By John Helmer in Moscow
PR spin battles US recession to hype Russian steel deal
Taylor Rafferty is an international public relations company which works for Alexei Mordashov, the controlling shareholder of Severstal, third ranked Russian steelmaker. Its job is to help Mordashov extricate his foot from his mouth, and his hand from public shareholder pockets.
Mordashov can be a nervous fellow, if he thinks the Kremlin disapproves of what he is doing. In 2006, when Mordashov applied to President Vladimir Putin for permission to buy other Russian steel companies, he was told no. But he was told he would be allowed to stretch his own neck in Europe. This meant Kremlin approval of Mordashov’s attempt in mid-2006 to take over Arcelor, the leading European steelmaker at the time. Mordashov’s bid failed when it was beaten by Lakshmi Mittal, who mobilized more effective investment banking by Goldman Sachs, more cash, and better PR.
Mordashov learned the PR lesson. The market hasn’t. According to Taylor Rafferty’s mission statement, it promises clients “a reality check and sharp focus to the investor relations program”.
What seems clear already is that since Severstal engaged Taylor Rafferty, the Times of London has been more positive about Mordashov’s doings than the stock market. The market sentiment has been especially negative since last Friday’s announcement that Mordashov has agreed on a deal for Severstal to pay $810 million in cash to acquire the Baltimore, Maryland, steel company, Sparrows Point.
The seller is ArcelorMittal, under a 2007 order from the US anti-trust authorities and a federal US court to divest the US plant as a condition of US approval of the ArcelorMittal merger.
Alexei Mordashov and Severstal’s spokesmen prefer to limit their exposure to critical questions to conference calls with fund managers and brokerage analysts. Mordashov is quoted in the deal announcement release as claiming: “with Sparrows Point, Severstal brings into its U.S. portfolio an asset with significant existing value as well as unlocked growth potential. This acquisition presents us with an opportunity to enhance productivity at Sparrows Point through our high standards of operational performance and will benefit our existing U.S. businesses. We expect to realize synergies in Sparrows Point and with SNA that will fuel increased production and profitability. We remain committed to growth in North America and believe in the long-term promise of the U.S. market; we’re confident that this acquisition will create value for our shareholders while strengthening our U.S. platform as a whole.”
The Moscow market reacted with disbelief, noting that the propsects for steelmaking in an economy on the verge of recession are doubtful at best; and that Mordashov’s performance in managing the US steel assets he already owns has been anything but “high standard”. The Severstal share price was cut 4% in the first hours after Mordashov’s release in Good Friday trading.
By Easter Saturday, Taylor Rafferty had managed to rally the Times into reporting the deal as if Mordashov was taking instruction from Putin, whose mission — the Times Industry Editor implied — was to save, and then subordinate the United States economy. “Russian companies, which have benefited from a booming domestic economy, have been urged by President Putin to buy more overseas assets and increase Russia’s economic clout,” according to The Thunderer.
The newspaper also reported Mordashov as believing “that longer-term prospects for the US economy were good, despite the current downturn. ‘We remain committed to growth in North America and believe in the long-term promise of the US market,’ he said. ‘We’re confident that this acquisition will create value for our shareholders while strengthening our US platform as a whole.”
Omitting a string of wobbly results recently reported by Severstal for its “US platform”, the Times quoted Gregory Mason, chief operating officer of Severstal, as claiming: “We are in this for the long term – we are not traders, this is consolidating our operations. Even if things go down a little in the US market, we don’t expect it to last for long. America cannot produce the steel it needs, that’s why it has had to rely on imports.”
Until Friday’s acquisition, Severstal North America included an integrated steelmill, formerly Rouge, in Dearborn, Michigan, and a new electric-arc furnace mill at Columbus, Mississippi, called SeverCorr.
By Easter Monday, Severstal’s share price opened the week’s trading on the Russian stock markets flat with Friday’s level, but 13% below the week before. Michael Kavanagh, the most experienced of the Moscow steel analysts, warned: “the transaction appears cheap based on price to capacity; however, the assets are unprofitable and may require substantial capital investment. As such, we consider the deal to be a short-term negative for Severstal.”
The best that could be said came from Alfa Bank analyst, Maxim Semenovykh: “Despite the fact that Sparrow [sic] Point will somewhat dilute the profitability of the company, we think the deal’s future prospects outweigh this.” Semenovykh was a sparrow short.
Sparrows Point was originally founded as Bethlehem Steel in 1887, and is currently an integrated producer with 3.6 million tonnes of crude steel capacity, produced by blast furnace technology. The plant sells slabs, hot and cold rolled sheets, galvanized products and tin; and serves the automotive, construction and container markets. Crude output last year was 2.3 million tonnes; but that was just 64% of capacity.
With the acquisition, the crude steel capacity of Severstal’s US assets (Rouge, Severcorr, and Sparrows Point) will reach 7.5 million tonnes, which is 8% of total US crude steel output in 2007.
Severstal has significantly increased its presence in the US flat steel market, especially in the auto building sector. Company statements claim that, notwithstanding the shrinkage in US demand for cars, Severstal sees cost-cutting and profit-enhancing synergies in the business; one of these is the proposal to supply about 800,000 tonnes of slab from Sparrows Point to Rouge, while one-third of the latter’s pig-iron capacity has been shut down after a recent production accident.
The all-cash acquisition price for Sparrows Point is $810 million. This is substantially below the offer for Sparrows Point tabled last year by the E2 Acquisition Corporation, a consortium of Chicago-based steel distributor Esmark, Brazil’s Vale and Ukrainian group Industrial Union of Donbass. Their offer was $1.35 billion. But when the partnership broke up, and Esmark ran into financing trouble, the bid was rejected by the plant’s court-appointed divestiture trustee.
Had the E2 bid succeeded, the combination of Esmark’s Wheeling-Pittsburgh and Sparrows Point would have amounted to one of the largest steelmaking groups in the US with capacity of 6.5 million tonnes per year. The new Severstal acquisition will make Severstal the fourth-largest US steel producer (after ArcelorMittal, US Steel and Nucor), with US steel-making capacities of around 8 million tonnes, and will increase Severstal’s total steel production by 13%.
There is talk among steel analysts in London that Mordashov wants next to go after Wheeling-Pittsburgh. This heavily indebted American steelmaker was taken over by Esmark in mid-2006 at a valuation of just under $500 million. Whether Esmark, which had wanted to combine the mills, is agreeable to sell remains to be seen.
What Mordashov hasn’t explained is why he is going after American losers he has so far proved unable to turn around? The suspicion is that to hedge his vulnerability to state takeover at home, where Russian steelmaking is booming, Mordashov is creating a parallel steelmaking empire he could hang on to, if the worst came to the worst.
According to Severstal, in 2007 Sparrows Point generated revenues of nearly $1.6 billion, level with the 2006 revenue figure. However, EBITDA dropped by 79% to $24 million (from $112 million in 2006), mainly due to low utilization and unfavourable pricing in the US market. This year Severstal is hoping that Sparrows Point revenues will reach $2.1 billion, EBITDA $74 million.
Severstal has yet to explain why it paid a higher valuation multiple for Sparrows Point than Severstal itself is worth, or at which other Russian acquisitions in the US have been made. “In our view,” reports Kavanagh of UralSib, “the acquisition will be initially dilutive for Severstal, as the deal took place at a 2008E EV/EBITDA multiple of 10.9, which is high in comparison with recent Evraz steel deals at 6-8 and Severstal’s multiple of 5.3.”
“The deal may be value-accretive in the long term for Severstal,” Kavanagh told the market conditionally, “if the company is able to turn around Sparrows Point as well as its existing US businesses, which were loss-making in 2007 (with an EBITDA margin of 1%). With a poor operating track record (in almost all its businesses), Severstal still has much to prove before the market will pay for upside potential. ”