ArcelorMittal - A Sustainable Global Steel Titan?

| About: ArcelorMittal (MT)

Mittal Steel (NYSE:MT) successfully concluded its hostile takeover bid for rival Arcelor, after five months of negotiations and two raised bids. MT paid $33.7 billion, in a cash-equity mix of 13 Mittal Steel shares plus EUR 150.6 for every 12 Arcelor shares. The final price was about% more than its first offer, and the "merger of equals", as it is termed by MT's superstar CEO L.N Mittal, has created an unprecedented steel company in scale and scope.

The M&A transaction netted $300 million for the investment banks - Goldman Sachs, Citigroup, HSBC Holdings, Credit Suisse and Societe Generale for MT, and UBS, Morgan Stanley, Deutsche Bank, Merrill Lynch, JP Morgan Chase, BNP Paribas and Calyon advising Arcelor. Besides the gamut of banks, the deal involved significant statements being made by the governments of several European countries, including France, Belgium, Luxembourg and Russia (whose largest steelmaker, Severstal, was Arcelor's "white knight" before it finally gave in to MT's overtures), besides the Indian government's unequivocal support to MT, whose owner holds an Indian passport, resides in London, and has incorporated his company in the Netherlands. Mining major Phelps Dodge's (PD) $40 billion acquisition of Inco and Falconbridge, which occurred days within the MT announcement, has gone relatively unnoticed.

The new entity, to be known as ArcelorMittal will have a production capacity of about 120 million tons of steel, or about 10% of the world output, thrice as much as its nearest rival, Japan's Nippon Steel. It has a leading presence across the Americas and throughout Europe, and even in Africa. Its product line spans the entire spectrum of steel types, from the full range flat and long products to stainless steel. Arcelor is a major producer of high-value steel used by the automotive industry, while Mittal is more in the high-volume low-quality steel business, and there is little product overlap. The two companies are projecting synergies of $1.6 billion post-merger, with revenues touching $80 billion, and EBITDA of about $15.7 billion for FY06. L.N Mittal and his family will hold 43.5% of ArcelorMittal (they held nearly 87% in MT), with existing Arcelor shareholders retaining 50.5% and the other MT shareholders taking the remaining 6%. Arcelor Chairman Joseph Kinsch will stay on as Chairman of ArcelorMittal, and Mittal will become president, with Mittal taking over as chairman after Kinsch finishes his term in a year. Arcelor and Mittal will have equal representation of six each on the 18-member board of ArcelorMittal, with three seats for shareholders and three representatives of the workers.

The deal has raised the shacklessness of the steel industry--one of the most fragmented, cyclical, boring and ignored sectors. That is until along came L.N Mittal and doggedly pursued consolidation for the last decade and a half. Both Arcelor and MT have been growing through acquisitions. Arcelor was formed in 2001 through the three-way merger of Europe's largest steel companies. Mittal built up MT through a spate of acquisitions that began with the purchase of a dilapidated steel company in Trinidad & Tobago in 1989 and was capped with the acquisition of the International Steel Group in 2005, creation of another turnaround expert, Wilbur Ross.

When the world was caught in the throes of the dot-com mania in the second half of the 1990s, Mittal dared to go where no man in his "right" mind would go, and was busy buying unwanted and bankrupt steel mills in countries like Kazakhstan, Mexico and South Africa. He has perfected the art of turning around sick steel companies, buying them for a pittance and turning them into steel goldmines. The man is also famous for the spectacular $90 million dollar wedding of his daughter held at the Versailles Palace in France, and owning the world's most expensive home, a 12-bedroom mansion located in London's posh Kensington area, bought for $125 million dollars from Formula 1 baron Bernie Ecclestone. Personally, I admire his guts more than anything else. That he managed to pull off this merger, despite the odds being stacked heavily against him, is in itself a seminal achievement, not to speak of his bold contrarian bets through the 1990s.

Mittal has stated that ArcelorMittal's focus will now be on India and China - the only markets, really, where the steel goliath does not have a leadership position. The Indian business press has poured praise on Mittal and MT, hailing the merger as a giant leap for India and a big boost for India's image. Mittal, of course, has been very appreciative of the praise, and has the state and central government ministers falling over themselves to shake hands with him. They have already having announced a $9 billion investment (the second largest foreign investment after Posco's $12 billion steel project in Orissa state) in the eastern state of Jharkhand in India last year. This week, Mittal signed an agreement to invest another $9.5 billion in the state of Orissa.

Both states are have very rich iron ore and coal reserves, and steel consumption in India is on the rise - per capita consumption stands at just 40 kg, whereas in China it is upwards of 200 kg, and in Taiwan and Korea, north of 850 kg. As India builds infrastructure to keep up the consistent GDP growth of 6%+ of the last two decades, it will be using more and more steel, and Mittal wants a piece of the action. With the world's largest steel company and its accompanying cash flows firmly in his grasp, Mittal is primed to move in for the kill in India, where the government is rolling out the red carpet for the global Indian hero, and China.

It all sounds a little too good to be true. Skeptics might argue that big mergers typically never deliver the value that is imagined at the time of the deal. Financial history is littered with examples of mega-mergers gone wrong. However, the key differentiator in this case is the history of the two companies - both Arcelor and Mittal Steel have grown through the inorganic route, and the merger of the two companies is in effect a merger of several companies themselves merged over the last 10-15 years, as the graphic below shows (taken from the presentation made to Arcelor shareholders at Arcelor's website).

MT image

The most important question, which will be answered only as time passes, is whether the cultures of the two companies will click together - Arcelor is the quintessential European firm, while MT is run by L.N Mittal (chairman & CEO) and a clutch of his long-time executives, mostly Indian, including Mittal's son who serves as president & CFO. Both management teams have considerable achievements, but all their previous transactions were outright acquisitions, whereas this one is, well, a "merger of equals" - the most dangerous of all mergers.

All things considered, it seems clear that Mittal wants this bad enough that he will be willing to do anything to make it work. This man's ambition knows no bounds. He has expressed his desire to purchase India's largest steelmaker, the state-owned Steel Authority of India, on several occasions, and rest assured, there is nobody in India capable of taking on Mittal, with perhaps the only exception being the Tata Group, whose steel business is India's second largest. Mittal also has a joint venture with India's largest oil and gas company, ONGC, called ONGC Mittal Energy, for global oil and has exploration and refining, combining Mittal's contacts and reach with ONGC's competence. The company recently announced an investment of $6 billion in Nigeria. My guess is L.N Mittal will bid (aggressively) if/when ONGC is divested by the government.

So, the question of interest to the investor is, whether MT is worth buying at this point. Since MT announced its offer in mid-January, the market cheered Arcelor stock, which has nearly doubled from the EUR 20-levels to trade at about EUR 37 today. MT, on the other hand, rose to a high of $42 in early May from $26, and has come back to those levels in the last two months, currently nudging the $30 mark, at a P/E of 7. The presentation made to Arcelor shareholders, available here at the Arcelor website, says the Net Debt (i.e total debt minus cash and cash equivalents)/EBITDA ratio for the new entity will be 1.7 - which is understandable, given the heavy cash component of MT's offer. In a merger of this type, numbers do not convey the whole story and will likely be skewed in one way or another till combined operations smoothen out - and by then the money will already have been made or lost. A judgment call has to be made.

Making a bet on MT is betting on two things: inevitably, China and India, which will be the growth drivers for ArcelorMittal, and the management skill of Mittal and his executives (who should doubtless have the upper hand, especially with ArcelorMittal's India-China focus) together with the Arcelor management to deliver on their grand vision. There may be teething problems with the mega-merger, but given their track record, I think MT is a fair wager.

MT 1-yr chart:

MT 1-yr

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