ThyssenKrupp Close to Finally Biting the Bullet

| About: ThyssenKrupp AG (TYEKY)

By Stuart Burns

ThyssenKrupp (OTC:TYEKY), the German steelmaker, looks close to finally off-loading its troubled Steel Americas group, according to a Reuters article. The new service quotes a spokesman as saying Thyssen aims to reach a deal in the near future and is currently in intense negotiations - principally, it would seem, with front runner Cia Siderurgica Nacional (NYSE:SID), or CSN, a Brazilian steelmaker.

The article quotes sources saying CSN has offered $3.8 billion for ThyssenKrupp’s Steel Americas, which comprises a slab processing plant in the U.S. state of Alabama and a 73% stake in Brazilian slab-making mill CSA, the balance 23% being owned by Vale (NYSE:VALE).

If correct, it would bring closure to a brave but ultimately costly venture for ThyssenKrupp which, according to the WSJ, has cost the German group some US$15 billion in losses since 2010.

The two plants opened in 2010 and each with a planned capacity of some 5 million tons per year. Quoting the WSJ, their output has been significantly below capacity, however, with Alabama producing 2.6 million tons and Brazil producing 3.4 million tons in fiscal 2012.

The Alabama plant was the largest built in the U.S. in four decades and sought to leverage low-cost energy and raw material in Brazil to feed cheap slab into the high-end automotive and quality steels market in the US. Economic volatility upended ThyssenKrupp’s plans.

The WSJ reports Brazil’s booming economy triggered wage increases and increased the value of the Brazilian real, which ate up the planned cost advantages. The slow U.S. economic recovery eroded steel demand and prices, while design flaws and technical problems, particularly at the Brazilian plant, caused cost overruns, which, in turn, amassed debt.

Under the plan that ThyssenKrupp currently prefers, CSN would buy the operations for more than $3 billion, but well below the current book value of $5 billion. Another option would be for ThyssenKrupp to keep a 33% stake in the Brazil plant, presumably as a potential source of slab for Thyssen’s European operations.

A third option is more of an outlier: a joint venture of ArcelorMittal (NYSE:MT) and Nippon Steel & Sumitomo Metal Corp. (OTCPK:NSSMY) has reportedly offered a binding bid of about $2 billion for the Alabama plant, but that would leave Thyssen with the slab mill in Brazil and CSN is probably more interested in the state of the art downstream operation that gives them access to the U.S. market than in the slab mill at home.

Apart from the massive debt weighing on profitability, the underlying rationale of low slab prices feeding a local high-end finishing mill still faces the headwinds of currency risk and a weak U.S. market.

It could be some time before capacity utilization and market prices move up in the U.S. on the back of stronger demand. Meanwhile, while Brazil’s real has weakened to about two reals to the dollar from highs of 1.5 in summer 2011, it is still a fair way above the nearly 3 reals to the dollar pertaining some 10 years ago when the project was first planned.

As a high-growth, increasingly oil- and mineral-rich emerging market, Brazil’s currency has more upside than down. It is a rather sad end to a brave investment, at least as far as ThyssenKrupp is concerned, but for CSN or whoever finally claims the jewels at a knock down price, it could prove to be a good - if still risky - investment in the long term.