In-Depth Analysis of Ternium IPO (TX)

| About: Ternium S.A. (TX)
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Ternium S.A. (TX) plans on offering 24.8 million shares (28.5 if over- allotment is exercised), at a price range of $16 1/2 - $18 1/2. Citigroup is lead managing the offering, Deutsche Bank is co-managing. Post-offering TX will have 206 million shares outstanding for a market cap mid- range of $3.605 billion. All IPO proceeds will be utilized to pay down debt.

From the F-1:

"Ternium is one of the leading flat and long steel producers in Latin America....Ternium produces and distributes a broad range of semi-finished and finished steel products, including value- added products such as cold rolled coils and sheets, tin, galvanized and electrogalvanized sheets, pre-painted sheets and tailor-made flat products...we believe Ternium is among the largest producers of crude steel in Latin America, with manufacturing, processing and finishing facilities that have aggregate annual production capacity of approximately 11.6 million tons."

TX is a holding company based in Luxembourg. They've controlling direct and indirect equity interests in Argentina’s largest steel company, Siderar, Venezuela’s largest steel company Sidor, and the recently acquired Hylsamex which is one of Mexico’s largest steel companies. Of the 11.6 million tons of capacity, 5 million tons is from Venezuela, 3.8 million tons in Mexico, and 2.8 million tons in Argentina.

The majority of TX's products are sold in the producing countries as TX is the leading leading supplier of flat steel products in Argentina and of flat and long steel products in Venezuela, as well as one of the leading suppliers in Mexico. 45% of sales are in Central/ South America, 48% to North America (predominantly Mexico) with the rest split between Europe and Asia. TX mentions increasing sales force in Europe and Asia, to date though that region of the world accounts for a small % of TX business.

The steel industry went through a very ugly period in the early 2000s. Most of the worldwide steel companies including TX restructured significantly after this period and are now in much better shape balance sheet wise. TX is coming public a bit more leveraged than most other worldwide steels, but not overbearingly so. It appears TX will have roughly $1.5 billion in debt post offering, a hefty amount but much less than before restructuring. Quite a bit of that current debt was taken on with the August 2005 acquisition of Hylsamex in Mexico. Note that NUE/ MT/ STLD/ X all have a much lower debt to equity balance sheet positions than TX post-offering.

Goals going forward are: 1) to continue integrating the three separate businesses into one operating structure, 2) continue to utilize position as a low cost producer-- production costs in Latin America are much cheaper than in the United States and Europe, 3) Focus on higher margin products and 4) continue to acquire.


As mentioned, TX will have approximately $1.5 billion in debt post- offering, a significant amount.

There doesn't appear to be concrete plans to pay a dividend. I would expect a small dividend here, possibly equaling 1% yield annually.

1 1/2 X's book value at a mid-range offering.

TX has only made financials available through June 2005. Also the financial sheets include a lot of pro forma data as they closed the purchase in Mexico after this period. TX has yet to release any earnings statements reflecting the company as currently structured. This combination does make projection out through 2006 quite difficult. Also the acquisitions really make comparisons to prior years other than pro forma for 2004 irrelevant.

TX should book roughly $6 1/2 billion in sales in 2005, an increase of 18% over '04 pro forma of $5 1/2 billion. Both estimates do include the Hylsamex acquisition as if it had happened prior to 2004.

Gross margins 42%, much stronger than US/ European steel producers.

SGA expenses each of past 2 years have been under 10% resulting in very strong operating margins of 33%. Of the other large worldwide steel companies, MT has been able to approach 30% operating margins the past 2 years. The rest of the group appears to be in the 10- 20% operating margin area. TX has definitely benefited from having business operations based in the cheaper operating environment of Latin America.

Net margins after taxes and minority interests are 12% resulting in roughly $3.75 - $3.85 a share in earnings for full year 2005. At mid- range then, TX will be trading 4 1/2 X's 2005 earnings. Keep in mind these results are pro forma and take into account the August 2005 purchase of Mexican based Hylsamex. The actual results for TX look a bit different, although these estimates represent the company going forward.

Looking into 2006, it is difficult to be comfortable with an estimate. There have been so many deals and changes to TX the past 2 years it is difficult to know for certain what to expect in 2006. TX has not given any results yet as currently structured. Based on guidance from similar steel companies worldwide, coupled with integrations saving I think we can be safe to assume somewhat flat earnings. Analyst estimates are for lower earnings per share in 2006 across the board in the steel sector. This assumes that Latin America continues economic expansion for the full year at similar rates to '05. I would than think that TX could earn potentially $4 per share in '06 or 4 X's 2006 earnings. I don't have a lot of confidence in this number, it is based more on similar company outlooks than TX specifically. There are so many parts to TX's business that have previously not been part of the whole, with only first half of 2005 results to work with-- projections for '06 here are more an educated guess than anything else.

At quick look at other large worldwide steel producers. Keep in mind that TX will be carrying more debt leverage into 2006 than those below but should be able to sustain earnings levels a bit better due to integrations savings and low 'cost of production' environment in Latin America

NUE - 3 X's book, 10 X's '05 earnings and 13 X's '06 earnings.

MT - 2.3 X's book, 5 X's trailing earnings 7 X's forward.

X - 1 1/2 X's book, 6 x's trailing 10 X's forward.

STLD - 2 X's book, 10 x's trailing, 12 x's forward.

TX - 1 1/2 X's book, 4 1/2 X's trailing, 4 X's forward.

Risks - Debt levels combined with a worldwide economic slowdown and the cyclical nature of the business - In the early 2000s TX's subsidiaries experienced considerable losses. If another similar period occurs in the near future it is entirely possible that similar would occur, the result being that shareholder value would be at extreme risk. This is a big reason why the sector trades at such low multiples. Investors got wiped out across the board in the steel sector just a few years ago, the market has not quite been ready to give back multiples to the group. MT for example hit a stock price of roughly $1 during the last economic slowdown while many other common shareholders of steel companies lost their entire investment in restructurings.

Latin America in particular is not known for smooth economic cycles, but rather for wild swings into growth and recession. If and when another Latin American slowdown occurs, if it is significant I would think TX shareholders could very well be at significant risk. This is why TX is coming 4 1/2 X's trailing earnings. I would very much like to see TX utilize cash flows going forward to significantly pay down their debt. If they continue to acquire by laying on more debt, I think they'll just be setting themselves up for a hard fall sometime down the line.

Venezuela - Venezuela appears intent on shifting ever closer to socialism, while politically and economically it seems to be a mess. A big chunk of TX's operation is their stake in the the Sidor facility in Venezuela. The Venezuelan government is a minority shareholder in Sidor and TX must receive governmental approval for nearly all significant operating decisions in regard to Sidor. If there is any political or economic unrest in Venezuela going forward, it is entirely possible net profits received by TX from the Sidor operations could cease, at least temporarily. I would expect TX stock price to take a hit on any negative macro Venezuelan news.

While yes, it is true that Venezuela's protective environment has limited imported steel, it also true though that the Venezuelan government takes a chunk of Sidor's profits and could very well opt to take more at some point in the future. I would be much more comfortable going forward if TX had operations in just Mexico and Argentina, not Venezuela. I think there is potential 'event risk' going forward in owning a majority interest in any major Venezuelan business.


TX appears to be coming priced for potential upside. There are sizeable risks here going forward, but at an estimated 4- 5 X's 2006 earnings TX on a mid-range pricing would appear to have much of that risk built in. This is a rather bulky deal, and a complicated one to boot but I like it in the current market and economic environment. This is not the deal to be in during a Latin American economic contraction, but with worldwide demand for steel continuing to remain strong coupled with TX's low production costs and strong gross margins this deal should work.