Part 3: Sparrows Point’s Owner Mauled

Russian oligarch Alexei Mordashov overbuys on the eve of the recession.

© by Mark Reutter
Posted 4/7/09

UPDATE (May 7-8, 2009) – Exactly one year after Severstal purchased Sparrows Point, the steelmaker is quietly working to sell off its North American assets, including the Point, in the face of substantial losses and plunging sales. Plant Manager Thomas Russo told workers and a Baltimore County official that the company planned to shut the “L” blast furnace in June or July for a period of 30 to 60 days.

Separately, the company announced that it will shut entirely its Warren, Ohio, (formerly WCI Steel) and Ohio Valley (ex-Wheeling-Pitt) operations, placing another 1,900 workers on indefinite layoff. This leaves a steel mill in Dearborn, Mich., and a coke plant in Follansbee, W.Va., as the only operations running (on a reduced basis) in the Midwest.

The following post explains how the company got into this fix. I have since gathered more information about the role that banks played in enabling Mordashov to overspend in America. Last September, Severstal signed a $1.2 billion syndicated credit facility with ABN AMRO, Barclays, Citibank, Commerzbank, Deutsche Bank, and others. Together with other transactions, Severstal’s net debt increased 217 percent between June and December 2008, from $1.34 billion to $4.25 billion. While moderate in comparison to the debt shouldered by ArcelorMittal and U.S. Steel, Severstal’s loan repayments – combined with vastly reduced cash flow – will constrain its business options and place its workforce in long-term jeopardy. 

A year ago when Alexei Mordashov, founder, CEO and majority owner of Russian steelmaker Severstal, announced his acquisition of Sparrows Point, this website asked, “Will No. 4 be a Keeper?”

This was not an idle question. Since the bankruptcy liquidation of Bethlehem Steel in 2003, the onetime largest steel mill in the world had been tossed to Wilbur Ross’ International Steel Group, then to Lakshmi Mittal’s ArcelorMittal, then to Craig and Jim Bouchard’s Esmark, the latter duo signing on the dotted line but ultimately failing to come up with the purchase money.

Through these years of uncertainty, the plant soldiered on, making steel with a streamlined 2,700-member workforce and scant resources. A little ownership stability, plus a restorative shot of capital, was critical to guarantee its future, as opposed to the slow cannibalization of the mill that took place under ArcelorMittal. (The latter deemed Sparrows Point a “swing” plant to even out production at other facilities; equipment was removed from the mill and placed elsewhere.) 

Mordashov pledged to end this era of disinvestment by spending $500 million to modernize and expand production to 3.6 million tons of steel a year. He floated the idea of bringing coke ovens back to the Point to cheapen the cost of raw materials and of adding hundreds of new jobs. A pillar of Baltimore’s manufacturing economy might be saved after all.

Modernization, not to speak of expansion, is now on hold as Mordashov struggles to save his North American subsidiary from a string of bad investments. Ironically, Sparrows Point is one the few U.S. investments that is currently performing at a decent level, which at best means breaking even.

The Point’s specialty in tinplate manufacture – a product that’s actually expected to show a modest increase in sales in 2009 – contrasts with a rapid fall-off of orders at Severstal’s other facilities in Ohio, West Virginia, and Michigan, which chiefly supply flat-rolled steel for the now-stricken automotive and “white goods” markets. Write-offs from these facilities accounted for the bulk of the $1.27 billion fourth-quarter loss reported by OAO Severstal, the parent company headquartered in Moscow. The results for the first quarter of 2009, not yet reported, are certain to be worse.

OAO Severstal shares have plunged 89 percent (PDF) to $3.24 from a high of $28.50 reached last May, despite efforts to shore up the stock price through a company share buyback program.

Mordashov’s fortune was built through the privatization of the Russian steel industry in the 1990s and was characterized by Severstal’s rapid-fire expansion from its base at Cherepovets, 400 miles north of Moscow, into mining (iron ore, coal, and gold), shipping, insurance, and banking as well as steelmaking abroad. Severstal controls Lucchini, one of Europe’s largest steelmakers.

As Severstal’s worth has melted, so has Mordashov’s billions. His holdings, valued $22.4 billion 10 months ago, now stand at $2.5 billion. “Russia’s super-rich are super-losers, too,” was the headline out of Moscow describing the deflated economic state of Mordashov and many other Russian oligarchs.

What happened? With cash to burn from record profits at his Russian operations last year, Mordashov went on an American buying spree. After paying $810 million for Sparrows Point, he spent $1.6 billion, including debt, for WCI Steel and Esmark.

Both companies had troubled histories. WCI, a Warren, Ohio, spin-off of LTV, only recently emerged from Chapter 11 bankruptcy, while the Bouchard brothers’ Esmark was reeling not only from its failed Sparrows Point bid, but from financial reversals at its Wheeling-Pittsburgh subsidiary.

Severstal asserted that buying WCI and Esmark fit perfectly into its plan of shipping slabs from Sparrows Point, reducing costs for the Midwest mills while increasing production scale at the Point. These acquisitions were followed by an August 2008 offer to buy PBS Coals Ltd. for $1 billion. Severstal said the obscure Pennsylvania miner was needed to give the company cheaper access to metallurgical coal for the Point and its proposed new coke oven facilities.

click on image to enlarge Mordashov owns 82.4 percent (about 810 million shares) of OAO Severstal through various entities listed in this statement. Fifteen percent of the company’s stock (about 150 million shares) is traded on the London Stock Exchange.

But within weeks of the PBS bid, the global recession hit with a vengeance that left the steel industry – rejoicing in its collective belief that it had been spared a downturn – exposed to heavy losses. Mordashov’s decision to buy at the height of the cycle looked foolish, but the 43-year-old billionaire was nothing if not resolute. He refused to back out of the coal deal and instead negotiated the price down to $698 million, which PBS’ owners quickly accepted in October.

The cost of his poor judgment, at least in the short run, was revealed in Severstal’s balance sheet. KPMG, its auditor, forced the parent company to write down $1.54 billion from its recent takeovers (excepting Sparrows Point, where there was no impairment).

The PBS coal assets that cost Severstal $698 million have been cut in half and are now worth just $361 million. The Wheeling-Pitt assets have lost 80 per cent of their value, and WCI is a total wipeout – its entire $370 million purchase price reduced to -(negative) $12.6 million.
        
These write downs have been accompanied by the idling of blast furnaces at Warren and Mingo Junction, Ohio, and the closure of finishing lines at Severstal Warren and Severstal Wheeling. This translates into about 3,000 layoffs, leaving the economies of eastern Ohio/northern West Virginia in deep depression. (The other large mill in the region, ArcelorMittal Weirton, has undergone massive layoffs in recent years.)

With the Ohio Valley mills either down or not running continuously, the business rationale for expanding production at Sparrows Point has disappeared. Instead of becoming the center of Severstal’s American empire, supplying stabs to the Midwest, including Severstal’s plant at Dearborn, Michigan, Sparrows Point is now left to fend for itself.

The good news (if it can be called that) is that mass layoffs have not been announced at the Point. Through a combination of voluntary layoffs and a mandatory 32-hour workweek, the labor force has stayed largely intact. But pink slips are undoubtedly around the corner if sales don’t pick up for the cold-rolling, hot-rolling, and galvanizing lines.

Also on the positive side, Severstal did complete a major overhaul (reportedly costing $30 million) of the Point’s blast furnace “L.” Under ArcelorMittal ownership, there was considerable worry that the furnace would be shut once it had run out its ironmaking “campaign” and required costly relining.

To counter the slump, parent OAO Severstal has cut capital expenditures from $3 billion to $1 billion (another sign that Sparrows Point’s modernization will be deferred) and will pay no dividends. Reported net debt remains relatively moderate at $4.25 billion.

Mordashov’s future strategy is hard to discern given the opaque nature of his company. Moscow-based journalist John Helmer posits that Mordashov has moved assets to the U.S. out of fear that his Russian operations may be oppressively taxed, nationalized, or otherwise taken out of his control in the future.

But there is little concrete evidence that Mordashov wishes to exile himself from Russia, where he has enjoyed a long and reportedly cordial relationship with Prime Minister Vladimir Putin. It is just as easy to believe that Mordashov’s overreach in America was an exercise of the very qualities that made him wealthy in the first place. Perhaps his stated desire to invest in the U.S., regardless of the present downturn, will bear dividends to the hard-hit communities now dependent on his business judgment.