How to Pocket $267 Million

© by Mark Reutter

Updated 4/06 and 9/05, originally posted 2/05

On the morning of Monday, October 25, 2004, the business media was abuzz with news that Ross had struck a deal with Indian mogul Lakshmi Mittal to sell International Steel Group (ISG) for $4.5 billion. Shares of ISG immediately jumped, so that by the end of the day, Ross and other ISG shareholders were $545 million richer than they had been when the stock market closed on Friday.

“We had an immediate love affair,” Ross said in a conference call announcing his shotgun wedding to Mittal, nullifying his earlier statements that he was not an “asset flipper” and had invested in the steel industry for the long haul.

When the dust settled, Ross cashed out with $267 million in stock profits from his 6,936,988 shares of ISG stock. He took half in cash and half in Mittal Steel stock when the transaction was completed on April 13, 2005.

The announcement ended a period of great activity by the New York financier. As early as June 2004, following a successful IPO (Initial Public Offering) that turned ISG into a public company traded on the New York Stock Exchange, his private equity firm, W.L. Ross & Co. LLC, began selling its 32.9 percent stake in ISG. These transactions were done through two funds, WLR Recovery Fund LP and WLR Recovery Fund II LP.

Ross & Co. had paid an average of $3.42 for each share when the company was private, but sold the shares to institutional investors at between $25 and $35 each (the price range of ISG stock on the New York Exchange). These sales netted Ross at least $800 million in profits even before his big score in October.

Now consider those who were left behind during Ross’s whirlwind romance with the steel industry. They total about 150,000 Americans, all of them old, quite a few of them sick, and all of them poorer than they had ever imagined they would be when they retired after collectively serving some 4.5 million years around the heat and soot of furnaces.

About 95,000 retirees of defunct Bethlehem Steel, for example, collectively lost $380 million in health-care benefits between March 31, 2003, when those benefits were terminated by Judge Burton Lifland of U.S. Bankruptcy Court, and October 25, 2004, when Ross agreed to sell the former Bethlehem assets to Mittal.

Over the same time span, the federal Pension Benefit Guaranty Corp. paid out roughly $500 million to maintain a reduced level of pension benefits for ex-Bethlehem retirees. Roughly $200 million more in PBGC funds went out to 40,000 retirees at LTV and the 10,000 retirees at Weirton Steel, which also shed their “legacy costs” before they were bought out of Chapter 11 bankruptcy by Ross’s ISG.

In back-of-the-envelope terms, about 145,000 Americans and the PBGC had absorbed about $1.1 billion in losses arising from Wilbur Ross’s “rescue” of the bankrupt steel companies, whose final days are recounted in (new) Chapter 23 of Making Steel.

Compare their loss to Ross’s gain:

$267 million to Ross from selling to Mittal
$800 million to Ross recovery funds from selling ISG stock to institutional investors
$118 million to Rodney Mott, president of ISG, and other top execs

Total: $1.185 billion

In other words, Ross did not restructure Beth Steel or the other companies by investing in new technology or seeking out new markets. Rather, he kept the mills running, gaining the workers’ goodwill and maintaining customer relationships, and then diverted the cash flow from the working class to the investment class.

Here’s how you do it in five easy steps:

Step 1: Offer to buy the physical assets of a bankrupt company at a fraction of its book value;

Step 2: Arrange to be released from paying “lifetime” employee benefits that the bankrupt company had promised (if you have enough chutzpah, and Ross did, express anger that the prior employer did not continue to pay retiree benefits without mentioning that your stingy bankruptcy offer was a major reason why);

Step 3: Form a private company to collect the assets and issue stock to yourself and your partners at a big markdown;

Step 4: Tout your company as a comeback story and sell the stock publicly at a big markup. (This process is generally known as “unlocking the value of assets.”)

Step 5: Stand ready to hand off the company (nominally public, but totally under your thumb) to the highest bidder, saying that your “restructuring” is now complete.

Let’s not forget the role of the United Steelworkers of America in this sleight of hand. USWA President Leo W. Gerard was putty in Ross’s palm. He sold his workforce on the financier’s commitment to turning around steel, while not insisting that the retirees share directly and concretely in any future “upside” of the new company.

But then again, the union’s actions may not be so inexplicable: Retirees do not pay dues to the USWA, but active steelworkers do. Even after Ross sold out the active workers by cashing out to Mittal, Gerard was still blowing smoke about the proceedings, telling U.S.News & World Report, “The union and Wilbur Ross were the catalyst that not only saved steel jobs, but saved the industry.” Go tell that to the retirees.

Ironically, if Bethlehem Steel had held out a little longer, it could have returned to profitability. With steel prices increasing to $750 a ton last year, just about anyone who could make a pound of steel could make a buck. (Even after paying full pensions and health benefits to its retirees, U.S. Steel Corp. reported record earnings last year of $1.08 billion.)

Ross’s successful attack on the claims of active and retired employees would not have been possible without the assistance of the officers and directors of the former steel companies.

Among those on the board of directors of Bethlehem Steel Corp. who unanimously approved the “asset purchase agreement” with ISG in 2003 that led to the termination of retiree health-care benefits were a former U.S. attorney general (Benjamin R. Civiletti); an ex-Columbia University law professor who practiced corporate law for the international law firm, Davis, Polk & Wardwell (Lewis B. Kaden); a former president of a major liberal arts college (Shirley D. Peterson, president of Hood College from 1995-2000), and a self-described “corporate recovery specialist” (Robert Steve Miller, CEO of Beth Steel). (1)

Former director Kaden deserves special attention. After napping for 10 years as a Beth board director, Kaden was instrumental in hiring Robert Steve Miller as the last CEO of Beth Steel, who set in motion the asset sale to ISG, which Kaden approved as a board member. Since then, Kaden has done very well for himself. He now sits as one of only two U.S. directors of Mittal Steel Co. – the other being Wilbur Ross.

On September 4, 2005, Kaden left Davis, Polk & Wardwell to become vice chairman and chief administrator officer of Citigroup, the world’s biggest bank, reporting directly to CEO Charles Prince. On March 24, 2006, Citigroup led a syndicate that loaned five billion Euros to Mittal Steel to cover the cash portion of its hostile bid for Arcelor Steel. Kaden’s position in the highest reaches of Wall Street make his $79,000 remuneration (in 2005) from Mittal a true bargain. But it also helps feed a lot of business to his new employer.(2)

The depredations of steel management have certainly not gone undetected among those who try to keep the mills running. As one concerned employee recently wrote to me: “Wilbur Ross pulled off one of the greatest self-serving atrocities the business community has ever seen. It has been a mystery to me that a government, especially the U.S. government, can be so passive with regard to the give-away of a vital industry.”

But don’t expect to read this kind of observation in the business press. With its narrow-minded focus on earnings and investor returns, the press has turned Ross into a corporate miracle worker. Business Week struck a Churchillian note in a Dec. 22, 2003 cover article that lauded Ross not only for rescuing steel, but for his defense of American industry (“he’s down in Washington every week to argue his view on trade and the need to protect American jobs”).

A hero? Wilbur Ross? Yes, The Economist proclaimed (“Americans have toasted Mr. Ross as the savior of their steel industry”), a view seconded by Fortune (“a latter-day Andrew Carnegie”) and the Washington Post (“It is a testament to the self-correcting nature of the U.S. economy that there are a few well-funded Wilbur Rosses around”).

In the strangely uniform eyes of major press outlets, glimmers of a more complicated story line are quickly stamped out by business platitudes. For example, just days before Ross sold ISG, the Chicago Tribune’s James P. Miller was hailing him for his dedication to the sector, writing, “Over the past few years, Ross’s steel investments have had such a dramatic impact that many observers no longer perceive him as just another vulture investor but instead see a pioneering figure who helped revive and rationalize a failing industry.”

Exactly who are the “many observers” cited? They are Wall Street analysts and academic experts dependent on pleasing the CEOs and industries they cover (3) – along with Ross himself, whose gift for spin befits a man who studied English literature when he was a student at Yale.

What honestly can be said about Wilbur Louis Ross is that he took a troubled business, shook it hard, and emerged laden with fruit. No distractions kept him from extracting maximum value from his assets; no balancing of his financial interests against the sacrifices made by many others. Just knife-blade bargaining and cutting-edge execution.

Or as Ross said in a speech before the American Iron and Steel Institute, “The building blocks [of ISG] are drastically reduced personnel costs, performance-based incentive plans, and innovative measures aimed at realizing great production efficiencies.” Those words were delivered back in 2003 when he was still taking bows as “chairman of a huge company in a vital industry.” It’s amazing how quickly he gave up his lady when Mittal came a-wooing – in a New York minute, one could say.

The sale of ISG capped a busy month for the 66-year- old (he was born on Nov. 28, 1937). Just three weeks before he tied the knot with Mittal, he wed blonde society hostess Hilary Geary, 54.

The marriage (the third try for both) followed his brief union with Betsy McCaughey while she was lieutenant governor of New York state. News of their courtship, marriage, and separation, all within McCaughey’s four-year term, made the papers on a regular basis. The New York Times planted a reporter at the Rainbow Room at Rockefeller Center as fellow billionaires and other members of the Manhattan gentry gathered to dance to the songs of Bobby Short (who died soon after) on Oct. 13, 2004. An excerpt:

The crowd, which included Carl C. Icahn, Georgette Mosbacher and Arnold Scaasi, topped off a dinner of lobster and filet mignon with banana splits. “God is in the details,” said the bride, who rented ice cream parlor dishes for their authenticity.

Mosbacher, CEO of the Borghese beauty company and Republican Party fundraiser, gave a toast that suggested how Hilary will help the groom take pleasure in his riches, saying, “When men are as accomplished as Mr. Ross, and have built what he’s built, they don’t have a lot of time to enjoy it. Hilary will open his eyes to that life, to the glamour. She rounds his life out.”

Having acquired a partner suitable for the society pages, Ross has turned his attention to repeating his success in steel in other troubled industries.

International Coal Group (ICG) is a knock-off of ISG, formed by Ross & Co. to buy bankrupt assets of coal companies. His biggest catch so far is Horizon Natural Resources, which operates surface and underground mines in Kentucky, West Virginia, Indiana, and Illinois.

As he did with Beth and other steel companies, Ross first legally discarded the “baggage” that weighed down the assets. Before he bought Horizon in partnership with A.T. Massey Coal Co., the bankruptcy courtroom of Judge William Howard obligingly eliminated the health-care benefits for 3,800 retired Horizon miners and their widows. (The Pension Benefit Guaranty Corp. had already assumed responsibility for Horizon’s underfunded pensions.)

Ross also purchased Anker Coal and CoalQuest Development, which own extensive reserves in the Lower Kittanning seam of coal near Grafton, W.Va. (once a major source of metallurgical coal for Sparrows Point). Hoping to repeat his success in steel, Ross has filed his intention to float a $250 million coal IPO through UBS Securities and Lehman Brothers. With energy prices rising, Ross has been angling for a position in UK Coal, Europe’s biggest coal mining outfit, with 12 deep and surface mines in central and northern England.

A second venture launched by Ross is International Textile Group (ITG), which controls the assets of bankrupt textile makers Cone Mills and Burlington Industries. ITG has entered into joint ventures in Mexico, Guatemala, Turkey, and India, purchased Canadian worsted producer Cleyn & Tinker, and reached an agreement with a Chinese clothing chain to sell apparel to China’s middle class.

As befits a man of wealth and taste, Ross collects art, summers in Southampton, and sits on a bevy of prestigious boards. He is former chairman of the Smithsonian National Board and the Parrish Art Museum. Through his wife, he has become active with the Boys Club of New York and Central Park Conservancy. He was appointed by former President Bill Clinton to the Board of the U.S.-Russia Investment Fund and served as privatization adviser to New York City’s former Mayor Rudolph Giuliani.

He is a member of the Yale School of Management Board of Advisors (joining Rupert Murdoch’s Yale MBA wife, Wendy Deng Murdoch), the Business Round Table, and the Turnaround Management Association. He is a popular speaker, recently addressing students and faculty at Columbia University’s Graduate School of Business and slated to appear at the Fall 2005 Private Equity Analyst Conference sponsored by Dow Jones & Co., publisher of the Wall Street Journal.

He and his equity company have won multiple awards and hosannas. In 1999, President Kim Dae Jung awarded Ross a medal for his help during Korea’s 1998 financial crisis. In 2002, Buyouts Magazine awarded his firm the Public-to-Private Deal of the Year award as well as the Middle-Market Deal of the Year award. Mergers & Acquisitions Advisor awarded the firm the Boutique Middle Market Private Equity Firm Award in 2002.

Notes
1. For the record, other members of the Bethlehem Steel board who signed off on the ISG sale were Worley H. Clark, former president and CEO of Nalco Chemical; John B. Curcio, retired chairman and CEO of Mack Trucks; Harry P. Kamen, retired chairman and CEO of Metropolitan Life Insurance; William M. Landuyt, chairman and CEO of Millennium Chemicals; and John F. Ruffle, former chairman of J.P. Morgan & Co. The two top financial officers at Bethlehem Steel were appointed to the same management positions at ISG after the Bethlehem asset sale. They were Leonard M. Anthony, Bethlehem senior vice president and principal financial officer, and Lonnie A. Arnett, Bethlehem vice president and principal accounting officer.

2. Mittal Steel Co. website, Company/Management/Board of Directors; “Lewis B. Kaden to Join Citigroup as Chief Administrative Officer,” Citigroup press release, June 15, 2005; “Mittal Steel Files Documents with SEC on Arcelor Takeover Bid,” Reuters, March 24, 2006. In December 2005, Citigroup loaned Mittal Steel $3.5 billion to help pay for its purchase of the Ukrainian steelmaker Kryvorizhstal.

3. Among the most frequently quoted experts is Professor Peter Morici at the University of Maryland, who has served as a researcher and paper-writer for the American Iron and Steel Institute and Steel Manufacturers Association, a fact rarely disclosed in media reports.