Public Display of Consolidation

For most of its existence, the scrap metal industry has been the domain of the sole proprietor—the only variations deriving from partnerships (often two or more brothers), and occasional references to the next generation (i.e. “& Son”).

As those in the industry have observed more closely than anyone else, in the span of just a few short years that portrayal of the industry seems to have become almost a quaint notion from an earlier time. First came the creation of closely-held corporations, then the growth of successful and aggressive companies that looked to stretch a traditionally local business into a more regional one.

In the late 1990s, a handful of companies—fueled by publicly-traded shares—have made a bolder play to build scrap processing companies of a national or even global scale. Among the most active of these has been Metal Management Inc., Chicago, a two-and-half-year-old company that has quickly combined the operations of some of the foremost names in scrap processing.

TAPPING THE COLLECTIVE KNOWLEDGE BASE

At less than three years old, Metal Management is just a toddler of a company. But a look at the company’s senior management roster reads like a scrap processing hall of fame plaque. Family names such as Proler, Cozzi, Schia-vone, Newell and Isaac are among those now linked with Metal Management.

Metal Management CEO Gerard M. Jacobs says the company will benefit from more than just the name recognition. “These are companies that have tremendous amounts of intellectual capital,” says Jacobs of the scrap processing firms acquired. “Much of the value of these businesses is not in a brick and mortar format. It’s the people, their personalities, their ambitions, their ideas,” he remarks.

In addition to its board of directors, Metal Management has a second decision-making body in place called the Office of the President. The panel is headed by president and chief operating officer Albert A. Cozzi, a scrap industry veteran who also leads Metal Management’s largest single operating company, Chicago-based Cozzi Iron & Metal. The Office of the President was conceived as a way to tap into the collective experience and knowledge of the veterans who head the regional processing firms being acquired by Metal Management.

While many of the decisions made by the Office are operational in nature, Jacobs indicates that the general marketplace knowledge of Al Cozzi and the other former owners of the acquired operating companies is used for other strategic reasons, such as in the initial stages of making acquisition decisions. “Certainly, the initial due diligence, so to speak, comes from Albert and the actual operating companies in terms of deciding what targets for acquisition are appropriate for us,” says Jacobs.

The CEO believes this informal screening process assists the company at several levels. “In my opinion, what they do provides kind of a sophisticated mosaic judgment based on the reputation of the company,” says Jacobs. “The experiences that our folks have had with that company over many years of experience [produces a] judgement call on where the company is place in the hopper of prioritization.”

This initial judgement not only tallies the views of several knowledgeable people, but also saves valuable management time, according to Jacobs. “When you look at the sort of effort we’re making nationally, we simply don’t have the management time to be able to pursue every company that we would like,” he remarks. Part of what could be an extremely time-consuming sort process “is short-circuited because of the many years of experience that Albert and the other folks in our business have,” Jacobs says of the Office of the President members.

One scrap industry observer, Merrill Lynch senior steel analyst Robert Schenosky, believes the strategy of retaining the former owners is a wise one. “When you take over these companies and get to know the region and the market, it’s good to have these people in place,” says Schenosky. “Even though there are up-front costs, it gives you that immediate entry in the market. Making the transition is easier.”

A STRATEGY BEYOND ACCUMULATION

There are critics of the fast-growing scrap metal consolidators who contend that they are buying companies for the sake of building impressive short-term revenue growth—but that the strategy ends there. The officers of Metal Management are quick to argue otherwise in regard to their own firm.

Metal Management co-founders Jacobs and chairman of the board T. Benjamin Jennings have legal and financial backgrounds primarily, although Jacobs spent several years in the waste handling industry as the owner of a company specializing in the development and financing of new landfills.

While their own backgrounds address the financial and legal aspects of building a consolidated scrap company, they say that the strategy they are employing does indeed consider the unique nature of the scrap processing industry.

“Things that we’re looking for are a successful operating history, which means a record of growth and a record of profitability,” says Cozzi. “We are not looking for companies we have to fix.”

The local nature of scrap purchasing and movement cannot be overlooked, he adds. “We want [acquisition targets] to be located in major market areas, and either be the market leader in their market or have the potential to be number one or two in that market,” says Cozzi. “And we want to go into markets that make sense to rationalize or consolidate; to have other tuck-in acquisitions available. We’re not looking for aggregation. You are not going to see us in the middle of North Dakota acquiring a scrap metal company when there are no other companies in that area and there is no complement to our other companies or the customers that we do business with.”

Where those markets or facilities are located is also a consideration. “We like companies that are located along the water system or have access to water or what I would describe as outstanding rail transportation or abilities,” says Cozzi, hinting that the ability to ship large volumes of material to major consumers is a primary consideration.

Several recent acquisitions have greatly strengthened Metal Management’s place in the Chicago market, while Cozzi also points to Houston as a market where Metal Management’s strategy can be witnessed.

“We initially acquired a company with a scrap processing facility located on 45 acres of concreted land along the Houston ship canal system,” says Cozzi, adding that the firm employed 85 people. Subsequent acquisitions brought in companies with 27 and then 55 people operating at several other locations. “The result is going to be that when we’re finished, we’ll have all of the business handled at one-and-a-half facilities versus five facilities that had previously been used to handle the same tonnage—and with a total of just 65 employees.”

While the Houston and Chicago markets were the first two the company focused on, Ben Jennings says that entering new major markets is next on the list. “You will see significant new entries in new major metropolitan areas being entered,” he remarks. [Just days after that comment, Metal Management announced its agreement to purchase Naporano Iron & Metal Co., a $150 million company with facilities at the Port of Newark.]

Jacobs notes that another key strategy of Metal Management is to stay focused on ferrous and nonferrous scrap processing. “Our approach is along the lines of ‘keep it simple stupid.’ Play your core competency, which is scrap metal recycling and reclamation.” Referring to his years in the solid waste industry, Jacobs remarks that he “saw where a company whose management had tremendous strengths—just tremendous people and expertise in hauling, and landfilling and solid waste—got involved in lawn care and port-a-lets and chemical waste and everything else. They really diluted their management time and talent in a lot of directions,” he says of a strategy he will not follow.

IT’S STILL A LOCAL BUSINESS

Gerard Jacobs says he saw something else first-hand when he was in the solid waste business: decisions made 2,000 miles away harming business relationships in local market after local market. He has vowed it won’t happen with Metal Management.

“I met landfill owners and hauling company owners, and I saw many very fine family businesses, very motivated and successful family businesses, demoralized if not destroyed by joining centralized management structures,” says Jacobs. “They would start getting directives from Oak Brook or Houston—30-year-old vice presidents 2,000 miles away telling people to raise tip fees at landfills and do once a week pick-up instead of twice-a-week pick-up.”

That management structure, says Jacobs, was “really destroying entrepreneurial spirit and demoralizing managers to the point that many of the most competent managers that were acquired by those big solid waste companies left as soon as their employment agreements were up.”

The model Jacobs, Jennings and Cozzi are setting up appears to be the polar opposite. “We’re trying to create a very decentralized structure, but in our opinion a very sophisticated means of . . . keeping that local service but at the same time taking the best practices, the best computer systems, the best inventory handling systems, the best information and the best practices of all kinds,” says Jacobs, “and letting these managers share them with each other under Albert’s coordination.”

Not fighting the local nature of the scrap business is critical, Jacobs adds. “I believe [success is] a function of how you allow the successful metropolitan areas to continue to be vibrant,” he says. “A lot of the transactions in the scrap industry [are a result of] personal initiative pushing it and getting a deal done. We’re trying to allow that to continue to flourish, and hopefully superimposing on that not the centralization of a public company, but the capital and access to growth under the leadership of Al Cozzi.”

Al Cozzi says that—other than a checklist of items to be centralized such as insurance, accounting, legal representation, and marketing—the company decided early on to “run a very decentralized management structure” to “team up with partners who have build successful businesses.”

“We want companies that have strong management that can be retained,” summarizes Albert Cozzi regarding acquisition targets.

WILL THE SHIP SAIL IN FOUL WEATHER?

The 1990s have proven to be a decent decade in which to build a fortress made from scrap. Material is moving quickly to feed hungry mills and smelters. The steady demand has—for most commodities—produced high per-ton prices, allowing some room for a profit margin at the end of the day.

But will the next downturn produce results that will be understood by investors and stock analysts? While traditional sole proprietors have had to explain a drastic decrease in sales revenues to few beyond their banker and their spouse, it will be different for managers of publicly-traded scrap firms. Brokers and investment analysts who make recommendations for other people’s money want answers. Is Metal Management prepared to go under the microscope?

“There is a kind of cultural sea change from being part of a fiercely independent private company to being part of a team of a public company,” acknowledges Jacobs.

With public trading comes public criticism and public second-guessing as well. One of the criticisms leveled against scrap processing consolidators has been the question of whether investors and investment analysts will have a suitable understanding of the price and revenue fluctuations that can occur in the industry.

“Our business model is based on buying at a margin,” says Jacobs. “We’re not going to be speculating on inventory. The fact that scrap prices might stabilize at lower levels than they are today really doesn’t impact our business model. We still expect the price that we’ll have to pay for scrap will float with the market prices of scrap on the sell side. As long as we can maintain our margins at a level that can allow us to recover our costs and make a reasonable profit, it’s an acceptable situation for us.”

Some investment analysts seem to agree with Jacobs. The stability of scrap prices may be more important than taking advantage of price spikes, one analyst notes. “Probably what had been one of the biggest impediments or barriers to consolidation had been the volatility of the price of scrap,” says steel analyst Mark Parr of McDonald & Co., Cleveland. “As you inject predictability—and put that together with the underlying growth in demand for scrap—it makes consolidation more viable.”

Merrill Lynch’s Schenosky also feels that investors—over time—are capable of understanding the nuances of the scrap industry. “I would say that the idea of a scrap company being a public entity is somewhat of a new type of stock for the investment community,” he notes. “It differs from, say, steel production companies as well as from other commodity markets. It’s a new type of investment idea for Wall Street. I think that’s been identified in the fluctuations in Metal Management’s stock price.”

The fluctuations Schenosky refers to include the company reaching a high of nearly $30 per share and falling to as low as $11 per share during an otherwise bull market.

A CONSOLIDATED VISION OF THE FUTURE

Will consolidation ultimately lead to something along the lines of the Big Three or—for history buffs—the Seven Sisters? That is a vision of the future offered by some industry observers.

The officers of Metal Management do see the industry being dominated in the near future by a half-dozen or so major processors, with smaller, locally-owned companies filling in the niches and acting almost as feeder yards.

“I would say that the scrap industry is changing. It is consolidating,” says Cozzi. “I think that a very large portion of the business will be controlled by five or six consolidators. I fully expect Metal Management will be one of the premier or preferred consolidators [and] part of that group,” he continues. “Right now, I don’t believe any one company has more than 8% of the market. I think that we probably expect that, at the end, we probably will have 20% of the ferrous and nonferrous scrap markets.”

Chairman Ben Jennings predicts, “At the end of five years, I would expect we’ll be a $3 billion or $4 billion organization with truly a national scope, both in the national and export markets.”

Many analysts see a similar future. “I think that you’re going to have a handful of companies that are going to be the significant players in the scrap industry,” agrees Schenosky. “I think there will be something like five companies that will either operate from coast to coast or have a very strong regional presence.” Referring to the local nature of scrap, he adds that “even if you’re a coast to coast company, the key is still going to be an ability to operate regionally.”

While that might sound like a prediction that leads to five or six identical companies, Metal Management’s officers insist that theirs is a company that offers some unique attributes.

“Even though our name may sound generic—Metal Management Inc.—we’re not generic in terms of our management philosophy,” says Jacobs. “I don’t view us as being necessarily some sort of box that any other collection of scrap metal companies is going to naturally just get dumped into. It would be very difficult for me to participate in the management of a national scrap company that didn’t have a decentralized focus,” states Jacobs. “We have a very pronounced, internal, decentralized, collegial approach led by the Office of the President and Albert Cozzi, and unless we really feel that a company philosophically is buying into that and really wants it, its tough for us to get a transaction done.”

That preference toward decentralization and reverent respect of past accomplishments may be why, according to Albert Cozzi, Metal Management has “really become the preferred partner for scrap processors to join.”

The author is managing editor of Recycling Today.

Sidebar

Questions and Answers

In the course of preparing the cover profile of Metal Management Inc., Recycling Today editor Bob Feigenbaum and managing editor Brian Taylor traveled to Chicago to interview CEO Gerard Jacobs and president Albert Cozzi. Excerpts from that wide-ranging exclusive interview follow.

RT: What do you think Metal Management Inc. will look like five years from now. How would you describe that?

Albert Cozzi: I would say that the scrap industry is changing. It is consolidating. I think that a very large portion of the business will be controlled by five or six consolidators. I fully expect Metal Management will be one of the premier or preferred consolidators out of that group. Right now I don’t believe any one company has more than 8% of the market. I think that we expect that we probably—at the end—will have about 20% of the ferrous and nonferrous scrap market.

RT: What does Metal Management look for in an acquired company? What makes an acquisition successful for both Metal Management and the company being acquired?

Albert Cozzi: We have a list of criteria that we look for, and there are really nine or ten things that we want a potential acquisition to have to be the perfect company. If they don’t make the first two criteria, they don’t make the cut at all. The first is, number one, impeccable integrity. And the second one is a history of environmental responsiveness or responsibility. If there are environmental problems we won’t do a deal. If they have integrity or ethical problems, we won’t do a deal either.

RT: By integrity you mean their finances are in order,

or?

Albert Cozzi: How they project and how they conduct themselves, whether it’s in the regulatory climate or with strictly ethical behavior. We want to make sure that everybody we deal with fits our culture. That’s one of the things that is very important to us. We want to be able to trust all our partners. And so, consequently, the cultural aspect is very important. After they meet the first two hurdle marks, the next thing is, they have to be priced right. It’s got to be accretive to the current shareholders of Metal Management. Things that we’re looking for are a successful operating history, which means a record of growth and a record of profitability.

We are not looking for companies that we have to fix. We want them to be located in major market areas, and either be the market leader in their market or have the potential to be number one or two in that market. And we want to go into markets that make sense to rationalize or consolidate—to have other tuck-in acquisitions available. We like companies that have synergies with our existing or planned acquisitions. We feel it’s very important that every company we acquire complements some of our other companies. We want companies that have strong management that can be retained.

Part of our goal is to continually become a better supplier or more important to our customers. We like companies that are located along the water system or have access to water or what I would describe as outstanding rail transportation or abilities. Physically, if they meet this criteria, we spend a lot of time getting comfortable with the acquisitions to make sure that culturally they fit in, and that platform companies are willing to take a certain amount of the consideration in stock, so that we know that the sellers are going to be there [and will] continue to be motivated to produce outstanding results.

RT: I don’t know to what extent you can comment on the stock price, but how do you think Wall Street will view the company for the remainder of 1998?

Albert Cozzi: I think there are a couple of things that affected our stock price. Certainly one of our competitors stumbled, and all of the consolidators’ stock prices tumbled when they stumbled. Also, we have been criticized by some analysts for taking a long time to close deals. That isn’t going to change. We’re going to continue to be very, very deliberate. We want to make sure the people that we’re teaming with are going to be good partners and that their goals and aspirations are compatible with ours. And the other thing, I think our stock tumbled a little bit [when] the Asian debacle started. We do very, very little business in Asia. It’s such a small part of our business that it’s not measurable. The fact of the matter is as far as the stock price is concerned, if we do the right things right, in the right ways, then we’ll earn money and it will be reflected in the stock prices.

Gerard Jacobs: And I would add to that, I think that there is kind of a selection mechanism that has gone on within the stockholder base. I believe at this point when you look at our stock, I believe that the stockholders that are in our stock right now are by and large in it for two reasons: one they have accepted the thesis of consolidation, that this business, this industry will consolidate a profoundly fragmented industry, and in the process will rationalize many of the business and operational practices. Because of that, this first factor, I believe that as long as we continue to show growth in the company and continue to execute the consolidation game plan, I believe that those stockholders will be satisfied.

The second factor that I believe has happened in terms of the self-selection of stockholders is that the stockholders that have really committed to our company, I believe, are stockholders that understand that because of the massive goodwill charges that we take, the SEC has made it extremely difficult for people to do pooling of interest mergers. As a result, we have these massive goodwill charges which [means], if we had done a bunch of poolings, we’d be making earnings per share much, much higher than what we’re making now. Because of all that, I think that the sophisticated investors that have been buying our stock are buying it on the basis of cash flow.

It’s very similar to the way stockholders were buying into cable television and telecommunications companies that were growing very rapidly, but incurring huge goodwil charges.

l charges. They understand that even though we have to take these huge non-cash goodwill charges, they understand that there is tremendous value in cash flow. And that’s where we are right now. Massive growth. Tremendously accelerating cash flow. And because of that I believe that our stock has got a very optimistic future.

RT: Does the company have any concerns about the vertical integration of steel makers as a form of competition in the future?

Albert Cozzi: No. I think the steel companies that decide they want to be a player in the consolidation in the industry [demonstrates] a verification of the accuracy of our philosophy that it’s an industry ripe for consolidation. As far as the integrateds, I think that being involved in scrap substitutes is also healthy. It is also a verification of the demand for our products going forward. I think scrap prices are too high right now. I think scrap ultimately will be capped by the production costs of scrap substitutes. I think there is enough capacity on the drawing boards now that that will happen. I think that ultimately we’re going to be looking at prices for our products at the production costs of the substitutes for it. Which will still be at very, very good levels.

Gerard Jacobs: I’d have to add that I think the issue of whether there will be continued efforts from steel mills to acquire scrap yards—and how intensive that effort will be and how threatening that effort might be in terms of us—I believe will ultimately shake out as to how comfortable the mini-mills are and the integrated mills are with us being a reliable supplier to them. I think that they will react in response to what our behavior is. What we’ve been trying to tell the mills is that its similar to when the big auto companies have long-term reliable supply relationships with tire manufacturers, or with engine manufacturers, or with other components or parts makers, it doesn’t mean that tires aren’t critical—tires are critical. But they have reliable relationships with stable suppliers who understand their place in the food chain.

We would like to be a long-term stable supplier of scrap to mini-mills and other steel mills and foundries; a company that these consumers look to month in and month out as being reliable, reasonable suppliers supplying a consistent quality of material and service—somebody that they’re not going to get surprises from. I think that when they feel comfortable that they can rely on our behavior in that sort of fashion, that the anxiety level we believe [will continue to decrease] tremendously as months go on. Over the last year and a half, as Albert said, initially there was this great deal of anxiety [that has gone down] significantly and we expect it to continue to go down, because we believe that our behavior will justify that.

RT: As far as similarities and differences in your approach to consolidating versus some of the other national and regional consolidators out there, we were wondering if you could maybe pick one or two things that Metal Management does differently when it acquires a company versus some of the other consolidators.

Gerard Jacobs: I guess I’d say first of all as opposed to say a Philip, there’s kind of a Continental Divide between the concept of cross-selling of services and being a multi-disciplinary service supplier as opposed to being ,as we’ve been described, kind of a pure-play scrap metal supplier. Our experience once again is from the solid waste industry. We saw where a company whose management had tremendous strengths—just tremendous people, expertise or whatever, in picking up, or landfilling of solid waste—got involved in lawn care and port-a-lets, and chemical waste and everything else they got involved in. They really diluted their management time and talent in a lot of directions, and I don’t think they truly understood—and I’m not criticizing Philip when I say this, I really wish them well, I hope they realize the benefits of what they’re trying to do—but to us, our approach is different. Instead of supplying multiple different services to the steel mills, our approach is more along the lines of Keep It Simple Stupid—play your core competency, which is scrap metal recycling and reclamation. And as in broad a product offering as we can, as national as we can.

You won’t see us taking a good company after we’ve acquired it and trying to change its focus. You won’t see us trying to change its management or trying to get them to do things that they’re not competent to do. Instead, we’re really trying to take a bunch of good companies, and keep them doing what they’re doing. And hopefully, through acquisitions. allow them to take a winning management formula on the road and to additional locations within their service region. I think that that kind of focus is probably the hallmark of what we’re trying to do with our acquisitions that probably distinguishes ourselves.

The second thing to me—again drawing from our experience in the solid waste industry; we saw two companies, Waste Management and BFI, that acquired many strong regional businesses and tried to impose centralized management on them. I personally was in the trenches in the solid waste industry from 1983 to 1995 and I met landfill owners and hauling company owners all along from Chicago east. And I saw many very fine family businesses, very motivated and successful family businesses, demoralized if not destroyed by joining centralized management. Structures where they would start getting directives from Oak Brook or Houston. You know 30-year-old vice presidents 2,000 miles away telling people to raise tip fees at landfills and do once a week pick-up instead of twice a week pick-up—really destroying entrepreneurial spirit and demoralizing managers to the point that many of the most competent managers that were acquired by those big solid waste companies left as soon as their employment agreements were up.

We’re trying to create a very decentralized structure, but in our opinion a very sophisticated means of cross-pollination, through this Office of the President led by Albert Cozzi that hopefully will allow us to have our cake and eat it too. This is a local service industry, just like the solid waste industry. Keeping that local service but at the same time taking the best practices, the best computer systems, the best inventory handling systems, the best information, the best practices of all kinds, and hopefully letting these managers share them with each other under Albert’s coordination: I believe that that is the heart and soul of consolidation.

When you ask why has this industry never been consolidated, at the heart of that question is the answer to whether Metal Management will succeed or not. I believe that the answer is that the industry hasn’t been successfully consolidated nationally—not to say that it hasn’t been done in some metropolitan areas and in some cases even regionally—but its a function of how you allow the successful metropolitan areas to continue to be vibrant, to continue to have this entrepreneurial spirit of the scrap industry. And a lot of the transactions, as you guys know, from the scrap industry is personal initiative pushing it and getting a deal done. We’re trying to allow that to continue to flourish, and hopefully superimposing on that not the centralization of a public company, but the capital and access to capital for growth under the leadership of Al Cozzi.

 

Sidebar II

 

Public Trading, Private Potshots

Perhaps the aspect of “going public” that is most commonly considered is the quarterly disclosure of financial performance and the resulting explanation for shareholders and investment analysts.

But the advent of the Internet era has added a new, often uncomfortable, aspect to managing a publicly-traded company.

Internet search engines and service providers such as Yahoo! offer what are known as message boards on any and all publicly-traded stocks, where individual investors and other interested parties can express (usually anonymously) for all to see their own opinions of the company and the performance of management and boards of directors.

The postings, as messages are known, can range from coldly analytical looks at numbers and earnings ratios to personalized indictments of the performance of top officers that seem almost certain to have come from disgruntled employees.

It is difficult to say whether the opinions and comments of alleged insiders have any affect on the stock prices or operation of these companies. What is noticeable is that when a stock is either volatile in price or a company comes in with quarterly results that are disappointing, activity on the relevant message board skyrockets. For those reasons, the message boards of scrap recycling consolidators have—in the second quarter of 1998—made for interesting reading for those browsing the world wide web.