bear hugs and bankers:
Behind the arcelor bid

© by MARK REUTTER

Posted 4/24/06

Until recently, steel was as welcome on Wall Street and London’s “City” financial district as pickling acid. (That’s the stuff that cleans the grit off of steel coils and smells like rotten eggs.)

Composed of aging warhorses such as U.S. Steel, National, Weirton, Wheeling-Pitt, and Bethlehem Steel, the industry stank of losses and long-term decline. In Europe, heavy-metal giants like ThyssenKrupp and Arbed were struggling, too.

When the sector hit rock bottom with Bethlehem Steel’s bankruptcy in 2001, the possibility of renewal seemed remote, if not ridiculous. “Steel is a destroyer, not a creator, of wealth,” sniffed a Wall Street analyst.

Some remarkable things have happened to change steel’s financial fortunes, at least in the short term (and short term is what the smart money is banking on). The Mittal-Arcelor battle is a case in point, the latest in a chain of events that has made this mature industry red hot among a handful of global players.

In the spotlight Lakshmi Mittal’s hostile bid for Arcelor has won applause from hedge fund managers and bankers anticipating a rich payday.

Two of the global players are publicly visible. Squarely in the spotlight today is Lakshmi N. Mittal, billionaire CEO of family-owned Mittal Steel Co. NV. A transplanted Indian living in London, Mittal (pronounced "middle") made headlines on January 27, 2006 by launching a $23-billion hostile takeover bid for Arcelor to form a steel company three times larger than any competitor.

Arcelor’s management and board of directors rejected the bid as stock-market speculation with no underlying industrial logic. They are correct. Arcelor is a profitable conglomerate, run by sturdy European engineers, which has proven to be an irritant to the wildly expansionist plans of Mittal and his 30-year-old son and company president, Aditya.

Aditya Mittal reportedly recommended the hostile bid to his father – the first time the family has ever made an unsolicited bid for another company. When a takeover is termed hostile by the target, business etiquette (at least in “old Europe”) is to turn away from the deal. Especially when the prime minister of Luxembourg, where Arcelor is headquartered, declared that “this hostile bid calls for a reaction that is at least as hostile.” Prudence would suggest that it was time for a strategic rethink.

But the Mittals have pressed ahead, cheered on by private equity investors in the U.S. and England who have amassed large holdings of Arcelor stock in anticipation of a rich payday. Such pot stirrers in pinstripes, who like to call themselves “activist shareholders,” resent prime ministers who step between a high-roller and his profit. “It’s crazy if they want to stand in the way of the free market,” said Stephen Pope, head of equity research at Cantor Fitzgerald LP in London, referring to the government of Luxembourg’ s hostility to the Mittal bid.

More seriously, the company’s assurances that a merger would result in added investment in Arcelor and a solid future for European steel are at variance with Mittal’s record in the U.S. since it purchased the International Steel Group (ISG) a year ago.

Capital expenditures at U.S. mills were slashed, proposed expansion plans shelved, management turnover was extreme, and some residents and politicians are openly unhappy at the secretive and bumbling nature of the new owner.

Underlining management’s poor execution were the financial results of Mittal in 2005. As noted in Making Steel Updates, the downswing in steel demand in 2005 hit the Mittal group especially hard. Earnings before interest, taxation, depreciation, and amortization (Ebitda) per ton of steel dropped by 29 percent last year compared to 2004. Arcelor’s Ebitda per ton gained 30 percent in the same period.

Guy Dollé, CEO of Arcelor, has compared the two companies’ products to high-class perfume and low-end cologne, and said a merger would take money away from Arcelor’s modern European mills in order to prop up Mittal’s aging facilities in the Third World and undernourished mills in the U.S.

But Mittal’s raid on Arcelor isn’t about sustainable growth of the steel industry. It about such things as a “bear hug,” an offer to buy the shares of the target company for a much higher per-share price than the company is currently trading.

Mittal is willing to pay about a 20 percent premium for Arcelor, based on Arcelor’s closing price before the bid was announced, because most of the offer is in stock. Arcelor stockholders would get about three-quarters of their money in Mittal stock, with the remainder in cash. In other words, Mittal could buy its rival through its own underlying value, while stockholders would assume the long-term risk that Mittal’s share price might perform worse than the price of an independent Arcelor.

The profits that can be extracted through bear hugs and other forms of arbitrage have drawn widespread interest from hedge funds. A Financial Times article (2/6/06) explained how it worked:

Virtually every big convertible arbitrage fund is examining the deal. Typically, convertible arbitrage funds buy the stock of the takeover candidate and sell short the potential acquirer on the belief that the former will rise and the latter will decline.

In the Mittal-Arcelor case, this opportunity is severely constrained by the fact that the Mittal family owns 88 percent of the shares. This means finding publicly floated shares to borrow and sell short is very difficult.

However, the manager at one large hedge fund said his interest was not necessarily in arbitrage. “We think there will be a higher bid,” said the manager, who bought Arcelor well before Mittal’s bid and has been accumulating shares all week. “I don’t need to sell Mittal shares to make a profit here.”

Indeed, other deal watchers have said they expect Arcelor could ultimately fetch €35 a share. Largely on these hopes, the stock has risen to €30.53.

It remains open whether the Mittal family will essentially lend some of its shares to hedge fund arbitrageurs to sell short, with the quid pro quo that they vote their Arcelor shares in favour of the deal. Individuals familiar with the matter see that as a trump card of last resort for Mittal if they have difficulty getting a majority [of Arcelor shareholders to favor the deal].

These hedge-fund arbitrageurs are nibbling around the edges. One of the real financial powers behind the deal revealed itself on February 20, 2006, when Atticus Capital LP called on Arcelor to negotiate a deal with Mittal. Atticus is one of the world’s largest and most aggressive hedge funds, with $10 billion of assets under management, including voting rights to 1.3 percent of Arcelor stock.

In a letter to Dollé, Atticus praised a Mittal-Arcelor tie-up as offering “synergies and strategic benefits to all participants in an industry in need of consolidation.” The fund concluded with a threat of legal action if Arcelor failed to heed its endorsement:

We would like to remind you of the Board of Director’s obligations and fiduciary duty to your shareholders, and we reserve the right to protect our interests through voting at the April 28th AGM [Arcelor general stockholders' meeting] and/or through the courts. We look forward to hearing back from you so that we might discuss the matter soon.

The letter was signed by Timothy R. Barakett, chairman, and David Slager, vice chairman, of Atticus. But the financial firepower behind Atticus is Nathaniel Philip Victor James Rothschild, scion of the Rothschild merchant-banking family, who co-founded and holds a 50 percent stake in Atticus.

On March 23, 2006, the world’s biggest financial group, Citigroup, officially waded into the battle. Disclosure statements showed that it had organized a syndicate to loan Mittal the $6 billion needed to fund the cash portion of the Arcelor bid. Citigroup had further arranged a $3.5 billion loan to Mittal to underwrite its purchase of Ukraine’s Kryvorizhstal mill last October. The mill was sold to Mittal by the “Orange Revolution” government after a fierce bidding war with Arcelor.

Two other banks were among the arrangers of the financing of Mittal’s hostile bid. They were Goldman Sachs of the U.S. and Société Générale of France. Société Générale has itself been cited as a potential merger target of American banks. The French paper Le Nouvel Observateur reported last month that Citigroup had been feeling out French authorities regarding purchase of the 142-year-old bank, which has long been associated with the Paris branch of the Rothschild family.

Arcelor’s annual meeting on April 28 will give a good indication of whether Mittal’s combination of political sweet talk and financial muscle is succeeding. The plan by Dollé and Arcelor Chairman Joseph Kinsch to thwart Mittal by locking Dofasco, a valuable Canadian subsidiary, into a special trust has angered arbitrageurs and some stockholders.

The U.S-based Institutional Shareholder Services, which provides proxy-voting advice to institutional investors, has recommended that its clients oppose the re-election of Kinsch and Arcelor Vice Chairman Jose Rendueles at the annual meeting to “show their displeasure with the company’s recent actions,” which ISS said has destroyed shareholder value.

Mittal is expected to launch the takeover bid formally in early May. Many observers predict that the company will add a financial “sweetener” to win support from shareholders. The battle over western Europe’s biggest steelmaker is not expected to be decided until late June.

Why is the Street and the City so keen on steel? The precipitating event was the sharp demand for steel by China in 2002, which spiked world steel prices by 2-1/2 times by December 2004.

In past booms, steel companies would have flooded the market with metal as soon as prices rose. But several structural changes had taken place in the sector. Following the dissolution of the Soviet bloc, many ailing state-owned steel mills were put on the auction block. Aggressive entrepreneurs could buy the properties at bargain prices, then consolidate and rehabilitate them with loans from the European Bank for Reconstruction and Development and other Western institutions.

Lakshmi Mittal pioneered this strategy. Moving systematically across the globe, Mittal acquired ex-state mills in Trinidad, Mexico, Kazakhstan, Ireland, Algeria, South Africa, Czech Republic, Romania, Bosnia, and Poland between 1989 and 2004. He parachuted in teams of Indian engineers, who wrung out costs and reduced the workforces. Using sophisticated risk-analysis tools to discern minute changes in supply and demand, Mittal would throttle down production in periods of oversupply, thus keeping steel prices higher for longer in the markets that he controlled.

The privatization of overseas assets was paralleled by the transfer of troubled U.S. steel assets from stockholder companies to financial middlemen via federal bankruptcy courts. Here the key figure is Wilbur L. Ross. As executive managing director for the American branch of Rothschild, Ross was responsible for developing the Rothschild Recovery Fund in 1997. Ross used some of the capital to buy into the coal company that opened the Sago, W.Va., mine where 12 miners died on January 2, 2006.

In 2000, Ross left Rothschild with several colleagues and set up his own merchant banking firm, W.L. Ross & Co.  By 2002, he had raised $450 million from private sources for his own recovery fund and created International Steel Group (ISG) to buy and consolidate bankrupt steel companies.

The trick to buying bankrupt companies – described in detail in MAKING STEEL – is to terminate “legacy costs” to retirees through the Chapter 11 reorganization proceedings. In Bethlehem Steel’s case, two other middlemen played important roles: Lewis B. Kaden and Robert Steve Miller. Kaden, a New York mergers and acquisitions lawyer who sat on the Bethlehem board, hired Miller as Beth’s last CEO. (Miller has since become famous as the CEO of Delphi, the auto-parts maker whose Chapter 11 bankruptcy proceedings are roiling both General Motors Corp. and the United Auto Workers.)

In a move presaging the Delphi bankruptcy, Miller placed Bethlehem in Chapter 11 bankruptcy and sold its steel-mill assets to Ross-controlled ISG – but only after the bankruptcy judge had voided health-care benefits for retirees and pension costs were taken over by the Pension Benefit Guaranty Corp. (PBGC).

Kaden signed off on these transactions as a Bethlehem director. The suddenly valuable ISG was sold in 2005 to Mittal Steel. Ross was placed on the Mittal board of directors, along with … Lewis B. Kaden.

According to Mittal‘s Form 20-F disclosure statement to the Securities and Exchange Commission, Lakshmi Mittal and his wife Usha control 98.3 percent of Mittal stock through “super-voting” rights (a point that shareholders critical of Arcelor’s governance policies seem to ignore). And regarding the election of directors of the company:

Mr. Lakshmi N. Mittal has the right to make binding nominations for the appointment of all members of Mittal Steel’s board of directors and to determine the outcome of any action requiring shareholder approval. In addition, Mr. Lakshmi N. Mittal has the ability, by virtue of his ownership of Mittal Steel class B common shares, to prevent or cause a change in control of Mittal Steel and its subsidiaries. (Form 20-F, pg. 109)

It should be noted that Kaden was elected to the Mittal board of directors by a margin in which the word “overwhelming” does not do proper justice. Minutes from the April 12, 2005 shareholders meeting held at the Rotterdam Hilton noted the following:

Proposal to appoint Mr. Lewis B. Kaden as a member of the company’s board of directors (class C Managing Director) for a term commencing on the day following this extraordinary meeting…. Chairman [Mittal] asked if anyone would like to ask questions regarding this item. After noting that there were no questions, the chairman then put the proposal to a vote.

After counting the votes, the chairman recorded that 4,744,328,506 votes were cast in favor, 6,225 votes were cast against, and 6,101 votes abstained, so that in accordance with article 31 of the Articles of Association of the company, the proposal had been adopted.

The chairman welcomed Mr. Kaden to the company’s board of directors. (“Minutes of the Extraordinary General Meeting of Shareholders of Mittal Steel Co. NV,” recorded by Henk Scheffer, company secretary)

Under these governance procedures, Kaden was designated an “independent” director because he does “not have a material relationship with Mittal Steel.” Last September (2005), Kaden left his law practice at Davis Polk & Wardwell to become a banker. He was appointed to the No. 2 position of Citigroup as vice chairman and chief administrative officer.

“Lew’s deep experience, insight and integrity will be of great value as we pursue our ambitious agenda to build the most respected global financial services company,” said Charles Prince, Citigroup’s CEO, in a press release announcing Kaden’s appointment.

“I am honored and excited to join Citigroup,” Kaden responded in the release. “I have the highest regard for the caliber of leadership at this extraordinary company. I look forward to working closely with the senior team while insuring that the flow of information to the CEO is direct, efficient, and enhanced.”

Among Kaden’s new responsibilities is the oversight of Citigroup’s “Mergers & Acquisitions Execution” group (a suggestive title). And in March 2006 Kaden was named interim head of “Citigroup Alternative Investments” group after Prince pushed Michael Carpenter out of that post. Citigroup’s website defines CAI as a private equity hedge fund that plays in the same high-risk markets as Atticus Capital. According to a Citigroup press release, the bank’s top executives closely monitor the fund:

CAI’s Policy Committee, whose members are Mr. Kaden, Mr. Prince, Robert Rubin [former U.S. Treasury Secretary and Citigroup director], and William Comfort, Chairman, Citigroup Venture Capital, LTD, will continue to provide guidance on strategic matters.

Click for larger image

Organization Mittal Steel is a holding company based in Rotterdam, Netherlands, with no business operations of its own. Instead, operations are carried out through subsidiaries that are wholly or majority owned by Mittal.

In his unique position of straddling the interests of the world’s biggest financial group that has helped raise $9.5 billion in bank loans to the world’s biggest steel company, Kaden has talked up Mittal’s offer as very positive for Arcelor shareholders. He was quoted in Bloomberg News (2/3/06) as commenting, “At the end of the day, the shareholders at Arcelor should have their own judgment.”

Having watched their stock drop from $24.00 to $0.09 a share during Kaden’s 10 years on the Bethlehem board, stockholders at Bethlehem Steel must be flattered by his touching regard for shareholder welfare. 

Postscript: On February 21, 2006, Kaden delivered the Bernard G. Segal Memorial Lecture in Law and Ethics at the Jewish Theological Seminary in New York City. The lecture’s title: “Values Come First.” According to the press release:

In a post-Enron, WorldCom, and Tyco world, the subject of business ethics has gone mainstream, with the importance of sound governance now apparent to investors, regulators, management, and customers alike.

But by themselves, are the laws, policies, rules, and their enforcement enough to guarantee outstanding corporate governance and business practice? Lewis B. Kaden, Vice Chairman and Chief Administrative Officer of Citigroup, will explore these issues.

The release went on to note that Kaden has served as moderator for PBS’s Media and Society Seminars, including the Peabody award-winning “Ethics in America” series, and was appointed Covington & Burling Distinguished Visitor to the Harvard Law School.

Fellow board director Ross has been active in voicing the same “let-the-stockholder-decide” mantra, spiced with denunciations of Dollé. In an interview with the Dow Jones MarketWatch, Ross worked up quite a head a steam about the steelmaker’s intransigence. “They [Arcelor] seem to be doing everything imaginable to prevent shareholders form exercising their rights. The position is totally at odds with any concept of corporate governance.”

In a speech in Chicago posted on Mittal’s website, Ross said a Mittal/Arcelor merger would bring the same results as Mittal’s takeover of ISG – an assertion that should strike fear in all Arcelor employees. Of course, Ross wasn’t talking about the welfare of employees or the long-term health of the industry, but about the financial goodies that would accrue to the top barons of a cartelized industry if the deal goes through. Couched in Street-speak, Ross laid out the aim of Mittal Steel and its financial backers in the Chicago speech:

We still have to demonstrate that consolidation has progressed enough to have a real benefit in terms of reducing volatility and ensuring sustainability of earnings. Ultimately this will be improved by better management of supply and demand, which will further improve through having a more consolidating production base.

A successful takeover of Arcelor would create a steel empire with 320,000 employees and control of 10 percent of world steel production. The Mittals, needless to say, don’t plan to stop there – Lakshmi and Aditya are already talking up the “synergies” and “shareholder value” of owning 20 percent of global production, and of the promise of invading China and India as their next big markets.

The operative words of Ross’s speech – “better management of supply and demand” – are the words of the middlemen and asset consolidators who package the deals for folks with globs of money.

Consolidation the Mittal way means the power of a few to set prices, curb competition, and thwart innovation. It means the monopoly of an essential commodity, which eventually could drive up the prices of everything from cars and airplanes to Army tanks and dishwashers. It all carries the whiff of rotten eggs.