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Steel: The Mergers Aren't Over Yet

You would think that Guy Doll?, the cerebral CEO of Europe's leading steelmaker, Arcelor, would have mixed feelings about Lakshmi N. Mittal. After all, when Mittal announced last fall that he was creating the world's largest steel company by buying U.S.-based International Steel Group Inc. (ISG), the Indian-born investor knocked Doll?'s company into second place. But Doll? applauded. "It's a very positive signal to the industry that it has to move and consolidate," he says. "In coming years you will see a speeding up of mergers and acquisitions in the steel industry."

Doll? is determined that Arcelor be among the few steel titans to survive that wave. The Luxembourg company was born out of the $10 billion union of three of Europe's top producers -- France's Usinor, Luxembourg's Arbed, and Aceralia of Spain -- in 2002. Doll?, a veteran Usinor exec who became CEO at merger time, now wants to continue the process in Asia and North America, possibly even striking a deal with U.S. Steel (X) or Nucor (NUE). And some analysts believe he can pull it off. "Mittal and Arcelor are a sure thing to lead this consolidation," says Peter F. Marcus, managing partner of World Steel Dynamics Inc.

Better market conditions are spurring the pace of M&A. After falling for years, steel prices began to rise in late 2003 and have stayed up ever since. The effect on earnings has been dramatic. In 2004, net profit surged 800%, to $3.04 billion, on revenues of $39.9 billion. Buoyed by the results, Arcelor shares are now trading near $24, a 50% increase from the 12-month low last May.

Chinese demand -- the main driver -- is expected to surge by 11% this year, to 290 million metric tons, or 29% of the global market. Arcelor managed to win 20% to 50% increases in an- nual contracts with car and packaging companies for 2005.

Doll? will need this financial strength if he wants to double Arcelor's size -- and to compete that may be necessary. Many analysts believe that in coming years, the fragmented industry will consolidate into four to six global behemoths, each with 80 million to 100 million metric tons of production capacity. In 2004, Mittal's estimated output of 58 million metric tons was about 16% greater than Arcelor's.

Arcelor is taking steps to match Mittal's growth. With 30% to 35% of the European market, it can't grow at home and is largely absent from the U.S. and Asia. But the recent takeover of Brazil's Companhia Sider?rgica de Tubar?o vaulted Arcelor to the top spot in Latin America. It has also signaled that it will bid for Erdemir, Turkey's largest steelmaker, which will be privatized later this year. In Japan, Arcelor has inked an R&D partnership with Nippon Steel.

In the U.S., the world's second-largest market after China, Doll? admits he's on the hunt. But a new plant built from the ground up is out of the question: "An acquisition, partnership, or merger" is the way to go. The timing is right, given Arcelor's stock price, strong balance sheet, and the weak dollar. Among the top candidates are a handful of North American players analysts consider too small to succeed solo, including AK Steel (AKS), Dofasco, Schnitzer Steel Industries (SCHN), and Steel Dynamics (STLD). Bigger deals may also be possible. For now, neither Nucor nor U.S. Steel -- the largest U.S. players -- can match Mittal's global presence, points out Mary V. O'Connor, an analyst at New York's Locker Associates. A friendly hookup would help them to survive. "Doll?'s reputation is likely to attract merger partners who believe he can get the job done," adds WSD's Marcus.

Doll? also acknowledges that steel is a cyclical industry and that a slowdown in demand is inevitable. Like Mittal, he's betting that consolidation will mean that steelmakers -- who have been prone to overproduce when prices fall -- will exercise restraint this time. "It's better to cut production to avoid the price collapses," he says. With size, he hopes, will come a new sense of discipline.

By Stanley Reed in London, with Adam Aston in New York

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