About Self-Improvement With The Sale Of Its U.S. Operations
Sep. 28, 2020 1:07 PM ET|5 comments | About: ArcelorMittal (MT), Includes: CLF
Stephen Simpson, CFA
Long Only, Growth At Reasonable Price, Value, Research Analyst
ArcelorMittal (MT) management has been trying to convince the Street for some time that it is serious about changing how it operates – instead of trying to bigger, management is focusing far more on being better, with a much greater focus on long-term capital returns from assets. Most have been skeptical about this, including me, as there seems to be one oddly questionable decision made by management to offset every good decision.
With the Monday announcement of ArcelorMittal’s intent to sell its U.S. operations to Cleveland-Cliffs (CLF) in a cash and equity deal, I believe ArcelorMittal management has taken a very big step toward showing that it is serious. I believe the company is getting good value for suboptimal assets in a difficult market, and I like how it backs up the general idea that management is now more focused on the long-term capital returns of the business.
I was lukewarm on ArcelorMittal back in August, as I didn’t like the company’s position as a less-than-great player in a market that I believe is not going to see a lot of pricing strength. The shares have since lagged names I preferred more (including Steel Dynamics (STLD) and Ternium (TX)), but if the indicated pre-market pop holds up, that ArcelorMittal’s relative performance will have improved meaningfully. It still won’t be my preferred name, but it’s harder to stick with a bearish argument regarding management’s vision and discipline toward making this a better steel company for the long term.
The Deal
ArcelorMittal and Cleveland-Cliffs have announced a transaction wherein Cleveland-Cliffs will acquire substantially all of MT’s U.S. business for an enterprise value of $3.4B. In effect, MT is getting $1.4 billion for the assets, split between $500 million in cash and $900 million in equity, with Cleveland-Cliffs also taking on associated net debt of $500 million and pension obligations of $1.5 billion.
Cleveland-Cliffs is acquiring around 16MMT of blast furnace and basic oxygen furnace capacity, or just under 60% of ArcelorMittal’s North American steelmaking capacity. The business has meaningful leverage to auto and construction markets (two of the largest markets for steel in North America), including its Usibor and Ductibor high-strength steels for the auto market, but the production costs are high on a relative basis.
Depending upon the assumptions you make given the data available, Cleveland-Cliffs is paying around $185 to $215/tonne, well below the replacement cost of the assets (around $900/mt), but there’s no way you’re going to get a large fraction of replacement value for blast furnace assets today. More to the point, Cleveland-Cliffs is paying around 6x full-cycle EBITDA, which I think is a great price for the assets (for ArcelorMittal) at not only a weak point in the cycle, but a weak point that could stretch on given both under-utilized capacity in the U.S. steel industry and oncoming lower-cost electric arc furnace (or EAF) capacity additions.
Not A Complete Exit
ArcelorMittal isn’t exactly walking away from the U.S. steel business.
First, the company is keeping its AM/NS Calvert operations (a joint venture between MT and Nippon Steel (NPSCY)), as well as its operations in Canada and Mexico. AM/NS Calvert is a good operation, one that currently uses pretty advanced technology to finish steel slabs with a walking blast furnace, 7-stand finishing mill, and laminar cooling system for hot strip, tension leveling and laser welding for its pickling lines, and a radiant tube atmosphere controlled furnace for cold-rolled steels. In English, that means this is a high-quality, advanced plant that turns slab into advanced sheet and coated products for autos, construction, pipe/tube, and appliance markets. It’s also going to be the site for a new, advanced EAF facility that ArcelorMittal had previously announced.
Second, ArcelorMittal will be literally invested in the ongoing success of Cleveland-Cliffs. The company will have a 16% stake in Cleveland-Cliffs that could rise to just over 25% if management ultimately chooses to convert the preferred equity into shares.
Truth be told, I don’t know if ArcelorMittal wants to be a long-term investor in Cleveland-Cliffs. Management has already announced a $500 million buyback with this deal, and I could see management taking an opportunistic view toward selling off the equity stake over time. Ultimately, I think a lot depends upon what Cleveland-Cliffs shows its can do with the combined AK Steel and ArcelorMittal USA assets. I believe the business is going to be under ever-increasing pressure from improved EAF processes producing steel for the key auto market, but AK Steel and AM USA have some good products of their own and upgrading EAF products to the standards of the auto industry (particularly for hybrids/EVs) is not without a lot of challenges.
The Bottom Line
I believe that exiting the capital-intensive, less-competitive U.S. steelmaking assets, and doing so at a good mid-cycle valuation, is a good move for ArcelorMittal. It’s not necessarily a bad deal for Cleveland-Cliffs (a lot depends upon the eventual recovery in auto production and steel prices), but I believe that ArcelorMittal has taken a big step toward reducing its long-term capital intensity and upgrading its asset base through subtraction. Given the pre-market indication for the shares, I still can’t say that ArcelorMittal is my favorite idea in steel, but it does remain undervalued and I believe management has shown that it is committed to upgrading its asset base and long-term return potential.