Ryerson: A Rusted-Out Fixture
On an early Wednesday morning in October, Neil Novich stepped to the microphone for what would be his final stockholders meeting as chief executive of Ryerson, one of Chicago's oldest companies. Few attended the somber event: two dozen employees and attorneys in a carpeted conference room at the company's headquarters. In less than 10 minutes it was over, as Novich reported that holders of 80% of the outstanding shares had approved the sale of the steel distributor to a Los Angeles private equity fund. Days later, Novich was out of a job.
That Ryerson would be forced to auction itself off during an unprecedented boom in the metals sector was testament to the company's years of poor performance under Novich. The CEO, according to former colleagues and others who know him, was simply the wrong man in the wrong industry at the wrong time. He was a reclusive analyst in an industry ruled by schmoozers, and his centralized business model kept the company from cashing in on the good times.
In his nine years as CEO, Novich weighed down an already stodgy operation with bureaucracy, layering senior vice-presidents upon division vice-presidents upon general managers. His penchant for data slowed the organization. He tried to capitalize on Ryerson's unmatched scale as the nation's largest metals wholesaler by cultivating such huge customers as Caterpillar (CAT). But long-term contracts with big metal benders limited his chance to tack on rich premiums when metal prices soared. Turning away smaller customers, meantime, signaled they weren't worth the bother. "There was a bit of arrogance," says David Sheer, general manager of a small distributor and fabricator in Rolling Meadows, Ill.
Becoming a Takeover Target
Novich succeeded in hiking Ryerson's top line, thanks in large part to his 2005 takeover of Integris Metals. But his company consistently fell behind its peers in profitability and shareholder return. Embarrassingly, it also was upstaged by the industry's No. 2 firm, Reliance Steel & Aluminum (RS). The Los Angeles rival grew 10-fold over the past decade by acquiring more than 30 distributors around the country. Last year, Ryerson's net income fell 27%, to $71.8 million, on sales of $5.9 billion, while Reliance's earnings jumped 73%, to $354.5 million, on sales of $5.7 billion.
The shifting fortunes caught the attention of Harbinger Capital Partners, a Birmingham (Ala.) hedge fund that bought a 9.6% stake in Ryerson and launched a proxy fight at the start of the year to elect a slate of seven directors to its 11-member board. Ryerson's executives and directors disagreed with the fund's characterization of it as a laggard, but felt they were cornered. Rather than let Harbinger win control, they put the company on the block. In July, it was acquired by Platinum Equity for $2 billion, or $34.50 a share, a premium of 45% over the stock's close in mid-December 2006, when Harbinger first disclosed its ownership stake. Harbinger opposed the sale, arguing it didn't represent the "best course for maximizing shareholder value." Still, it earned an estimated $30 million on its investment, before its own expenses.
Novich, 53, declined to comment. Terence Rogers, recently promoted by Platinum Equity to chief financial officer at Ryerson, says Harbinger painted the company in the worst possible light. By its calculations, Ryerson performed respectably compared with its peers.
Ryerson operates out of a 1 million-sq.-ft. complex of warehouses and low-slung offices in Chicago's Pilsen neighborhood. (It has 100 warehouses across North America and joint ventures in China and India.) The company may well be Chicago's oldest, dating to 1842, only five years after the city itself was incorporated. The business thrived by supplying steel to the railroads, the makers of farm equipment and automobiles, and the builders of Chicago's skyscrapers.
Novich, a veteran Bain & Co. consultant who led the firm's distribution and logistics practice, joined Inland Steel in 1994 to head its Ryerson subsidiary. He was named chairman and CEO of Ryerson when it was spun off as a publicly traded company in 1999. With an undergraduate degree in physics from Harvard University and an MS in nuclear engineering from the Massachusetts Institute of Technology, he was an odd fit in steel distribution, where most executives had less storied résumés and had worked their way up through operations, sales, or finance.
Waist Deep in Minutiae
By all accounts, Novich rarely visited customers and suppliers. His absence was conspicuous at industry conferences, where executives often play golf and network over banquet dinners of surf 'n' turf. He also didn't seem comfortable glad-handing on the shop floor. He might visit a branch, walk into the general manager's office, and then abruptly leave without shaking hands or greeting workers, according to people familiar with his management style.
Novich steeped himself in the numbers and minutiae of the business. "He would take complete ownership of a project, but I wondered, ‘Why would the president do that?'" recalls Walter Wallace, a former Ryerson executive who held posts in marketing and purchasing. Wallace remembers Novich wanting to send out a customer survey with more than 150 questions, ensuring that few would respond. Novich's staff talked him out of it, but it suggested Novich felt he needed tons of information to do his job with precision and certainty.
To dampen cyclical swings, Novich steered more of Ryerson's business to large national accounts, such as Deere (DE) and Caterpillar, reasoning that these elite customers were efficient to service—not a lot of stops for a delivery truck. True enough, but the big equipment makers drove hard bargains, demanding better packaging and guaranteed deliveries, which could eat into margins. The deals also limited price changes.
That could be a plus in a down market, but when steel prices soared in 2004 and some products became scarce, distributors that sold on a spot basis were able to hike prices quickly and reap big gains. Ryerson benefited as well, but it took much longer to pass along price increases. "If you're locked in, you can't charge a premium for something that's scarce," says G. Thomas McKane, the former CEO of rival A.M. Castle (CAS).
Ryerson's Rogers notes that few foresaw the big runup in metals prices in the mid-2000s. "The market taking off like a rocket shot doesn't happen too often," he says.
Taking a page from automakers, Novich also set out to use Ryerson's heft to get lower prices from steel producers and cull its own base of suppliers. In late 1999, he invited suppliers to a dinner at the Hotel Sofitel Chicago O'Hare to kick off a three-step, year-long process that required all the contenders to answer detailed questions about their capabilities, host on-site inspections, and then, if they made the final cut, enter into contract negotiations.
Leveraging its purchasing power made sense—Ryerson bought as much as 3.5 million tons of steel a year, after all—and the trimming reduced its suppliers by a third. But the amount of information the company demanded from suppliers was excessive, says a former executive involved in the process. There was also no assurance that the steel producers who lost out wouldn't simply go to competitors and offer them prices similar to what Ryerson had tried to negotiate.
Problems Under Wraps
Centralizing the supply chain had another unintended consequence: It made it difficult for Ryerson's salesmen to take advantage of unexpected opportunities. In a classic chicken-and-egg conundrum, they couldn't accept a new order unless supply was assured. But the company's purchasing managers in Chicago didn't want to buy the steel if they weren't certain that the order was for real. Rogers responds by saying that centralized buying shouldn't have prevented spur-of-the-moment deals since it merely required sales reps to call the head office rather than a contact at one of the company's steel mills.
Early in Novich's tenure, any missteps were hard to see. From 2001 to 2003, the entire steel industry was in the tank, with almost every producer and wholesaler reporting losses or shrunken earnings. Also, Ryerson's $640 million acquisition of Integris Metals of Minneapolis, a specialist in aluminum and stainless steel , obscured what was happening to its own financial results.
But by 2006, Ryerson's lagging performance was becoming more evident to Wall Street. One of the first to detect trouble was Moody's Investors Service (MCO). In an April, 2006, report, the ratings agency found that Ryerson had the worst operating margins—averaging 0.4% over the previous five years—among six publicly traded metals distributors.
The following year, hedge fund Harbinger delivered a harsher assessment. Despite Ryerson's industry-leading position and the industry-wide consolidation, which was driving up stock prices, the company had "significantly underperformed market indices and its peer group in profitability and efficiency," the fund stated in an August Securities & Exchange Commission filing. Between March, 1998, and December, 2006, Ryerson's return to shareholders fell 3.2%, while the industry stock composite soared 233% and the Standard & Poor's (MHP) 500-stock index climbed 30.7%, Harbinger pointed out.
In the war of words that followed, Ryerson countered that Harbinger's metrics overlooked Ryerson's product mix of pricey stainless steel and aluminum, which generated a lower gross margin but more revenue. By another standard—return on invested capital—Ryerson argued that it stacked up favorably, at 15.1% over the previous three years, vs. 15.8% for its peers. "I'm not going to tell you we outperformed Reliance," says Rogers. "But we did better than you think."
By then, though, it was too late. Giving in to investors, the company auctioned itself to the highest bidder.
Three days after the Platinum takeover closed Oct. 19, Novich, CFO Jay Gratz, and Executive Vice-President Gary Niederpruem left the company. They won't be strapped, thanks to change-in-control agreements—Novich's package alone is worth $18.4 million.
Debt Nearly Doubles
The new management team includes Rogers, who previously had been vice-president of finance, and President Stephen Makarewicz, a veteran of J.M. Tull, a metal wholesaler acquired by Ryerson in 1986. Rob Archambault, the partner at Platinum overseeing Ryerson, was named interim CEO.
Since taking over, Archambault has told employees that Ryerson would reverse course and decentralize operations. The new management team is expected to reduce costs by closing some warehouses and laying off workers. People familiar with the situation expect a minimum 20% workforce reduction, with a bigger hit at headquarters and two nearby sites, where the company employs an estimated 650 people.
As with most private equity buyouts, any higher earnings are likely to be used to fund dividends to the parent and pay down debt. Ryerson's current debt, $1.4 billion, is nearly double the $876 million it owed on June 30. Greater profits could also help prepare the company for an eventual sale or public offering.
"What the new owners will do is squeeze as many bucks as they can," says Philip Block III, a descendant of one of the founding families of Inland and a former vice-president of purchasing for the steelmaker. "You hate to see a company so old no longer there."