through acquisitions, Mytton sees some of these moves as companies looking to leverage their steelmaking. While shopping for acquisitions, the companies looking to grow their business are often looking to gain some additional knowledge. "It is the synergy from a low cost base and R&D (research and development) product development. Both India and China wish to make cars, but need help to do so," Mytton adds.

While the pace of consolidation has been humming, going hand in hand with the consolidation is the growing awareness of the globalization angle of many of the mergers. Russia-based Severstal has acquired Rouge Industries, a Michigan steel company; Evraz, also of Russia, has acquired Oregon Steel Mills; India’s Tata Steel has acquired Corus, based in the United Kingdom; and, the granddaddy of them all, Arcelor Mittal, which was started by an Indian financier, has acquired another European-based company and has stakes and positions in operations in North America, South America, Asia and Europe. The company also is eyeing the China market as an opportunity for even further growth.

But even as consolidation grows and globalization becomes the buzz word, the key for whether the large or small niche steel companies flourish will come down to being able to run the most efficient operation on a plant-by-plant basis.