Mittal Steal in 2006: Changing the Global Steel Game Industry Analysis Although steel was a highly demanded good, the industry as a whole was largely unprofitable. One reason for this was that the industry remained highly fragmented in contrast to their suppliers and even some of their buyers, who were considerably more consolidated. Aside from the increased competition that fragmentation contributed to, it also degraded the steal industry’s bargaining power to raw material suppliers and in some cases, such as the auto industry, the buyers.
The resulting high fixed costs, volatile raw material prices, and intense price competition fueled unstable profitability. Adding to the fragmentation issues was a lack of differentiation in the market. For the longest time there were really only two production possibilities. One, being vertically integrated and producing higher-grade steel at a higher cost of operation, or two, de-verticalize and focus on low cost, low-grade steel production. Depending on the production selected, the resulting accessible customer base was limited.
This lack of differentiation further fueled the limited bargaining power of steel manufacturers. As stated above, steel was highly demanded. The problem was that the growth of that demand remained quite stagnate for nearly 20 years. It wasn’t until the explosion of growth in the Chinese construction industry, attributing to 25% of total steel consumption, that the steel industry saw any profitability. In an industry where customers demand a low cost and a consistent product, being able to maintain a reliable supply while being as cost efficient as possible was key to a firms success.
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Though there was a spike in Chinese demand, only those strategically positioned could access the true value of the Chinese market. This was because the steel industry operated primarily on an intra-regional basis. Many factors attributed to this, but a firm’s dependence on raw material access, and trying to avoid high transportation and tariff costs, as well as delivery lags, were the primary reasons for high regional trade. In order to access the benefits of regional trade, firms had to expand their operations through high FDI in the form of M&A’s.
This gained them access to highly profitable regions and it allowed firms to spread their risk over a larger area, reducing the impact of demand fluctuations in one particular region. The reason many of these M&A opportunities existed was because of a major shit from government owned steel plants to privatization. Through privatization, FDI opportunities became possible in many countries, thus make intra-regional trade more accessible and attractive. Consolidation & Integration Recognizing that the dynamics of the market were changing, LNM was quick to take advantage.
He was steadfast in his belief that they only way to create sustained success was through consolidation and integration. With increased privatization opportunities available, LNM began a series of M&A’s that would gain him access to regions that were highly profitable, had lower labor costs, and would position him to have higher bargaining power with suppliers. LNM made the first moves in the industry toward consolidation, and was this strategic initiative that has since driven the evolution of the industry to where it is today.
A major source of value creation was derived from their technological lead in DRI. LNM decided early on to focus their operations around “integrated minimills”, which was untraditional at the time. Through this structure he was able to capture the maximum value of his operation, using scrap in the minimills, then reverse integrating into DRI. Once unreliable, DRI technology had advanced so much that it’s output was now comparable to the quality of integrated steel plants.
This technology stronghold provided them better quality steel at a cheaper cost of production, providing them with a huge competitive advantage. Additionally, It was this technology, aided by a proven SWAT team and protocol, which supported their ability to transform underperforming government owned plants to profitable ones in a short period. LMN’s initial approach was to resurrect distressed government owed plants then breath new life into them through technology sharing and smart practices.
He soon sought larger targets that would provide him not only economies of scale, but also provide competitive advantages through geographic scope. Starting with Karmet, he began to shift his targeting toward plants that were either highly integrated, possessed significant mineral rights, or supplied a strategic geographic advantage. Through designing their activity architecture in this way, Mittal steel became the world's largest and most integrated steelmaker; providing strong positions in North America, Europe, Asia, and Africa.
The result of their strategic positioning, combined with their focus of coordination through KIP and KMP, made Mittal the first firm in the industry to operate as a transnational organization. Each plant provided its own uniqueness, providing different capabilities and skills that could be harnessed for the good of the whole organization. There was also a heavy flow of people, materials and finances between the interdependent plants, but at the center of it all was the Mittal Steel directing tight coordination and a shared strategic decision making process. On a regional level, they operated through regional hubs.
This allows Mittal’s positioning of adjacent plants to source from the same suppliers, increasing their bargaining power and reliability of supply, while not jeopardizing cannibalism of sales as each plant’s customer base was unique to their location. Mittal’s vertical integration in mining and low cost position helps support profitability and helps to reduce capital expenditure needs. They are the most diversified steel company in the world in terms of asset location and market presence. They also have a diverse product range, including both flat and long steel.
As such, Mittal is not overly dependent on any single region, product, or end market. These benefits are somewhat mitigated however by the risks associated with Mittal’s rapid expansion through acquisitions. These include such things as institutional risks associated with emerging markets and uncertainties regarding the integration of newly acquired assets, although Mittal's integration track record has been successful to date. Arcelor Acquisition In light of the above information, I believe that Mittal should pursue the Arcelor acquisition aggressively.
Mittal Steel & Arcelor complement each other in terms of geographical coverage and product mix, as there is no significant overlap. Mittal has strong positions in the U. S. market; low-cost operations in Central and Eastern Europe, Asia and Africa; and vertical raw-material integration. Arcelor is the leader in higher value-added products with strongholds in Western Europe and Brazil, as well as a focus on Russia, India, and China. I believe that the positioning of Arcelor’s plants and resource capabilities would integrate nicely to Mittal’s activity architecture.
There would be very minimal duplications of effort, and many of the regions that Arcelor operates are in prime locations to source raw materials. The addition will only strengthen Mittal’s integrated transnational value chain. Through acquisition, Mittal would produce nearly 110 million tonnes of steel per year, making them three times as large than their next competitor. Although this can lead to diseconomies of scale, in Mittal’s case, as the largest player in the steel industry both globally and in the key markets, the combined group would enjoy significant bargaining power.
Additionally, through shared expertise, the combined entity would be in a better position to develop the high growth region of China and South East Asia. Arcelor’s alliance with Nippon and Mittal’s acquisition of Karmet and stake in Valin will provide access to critical Asian markets. Regardless of the “synergies” the acquisition will create, caution still needs to be exercised by Mittal. There are evident signs that the acquisition will not be welcomed by Arcelor, assuming that Mr. Dolle’s canceled meeting and unreturned phone call was an indication to his temperature on the proposal.
If the acquisition turned hostile there is a good chance Mittal would have to overpay for Arcelor, which could have adverse affects to it investment ratings. At the current bid price Mittal would already have to leverage €5 billion and would be in debt by €11. 5 billion. Although they have a good track record of ROI and the industry as a whole has seen a spike in ROIC, they do not want to spend more than they have to. Despite the favorable history and perceived synergies, Mittal should pay at a maximum €27. 1 billion for the deal. They should obviously try to pay as close to the current bid as possible, but at €27. billion they are still in a position where they could access the capital needed given their successful history. Also, at the mark of €27. 1 billion their debt would raise to €20 billion, but with an EBITDA of over €5. 5 billion annually, not to mention the added revenues from the acquisition, the debt could be confidently paid off in a reasonable timeframe. If the bidding exceeds the mark of €27. 1 billion, the negotiations should be ceased and Mittal should pursue other opportunities to continue their global footprint expansion.
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