Jeremy Warner: Steel giants struggle under a mountain of deal-induced debt
Thursday 30 April 2009
Outlook Sales down by a half, another $1bn-plus quarterly loss and a distress $3bn issue of new equity and convertibles to match. Anyone would think this another everyday tale of banking folk. In fact, it is the latest update from the steel giant ArcelorMittal. Unless it be banking, few industries are quite as cyclical as steel.
With each successive cycle, steel managers claim to have learned their lesson and vow to make their companies immune to the next downturn, but it never works out that way. Invariably, they end up having to be bailed out again. I've not done the sums, but I'm willing to bet that most steel companies will have consumed far more capital than they have ever generated.
Hope springs eternal that this time it's going to be different. It never is. This doesn't mean that nobody ever makes any money out of steel. Over the years, Lakshmi Mittal has taken several £1bn-plus dividend cheques out of his far-flung steel empire, which is why he can now afford to put up 10 per cent of the $3bn needed to keep ArcelorMittal going long enough for the next upturn to come along.
Wisely, he's making no predictions on when that might be, though he does anticipate a "technical" recovery after the present inventory adjustment has run its course. There must come a point, possibly quite soon, when customers are forced to resume placing orders for steel. Destocking can be taken only so far, even by the now almost universally bankrupt auto industry.
But it may be many years before overall demand returns to the boom-time levels of a year ago. In the meantime, the $3bn of new equity and convertibles announced yesterday barely makes a dent in ArcelorMittal's $27bn debt mountain.
That's another characteristic that steel companies share – they invariably seem to enter a downturn in an overly debt-geared state. Amazingly, it once looked as if the Anglo-Dutch steel group Corus might avoid the debt trap this time around. Then along came the Indian steel group Tata with a highly leveraged bid for Corus which loaded the company up with debt again. This was an excellent deal for pre-existing shareholders, enabling them to exit the company at the pinnacle of the cycle with a top-of-the-market price.
But it is obviously not much good for the new owners, Tata, or indeed for Corus itself, both of which are now in some difficulty. Tata's similarly leveraged acquisition of Jaguar Land Rover is also in trouble.
The strategic thinking behind these acquisitions may be sound, but their timing, price and structure has been disastrous for the Indian conglomerate.
Little is known publicly about the terms of the debt which was taken on to buy Corus, except that it was non- recourse, in the sense that it was secured against Corus rather than Tata. One saving grace is that the debt was acquired while the leveraged buyout boom was still at its zenith, so it may have been relatively "covenant-lite".
What's more, the whole transaction was based on an assumed steel price a bit lower than it is today. But it seems unlikely the covenants also allowed for a near-halving of production.
Tata has already had to put in more equity once. It is a racing certainty bankers will be back for more before the recession is out. Corus was forced into a debt-for-equity swap plus accompanying rights issue in the last recession. Are we about to see history repeat itself? If things don't pick up sharply next year, the same prospect may await ArcelorMittal and others who built their empires of steel on the belief that rapid growth in emerging market economies would make things different this time.
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