PANKAJ GHEMAWAT -DRAFT- RAVI MADHAVAN JANUARY 15, 2007 Mittal Steel in 2006: Changing the Global Steel Game On January 27, 2006, Laxmi Niwas Mittal (LNM) and his son, Aditya Mittal, Chairman & CEO and CFO respectively of Mittal Steel, prepared for the press conference at which they would announce Mittal Steel’s unsolicited $22.8 billion bid to acquire the European steelmaker Arcelor. Although Mittal Steel had been a prime mover behind the consolidation of the industry—and most participants and observers in 2006 seemed to accept the logic of consolidation—an offer for Arcelor was unlikely to have been anticipated by the industry. Arcelor had been created in 2001 by the merger of three European steelmakers—Usinor (France), Arbed (Luxembourg), and Aceralia (Spain)—that were themselves, in turn, the result of previous mergers in their respective countries. Mittal Steel and Arcelor were at that point the two largest and most global steel producers; it would have been far easier to imagine the two giants growing in parallel through other significant acquisitions. For example, World Steel Dynamics had sketched out a scenario in which Mittal Steel acquires the Anglo- Dutch steelmaker Corus and Arcelor acquires ThyssenKrupp of Germany1. Yet, at the announcement of the offer on that winter day in London, LNM, described by the New York Times as having “never been bashful about his global ambitions2,” would present the combination of Mittal Steel and Arcelor as the next logical step in the evolution of the industry. “This is a great opportunity for us to take the steel industry to the next level. Our customers are becoming global; our suppliers are becoming global; everyone is looking for a stronger global player.”3 A torrent of deals The amount we will receive for this company [the Kryvorizhstal steel plant] will be 20 per cent higher than all the proceeds received in all the years of the Ukrainian privatization. — Ukrainian President Viktor Yushchenko4 I can say that the Ukrainian administration has been very lucky to receive this price. — Laxmi Mittal, Chairman of Mittal Steel, the winning bidder5 Arcelor will continue to seek to grow through strategically compelling acquisitions; however, management will not compromise shareholder value in the pursuit of this goal. 6 — Guy Dollé, CEO of Arcelor, the losing bidder ________________________________________________________________________________________________________________ Professor Pankaj Ghemawat of IESE Business School and Professor Ravi Madhavan, of the University of Pittsburgh, prepared this case. This case was developed from published sources. Cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2009 . No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Pankaj Ghemawat. -DRAFT- Mittal Steel in 2006: Changing the Global Steel Game Barely 3 months had passed since Mittal Steel’s previous acquisition. On October 24, 2005, LNM had announced that Mittal Steel had won the bidding for Kryvorizhstal, Ukraine’s 10- million tpy7 capacity steel plant, which produced one-fifth of the country’s steel output. Kryvorizhstal was a controversial privatization, having been sold in 2004 to former president Leonid Kuchma’s son-in-law and a business partner for around $800 million. The opposition, led by Viktor Yushchenko, called the sale a “theft” that gave away a very valuable industrial property and promised to annul it.8 After the Orange Revolution brought him to power, President Viktor Yuschenko kept that promise by organizing a second auction—despite resistance from the former owners who appealed to the European Court of Human Rights, mounting social skepticism about privatization because of past corruption, and a Parliamentary vote to halt the sale. The new government wanted to highlight the transparency of Ukraine’s new business culture to potential investors, and therefore arranged for the auction to be televised live, with President Yushchenko attending in person. Mittal Steel, the world’s largest steel company with 59 million tons of crude steel production in 2004, was an obvious bidder in the second auction: it had lost the first auction, in 2004, despite bidding $1.5 billion, or nearly twice as much as the winning partnership. The other competitors this time around were a consortium led by Arcelor, the world’s second largest steel producer with 51 million tons in crude steel production in 2004, and LLC-Smart Group, a local investor group reportedly controlled by a Russian businessman. LLC-Smart dropped out of the auction early on, leaving Mittal and Arcelor to go head-to-head. The $4.8 billion that Mittal ended up paying greatly exceeded expectations, with some reports suggesting that the Ukrainian government’s target price had been around $3 billion.9 The World Steel Industry10 In 2005, the global market for steel was estimated at around 998 million metric tons (mt).11 Although the market for steel comprised several thousand distinct products, they could largely be grouped into a few broad segments. Semifinished products were at least 8 inches thick and required further processing. Flat-rolling them yielded plates (more than 0.25 inches thick), or sheet and strip, thinner products that could be shipped in coils. Other kinds of products that could be formed from semifinished steel included bars and wire rods, that were even thinner; a wide variety of structural shapes that were used primarily in construction; and hollow pipes and tubes. Flat sheet was by far the most important of these segments, both because of the volumes and because it included the higher-value-added sheet steel for the automotive and appliance sectors. Other major customer groups included service centers and distributors, and the construction sector. Price, quality, and dependability were considered the three most important buyer purchasing criteria, although it was difficult to get qualified by major buyers such as the automobile companies. Higher price realizations typically reflected a focus on higher-end products, and tended to be accompanied by higher operating costs. From a technological perspective, there were three groups of steelmakers: integrated firms that produced steel by reducing iron ore, minimills that produced it by melting scrap, and specialty steelmakers that produced stainless steel and other special grades of steel for distinct submarkets and will not be considered further here. Integrated firms traditionally dominated the industry and followed a strategy of vertical integration, owning not only steel plants but also iron ore and coal mines, transportation networks, and downstream processing units. In recent decades, however, many 2 Mittal Steel in 2006: Changing the Global Steel Game -DRAFT- had reduced their holdings in upstream and downstream segments so as to focus on the core business of steelmaking. Minimills operated their scrap-based Electric Arc Furnaces (EAF) at much lower scales than integrated steelmakers’ blast furnaces, reducing their minimum efficient scale from millions of tons to several hundred thousand and their capital cost per ton of new capacity from $1000+ to the range of $200–$300. Minimills had historically had a significant cost advantage over integrated steelmakers, and had forced them out of low-end products, to the point where in the United States, the minimills held about 45% of the total market, but continued to face difficulties in meeting the exacting standards of automotive and appliance manufacturers. The constraints reflected, in part, minimills’ reliance on scrap steel as primary input: impurities in the scrap steel tended to reduce the quality of the finished steel and, furthermore, scrap prices had come under pressure even in markets where scrap had historically been abundant. In the 1970s, the new technology of Direct Reduced Iron (DRI) began to catch on—this process produced a scrap substitute from iron ore that could be used to feed the EAF. In its early years, DRI quality had been very variable, but had improved gradually, and was expected to eventually provide the same clean metallic feedstock for EAF as the blast furnace, but at a lower cost, and without scrap’s inherent price volatility and quality problems.12 On the whole, steel producers around the world had posted significant economic losses for decades. Thus, Marakon Associates, calculated that steel had persistently been the most unprofitable of the major U.S. industry groups between 1978 and 1996 (see Exhibit 1), although economic losses had since narrowed. The pattern was repeated in most other mature markets. Thus, Mittal Steel’s comparison of the return on invested capital (ROIC) and the weighted average cost of capital (WACC) of the 10 largest steel producers worldwide suggested narrower but still chronically negative spreads, with only the most recent year—2004—generating significant positive returns (see Exhibit 2). The reasons were various and included fragmentation, very high fixed costs and exit barriers, generally slow growth and induced excess capacity, limited product differentiation, intensified competition from minimills and imports as well as substitution threats (which included less-intensive use of steel as well as replacement by other materials),