Part 2: The Debt Noose

The world’s biggest steelmaker faces a liquidity squeeze as the bill for Lakshmi Mittal’s buying spree comes due.

© by Mark Reutter
Posted 4/7/09

The above paragraph, from page 10 of ArcelorMittal’s latest Form 20F statement to the U.S. Securities and Exchange Commission, underscores the economic troubles that the company may face if the present downturn continues.

What’s not stated is that people – 320,000 employees as well as shareholders, suppliers, contract workers, residents of towns dependent on company taxes to provide essential government services – will suffer as ArcelorMittal cuts costs and lays off personnel to repay the international bankers whose money got it into the predicament it finds itself in today.

Simply put, “the world’s largest and most global steel producer,” as CEO Lakshmi Mittal likes to call the company, was built on a foundation (or should we say, mountain) of debt. Total debt stands at $34.1 billion as of December 31, 2008. That’s $5 billion more than the entire company is currently valued on the stock market. Net debt, which is total debt minus cash, cash equivalents, and short-term bank deposits, is $25.7 billion.

Debt grew rapidly as Mittal hammered together his company through a patchwork of mergers and acquisitions capped by his hostile takeover of Arcelor in 2006. Here are the numbers from company financial statements:

Year           Net Debt
2004          $1.6 billion
2005            7.9 billion
2006          21.6 billion
2007          22.1 billion
2008          25.7 billion

Four-year growth of net debt: 1,506 percent

Compare the company’s 15-fold increase in debt with its 5-fold increase in sales and only 1.2-fold increase in operating income.

Year             Sales         Operating Income
2004      $20.6 billion        $5.5 billion
2005        28.1 billion          4.7 billion
2006        58.9 billion          7.5 billion
2007      105.2 billion        14.8 billion
2008      124.9 billion        12.2 billion

Four-year growth of sales: 506 percent
Four-year growth of operating income: 122 percent

In summary, whereas in 2004 the company’s operating income was 3.4 times greater than its net debt, by 2008 its net debt was more than double its operating income. And, remember, it’s operating income that generates the cash flow needed to repay debt.

Traditionally, corporations raise money by issuing debt (bonds) or equity (stock). In the last decade of go-go finance, however, many corporations financed mergers and acquisitions with infusions of cash from banks. The banks provided the companies with syndicated credit facilities, which are like revolving credit-card accounts except that they let companies withdraw billions of dollars of cash.

Because the interest on these loans is relatively high and the maturity periods brief, most companies repay and cancel their credit facilities as soon as possible and issue stock or bonds to fund their debt more cheaply.

Mittal, however, opted to make bank credit facilities the key instrument for his acquisitions. By doing so, he avoided floating big issues of new stock, which would dilute his share of the company and reduce his control.

Mittal first went to the bankers in January 2005, shortly after he announced the purchase of International Steel Group (ISG) from New York financier Wilbur Ross. He paid six banking giants to arrange and sell a five-year, $3.2 billion credit line among their peers.

It should be noted that prior to this merger, Mittal paid himself a $2.26 billion stock dividend, which meant that two-thirds of the credit facility was used, in effect, to replenish cash that Mittal had withdrawn from the company. 

He followed up in October 2005 with a $3 billion credit facility arranged by Citigroup that financed Mittal Steel’s cash portion of the purchase of Ukraine’s Kryvorizhstal mill. In January and May 2006, Mittal obtained two more credit facilities, totaling 7.8 billion euros ($9.5 billion), to finance the cash portion of his takeover of Arcelor.

Again, typical corporate finance would call for these credit lines to be repaid and cancelled promptly. But in this case, the banks were all too willing to increase the credit lines to accommodate Mittal’s desires.

In December 2006, ArcelorMittal signed a 17 billion euro ($22.6 billion) credit agreement subscribed by 26 European and U.S. banks led by Citigroup and Goldman Sachs. This facility consolidated the Arcelor and Mittal credit facilities and, as an added bonus, extended the length of the credit period.

The result of the extensions and increased credit limits was that just as the economic recession hit last September, ArcelorMittal faced $9.7 billion of bank debt coming due in 2009 and 2010.

Mittal and his son, Aditya, the chief financial officer, have been scrambling ever since. In October, the banks agreed, for a fee, to refinance $4.8 billion of the credit facilities, so that repayments due in 2009, 2010, and 2011 would be pushed back to 2012. That’s the kind of debt break that a homeowner can only dream about.

The steelmaker is now trying to replace the $3.2 billion credit line opened for the ISG acquisition, due in 2010, with a “forward-start loan” that, contrary to its name, extends maturities out until 2012. Citigroup, Lloyds, Société Générale, Banco Santander, Calyon, and HSBC are arranging subscriptions for the new loan. 

ArcelorMittal’s refinancing task, however, is made tricky by financial covenants in the facilities that limit net debt to 3.5 times earnings before interest, taxes, depreciation and amortization, or Ebitda. To avoid breaching the covenants, ArcelorMittal needs to produce Ebitda of at least $7.3 billion this year.

The company’s $2.6 billion Ebitda for the fourth quarter of 2008, projected over a full year, would cover that amount. However, the currently estimated Ebitda for the first quarter of 2009 (about $1 billion) would fall short if projected over the year.

To offset the possibility of violating the covenants, Mittal father and son have announced plans to cut $4 billion in debt by the end of 2009. That would reduce the Ebitda needed to stay within the loan terms to about $6.4 billion in 2009. Despite their promise, a JPMorgan report recently placed ArcelorMittal on its watch list of steelmakers potentially at risk of violating their debt covenants. (Other steelmakers on the watch list include AK Steel, Steel Dynamics, and U.S. Steel.)

On February 19, 2009, Standard & Poor’s revised its outlook on ArcelorMittal from stable to negative, citing a sharp deterioration of conditions in the steel industry. Moody’s lowered the company’s investment-grade rating to BBB+/Baa2, which makes it more expensive to access the bond market. Both ratings agencies said they would downgrade ArcelorMittals’s credit further if it failed to reduce debt. And S&P pointedly warned management to refrain from undertaking any new acquisitions.

Additional ratings downgrades would dramatically increase the costs of capital – from the markets and from banks – and would have a ripple effect across ArcelorMittal’s worldwide supply chain. That could quickly lead, in today’s volatile markets, to a liquidity squeeze along the lines of the banking crisis that erupted last fall.