Strategic plays

Steel mill operators such as Steel Dynamics Inc., Cleveland-Cliffs and BlueScope have acquired scrap processing companies, vertically integrating to capture a larger share of the ferrous scrap needed for their operations, while scrap processing firms SA Recycling and Alter Trading Corp. have purchased scrap companies that can help feed their networks of shredders.

While obtaining feedstock is the ultimate goal for acquisitive steelmaking and scrap processing companies, the valuations they place on companies can vary significantly.

At Recycling Today’s Scrap Expo, held Sept. 17-18 in Louisville, Kentucky, SA Recycling CEO George Adams and Alter President and CEO Jack Grundfest spoke about their acquisition objectives and what business owners can do to improve their company valuations in a discussion moderated by Chicago-based Vince Pappalardo, managing director and lead of Brown Gibbons Lang & Co.’s Metals & Advanced Metals Manufacturing group.

Ensuring supply

Some companies are establishing steel mills and buying scrap companies around those mills, Pappalardo said, while others might not be adding capacity but understand the importance of having access to ferrous scrap.

For example, Charter Manufacturing, the Wisconsin-based parent company of Charter Steel, purchased Niles Iron & Metal Co. of Niles, Ohio, this summer. While Charter has not announced any new steelmaking capacity, the company operates a 500,000 ton-per-year electric arc furnace (EAF) steel mill about 60 miles west, near Cleveland. With its purchase of Niles Iron & Metal, Charter likely was responding to supply pressure created by new EAF steel mills Nucor Corp. is building in Apple Grove, West Virginia, and CMC is constructing in Berkeley County, West Virginia.

“There seems to be a little bit of a run to purchase scrap companies around the mills that are there,” Pappalardo said.

Orange, California-based SA has more than 150 locations in 17 states, with 24 automobile shredders in its network, while Alter has 75 locations that include 19 automobile shredders.

“You don’t have a mill to feed, so to speak, and you’re … running a business rather than a cost center,” Pappalardo said to Adams and Grundfest, asking them to comment on what the steel mills are doing and how that affects their acquisition strategies.

Adams said SA Recycling seeks to acquire operations that can support its base, meaning the company is not interested in acquiring yards in the northern part of the country where it does not have operations.

“I try to buy yards to feed my shredders because I want to own my supply as much as possible,” Adams said.

Grundfest said Alter, headquartered in St. Louis, takes a similar approach, looking for acquisitions that enable the company to add to its existing footprint.

Alter has not encountered much competition from steel mills as it explores acquisitions, he said, because of the states it operates in, which include Arkansas, Colorado, Illinois, Iowa, Michigan, Minnesota, Mississippi, Missouri, Nebraska, Wisconsin and Wyoming.

“I think it’s really hard to beat a steel mill,” Adams said. “If they want to buy something, they’re going to buy it because they’ll overpay. They just have a lot more money than we do.”

He said SA Recycling tends to purchase smaller yards, whereas steel mills generally buy much bigger yards.

“Not that we won’t buy big yards, too, but the steel mill doesn’t want to run a little yard,” Adams said.

Acquisitions versus internal growth

“Coming off the cycle that we’ve been in for the last four or so years, everybody in the industry has done pretty well on a relative basis. And everybody who’s ever been interested in selling their business thinks this is the ideal time, so there’s a lot of opportunity to look at acquisitions.”

Grundfest noted it would be an understatement to say Alter has “plenty” of potential deals to look at, however, he added, “You can’t acquire all your growth. You’ve got to do some of it yourself,” noting that organic growth often involves the need for better management than acquisitions do.

Given the regulatory environment, Grundfest said, greenfield shredding operations are difficult to permit, making existing shredders attractive acquisition targets.

“We like the shredding business, and if we find the right opportunities, we’ll certainly try to take those down,” he said.

Adams described SA Recycling as a ready acquirer, particularly of shredding operations.

Purchasing an existing business provides an additional important benefit: personnel. “The hardest thing out there is people,” Adams added.

When SA purchased Newell Recycling in 2015, the company added 500 employees.

“Could you imagine trying to go out and hire 500 people?” Adams asked. “They had 17 yards or 18 yards. … Can you imagine trying to greenfield that and hire those employees?”

Grundfest also mentioned the importance of people in an acquisition, noting that newly acquired employees must fit in with the acquiring company’s culture. “It’s incumbent on us to do the best job we can [to integrate and] not to isolate them.”

Adams said, when considering acquisitions, he looks at how a company or yard could be a strategic fit for SA, using a hub-and-spoke model to guide those decisions.

“Normally, I try to buy yards that are not selling to me … because I accomplish two things: I increase my tons and I get new scrap,” Adams said.

“We certainly have some opportunities to infill in our existing geographic areas,” Grundfest said, citing the Great Plains region, where the company has operations in Nebraska and Colorado, as an example. “But as far as jumping out to new states that don’t touch us geographically or we don’t see any synergies there geographically, that’s not really in the plan.”

For those looking to sell

For potential sellers, Adams and Grundfest stressed the importance of having financial statements in order.

“I just can’t tell you how many times we walk into a yard, even a good-sized yard, and their financials are dog crap,” Adams said. “No one wants to pay taxes, and so they hide all their profits. They tell you how much money they’re making, and yet, you look at their financials, and they don’t make a dime, and you look at their tax returns, and they don’t make a dime.”

He added that if the financial statements don’t show profitability, calculating the value of the business is challenging.

“Now we’ve got to get an audit,” Adams continued. “We’ve got to try to build our own financials.”

“Then you’ve got folks who own their RVs and their deer club and airplanes and everything else in their businesses and don’t account for them properly, so that is a big problem,” Grundfest added.

Once profitability is established, product mix, suppliers and consumers are taken into account.

Adams and Grundfest said diversity is a key attribute.

“We don’t want them to only have one consumer; that’s not a good thing,” Grundfest said. “Usually, we’re looking for diversity in consumers, and we’re looking for diversity in supply and then processing. If there’s diversity in processing, that’s even better.”

Building people and having a succession plan in place with a manager, an assistant manager and supervisors in different areas of the business also are important, Grundfest said.

Adhering to laws and regulations is another area of importance. Adams recalled buying a business in Arizona that commonly had customers lined up down the street. “We buy the yard and, all of a sudden, there’s no customers because, of course, [the previous owner] didn’t follow the law in Arizona. He didn’t take IDs, he wasn’t taking pictures [of incoming scrap], he wasn’t doing anything he’s supposed to.”

For companies in areas with expensive real estate, Adams advised separating the land from the business on the multiple.

Instead, he suggested determining the going rate to rent the property and adding that as a business expense. “Just keep it separate as if you were leasing that land and you didn’t own the land,” Adams said.

Older firms might want to reconsider how they are organized. If they are C corporations, the owner is subject to double taxation in the sale, Grundfest noted.

“The IRS has rules where you can elect out of being a C corporation and move to a more favorable tax status,” he said. “If you’re planning long enough ahead to sell your business, that’s probably a good thing to talk to your accountant about.”

The author is editorial director of the Recycling Today Media Group and can be reached at dtoto@gie.net.