Key Figures
Company		Mittal (MT)	Arcelor (Paris: LOR)
2005 Sales (bil.)		$28.10	$38.84
1-Year Sales Growth		27%	8%
2005 Net Income (bil.)		$3.37	$4.58
1-Year Net Income Growth		-28%	66%
Employees		175,000	96,000
Soucre: Companies' statements

Steel moves faster these days

Steel has always been a highly fragmented industry in which the top 10 companies control less than 10% of the market. For comparison, in its customer, the auto industry, the top 10 companies control almost 80% of the global market. The situation is similar in the steel industry supplier, the raw materials industry.

Consolidation seems to be a logical development but it started at an unexpected place, the East. For more than a decade Lakshmi Mittal has been buying post-communist factories and in 2004 he entered the North American market with the $4-billion purchase of International Steel Group, a conglomeration of formerly bankrupt U.S. companies and built the largest steel company in the world, Mittal Steel Co. N.V. (MT: chart).

His consolidation efforts triggered heated competition in M&A activity, thus pumping up the prices of the acquired assets. According to industry research publications, in the past year the enterprise value of steel-making assets has skyrocketed to between $500 and $800 a ton of steel produced at the target company from $80 to $100 a ton in the period 2000 and 2003.

Another important development in the industry is the rising price of steel. Steel is anything but dull in the context of the booming Asian economies led by the huge demand of China and India. Steel prices have doubled in the past four years, while worldwide output has risen by more than 30% since 2000. The revenues of steelmakers amounted to about $742 billion in 2005, or $742 a ton shipped, compared with $362 billion in 2001, or $460 a ton shipped, according to the research firm World Steel Dynamics.

Although prices have slipped in 2005, they remain historically strong, approximately double the historical average. Chinese demand is expected to surge by 11% this year, to 290 million metric tons, or 29% of the global market. Production, logically, is also on the rise, with a 6-percent increase in 2005, according to the International Iron and Steel Institute in Brussels.

Mittal and Arcelor against each other

Lakshmi Mittal managed to single-handedly build the largest steel company in the world starting with a small mill in Indonesia in the 1970s. Today, he operates steel plants and raw material mines in Eastern and Central Europe, USA, Africa, Asia, and the Caribbean. He manages 175,000 employees around the globe from his headquarters in Netherlands and London.

The unprecedented growth of Mittal Steel came mainly through debt-driven acquisitions, but it was facilitated by high steel prices, low interest rates, and above all, by the significant market share and production capacities up for grabs after the collapse of the communist economies. While the Western companies viewed the steel plants in Eastern and Central Europe as obsolete and doomed to extinction, he saw the opportunity that turned his company into the largest steel empire and himself into a member of the billionaires' club with an estimated worth of $20 billion.

In the process, however, Mittal also piled up a lot of debt. Currently, the long term debt per share stands at $11.44, not much lower than the book value per share of $14.42. The company's debt rating is below investment grade, so it needs a definite improvement to continue with acquisitions and to handle a possible industry downturn. In 1997 an initial public offering floated 12% of the shares, but the Mittal family kept the remaining 88%.

Arcelor (ARLOY: chart) itself was born by the $10-billion merger of three European national steel giants - Usinor (France), ARBED (Luxembourg), and Aceralia (Spain). Until 2004, the company was considered the world's leading steelmaker before it was pushed into second place by Mittal. The company manufactures about 50 million metric tons of crude steel per year mainly for the high-end auto, construction, transportation, and packaging industries. The CEO, Guy Dollé, is trying to build Asian and North American presence.

A crucial part of the European steel industry, the company is partially owned by European governments, with Luxembourg being the largest shareholder. It is heavily unionized and often business decisions have to comply more with the political reality than with the business logic.

Effects of the Deal

Mittal hasn't changed his vision of the industry and his goal – to become bigger and the largest so that he can have leverage with clients and suppliers and flexibility with operations in a highly cyclical environment. If the deal with Arcelor goes through, it will not only create a clear industry leader, but will also facilitate the road for further consolidation. The elimination of a tough rival will bring pricing power and easier access to debt in acquisitions, so it makes a lot of sense when aiming to consolidate the industry.

And further consolidation is imminent. Even after the possible merger, the two companies will control only about 11% of the global market so there is a lot of room to grow. Both Mittal and Arcelor share the view that consolidation would bring stability and sustainability to a highly cyclical industry. Mittal has always argued that volatility can be better handled by large, financial healthy companies with the leverage and the flexibility to respond to market conditions that small players lack.

The new company would have had sales of about $69 billion, market capitalization of about $40 billion, and EBITDA of $12.6 billion in 2005. Mittal estimates $1 billion in synergies through the combined purchasing power, marketing, and manufacturing processes. The markets reacted positively as shares of both companies rose on the news.

Overall, the two companies would combine Arcelor's leading position in Western Europe with Mittal's strength in Eastern and Central Europe; Arcelor's presence in Latin America with Mittal's position in the U.S. The business logic and the benefits of this merger, thoroughly discussed in the press, make a lot of sense.

What is questionable, though, is the timing.

How far and deep is the next downturn?