Part 1: Free Fallin'

Led by Lakshmi Mittal, the pied piper of consolidations, steel topples off a cliff. At least $600 billion of market value has vanished since June. How “hot money” mergers in a mature industry set the stage for disaster.

© by Mark Reutter
Posted 4/7/09

The mood was downright giddy last June (2008) as industry bigwigs assembled at the Sheraton Hotel and Towers in Manhattan. ArcelorMittal had just smashed through the $100-a-share barrier to reach a staggering $152 billion in market capitalization. Other companies, such as U.S. Steel and Gerdau Ameristeel, were stock market darlings. Anything that was red, ferrous, and could be smelted or rolled was fetching record prices. 

The industry’s triumphs appeared to be a ringing endorsement of the strategy followed by Lakshmi Mittal, chairman and CEO of ArcelorMittal. As his own empire expanded, he preached that steel’s biggest problem was not its lack of innovation or failure to tap new markets, but rather “cyclicality.” Mittal defined this as the inability to sustain steel prices during downturns as a result of too many small companies flooding the market with steel. The only way to combat cyclicality was to consolidate the sector into two or three global behemoths, led by his concern, that would exert “market discipline” to end the punishing boom-bust cycle.

Mittal used his platform as keynote speaker at the Steel Success Strategies conference to announce that the gods of supply and demand had been tamed. Regardless of the problems in the financial markets, demand for steel would remain “strong,” Mittal told the 1,400 attendees, and the industry would ride out any recession. His speech had the haughty ring of “Mission Accomplished,” as reported in the June 25, 2008, issue of American Metal Market:

Ten months later, Mittal’s vision lies in smoky ruins. The benchmark price of hot-rolled coil (HRC) is down 55 per cent from its summer high. Outside of China, steel production plunged 37 percent in the first two months of 2009 compared to 2008, according to the World Steel Association.

From Gary, Ind., to Porto Alegre, Brazil, and from Vanderbijlpark, South Africa, to Benxi, China – the economic meltdown has left roughly 300,000 steelworkers unemployed or on restricted work weeks. Workers have staged protests in Belgium, France, and Romania, and February 10, 2009 was declared “a day of action against ArcelorMittal” by the European Metalworkers Federation.

The meltdown has taken away $600 billion of market value – maybe more – from the industry. At one point, according to the Financial Times, steel shares underperformed the Datastream composite index of all quoted companies worldwide by a stunning 52 percent.

Despite its purported advantages of size and geographic scope, ArcelorMittal has been one of the sector’s poorest performers (opens PDF). On Mittal’s watch, share prices sank 85 percent between June 9 and November 20, 2008, wiping out a mind-boggling $130 billion in shareholder value. On the final day of the first quarter of 2009, the share price was $20.04, down 81 percent from its June high.

The market decline has cost Mittal and his wife, Usha, dearly. The couple’s 623,285,000 shares of ArcelorMittal lost $53 billion in market value in the last 10 months. They still have plenty to tide them over any rough patches – $12.5 billion worth of stock at present, along with $935 million in ArcelorMittal dividends for 2008 and valuable real estate holdings in India, Switzerland, and Britain.

This is not a typical downturn that we are seeing in steel; it is a much deeper collapse caused in no small part by four years of overpriced consolidations and ginned-up talk about steel’s revival by Mittal and his “hot money” allies.

Macro-economic factors played a role in bursting the bubble and flattening the sector. The credit crunch following the collapse of Lehman Brothers last September caused banks to pull back short-term credit across the manufacturing supply chain, freezing up liquidity.

But the supply chain was already under strain due to a spike in steel prices. HRC jumped from $550 to $1,120 a ton between December 2007 and July 2008 – a 104 percent increase. Panicked by reports that steel prices would continue to escalate, buyers over-ordered. Steel increasingly got out of whack with a slowing world economy.

Demand in China continued through the Summer Olympics in Beijing, then, shockingly, steel mills in that country began to close. In the West, consumers stopped buying refrigerators and other steel-intensive items as housing prices dropped and stock market losses accelerated. With built-up inventories, manufacturers and steel service centers stopped buying. By the time automobile sales tanked in October, orders for steel in the U.S. and Europe were falling at a dizzying rate.

As late as February, stock analysts were saying that steel production would rebound in the second quarter 2009 as buyers restocked inventories and China rebooted its economy. But China’s stimulus package so far has benefited only Chinese mills, and there’s been no worldwide pickup in prices. Some analysts now predict that steel production will drop by 10 percent in 2009 and perhaps by as much as 20 percent.

What does the world’s biggest steelmaker say? On February 10, 2009, Lakshmi Mittal put on a brave face and told reporters that January and February were "the bottom of the market” and that prospects in the second half of 2009 were good. "We believe things will start getting better from the second quarter and have a much deeper and positive impact from the second half of this year.”

Dan DiMicco, CEO of Nucor Corp, begged to differ. On March 17, 2009, he reported that demand had “fallen off a cliff” and “there is no visibility as to the timing of the recovery.”

As documented in numerous posts at this website, Mittal is a buyout artist who rode the frothy markets of international finance and the geopolitical changes that followed the end of socialism. He started in the 1990s by scooping up distressed government-owned steel mills in such far-flung places as Trinidad and Kazakhstan. By 2004, he was settled in London in a palatial mansion and hooking up with “hot money” bankers and hedge fund operators.

With his radiant smile and King Louis XVI lifestyle, Mittal became the public face of the steel company, while his son, Aditya, did the hard-nosed negotiating behind closed doors. Financiers loved Mittal and son because they churned out fees for everybody. He bought International Steel Group (ISG) in 2005 from New York investor Wilbur Ross at a steep markup, which netted Ross’ hedge fund a $267 million profit.

During the Arcelor takeover in 2006, I wrote that the Mittals’ bid was the latest “in a chain of events that has made steel red hot among a handful of global players.” These included the likes of Nathaniel “Nat” Rothschild, scion of the British Rothschild fortune, and co-founder of the hedge fund Atticus Capital. Buying up Arcelor stock, Rothschild made a killing when the Mittals paid 40.40 euro ($50.51) a share for Arcelor, a 49 percent improvement on their first offer.

Because the Mittals didn’t have enough money to fund the cash portion of the deal, they had to rely on their financial allies. Luckily for them, Lewis B. Kaden, chief administrative officer and vice chairman of Citigroup (then the world’s largest bank), sat on the Mittal Steel board.

Mittal Steel received credit facilities, or loans, totaling 7.8 billion euros ($9.5 billion) to fund the cash portion of the Arcelor takeover. These loans were arranged by Citigroup and Goldman Sachs, then syndicated by a “who’s who” in international banking, including HSBC, Société Générale, Credit Suisse, Royal Bank of Scotland (RBS), UBS, Lloyds TSB Bank, and Commerzbank. These were the same banks, we have since learned, that were madly trafficking in subprime mortgages and other “toxic assets” that would help upend the world financial system.

There was absolutely no pressing business rationale or public purpose for forcing Arcelor to sell. As correctly pointed out by several European politicians before they caved into the “hot money” crowd, Arcelor was a profitable company with superior facilities to Mittal’s hodgepodge of properties.

But grabbing Arcelor gave Mittal a legitimacy in the eyes the media, while at the same time showering bankers, lawyers, accountants, and P.R. consultants with $188 million in advisory fees. Mittal was the alchemist who could turn steel into gold.

Thus it came to pass that last June Lakshmi Mittal was not only feted by the steelmen at the Success Strategies conference, but also rewarded by his banker friends.

Just days after Mittal declared the repeal of the business cycle in steel, he was put on the board of Goldman Sachs, which maintained $750 million in credit facilities with ArcelorMittal. In announcing the appointment, Lloyd Blankfein, Goldman Sachs’ CEO, lauded Mittal’s “keen understanding of the global economy” and said that his role as an independent director would be of “tremendous value to our people, our shareholders, and our clients.”

The marriage of high-roller finance with a mature industry was not limited to ArcelorMittal. For example, JP Morgan Chase acted as the advisor to Gerdau Ameristeel and the Gerdau Group in their acquisition of Texas-based Chaparral Steel in 2007. Morgan then worked with HSBC and ABN AMRO to syndicate a credit facility that provided Gerdau with $2.75 billion to pay for Chaparral.

U.S. Steel also jumped onto the bankers’ bandwagon in a big way. First it used a $1.75 billion credit facility arranged by JP Morgan to buy Lone Star Technologies, a Texas oilfield pipe maker; then it opened a $900 million credit line supplied by JP Morgan and a subsidiary of the Bank of Nova Scotia to buy Canada’s Stelco.

The Stelco deal, in particular, made a small group of insiders rich. The hedge funds Appaloosa Management, run by David Tepper, and West Face Capital, run by Gregory Boland, each pocketed $163 million, while Stelco’s CEO, Rodney Mott, earned nearly $67 million.

U.S. Steel’s chairman John P. Surma defended the high price of the buyout as a “very strategic transaction” and averred that “the potential synergies [between U.S. Steel and Stelco] are significant.”

On March 3, 2009, U.S. Steel announced that it was temporarily shutting down Stelco’s mill at Hamilton, Ontario, and most of its Lake Erie operations, throwing 1,500 employees out of work. In a written statement, Surma called the shutdown a “difficult decision,” but was “a necessary response to current market conditions.”

The fiasco at Stelco was matched by U.S. Steel’s decision to idle the Lone Star plant in February 2009. Let’s review this transaction: Advised by JPMorgan, U.S. Steel paid $67.50 a share for the Texas pipe maker, a premium of 43 percent over its 90-day average selling price. And then, less than two years after it bought Lone Star, U.S. Steel “temporarily” shut it down.

U.S. Steel’s shareholders, who include many employees and retirees, have seen their stock skid from $196 a share during the Steel Success Strategies conference last June to a low of $16.66 on March 17, 2009. At the end of the first quarter of 2009, the stock stood at $21.13. A 100-year-old company with an iconic name had lost 89 percent (opens PDF) of its market value on Surma’s watch.

It’s outrageous that so much money was squandered on buyouts, which chiefly enriched bankers and short-term investors, when it was steel employees who had sacrificed the most to get the industry out of its last depression.

Recall that employees and retirees (together with the government-run Pension Benefit Guaranty Corp.) were forced to absorb huge cutbacks in health-care benefits and pension payments during steel’s 2001-03 meltdown. The brutal elimination of health and pension benefits via bankruptcy proceedings was hailed by Wilbur Ross, then chairman of International Steel Group (ISG), as essential to restoring the industry’s economic health.

Ross, who’s on the board of ArcelorMittal and moonlights as a commentator on business cable talk shows, has acted as a pom-pom twirling cheerleader of more steel mergers.

The industry does not need to consolidate into two or three global giants so much as to retool and expand its product base. The present recession has exposed (yet again) the industry’s overdependence (opens PDF) on the automobile and construction industries and its failure to make a concerted effort to develop new growth markets.

New products could include “green metals” to tackle global warming and specialty items, such as super-strength alloys, that lower the cost of infrastructure building. The industry should also develop partnerships with engineering pros, such as General Electric and Siemens, to build alternative energy facilities and mass transit networks.

But lured by false prophets and enabled by a devil-may-care attitude towards risk by the financial community, many steel companies will spend the next few years digging out of a recession made all the more painful because of debt loads they had assumed to pay for acquisitions that now seem reckless.

To understand how debt poses a threat to the industry’s largest company, see “The Debt Noose.”