Mergermania, look for further deals in China: PwC

Commentary

The metals industry continued to consolidate in 2005, as the leading producers sought to control the rising cost of raw materials by purchasing their suppliers, says consulting firm PricewaterhouseCoopers (PwC) in a report titled Forging Ahead: Mergers and Acquisitions Activity in the Global Metals Industry 2005.

PricewaterhouseCoopers predicts that further merger and acquisition activity in the sector is likely, and that a lot of that activity will take place in China, especially with companies involved in steelmaking there.

“Our predictions of last year have been borne out, with rampant consolidation in the metals industry and, most specifically, in the steel sector,” says Mark Okes-Voysey, global metals leader with PwC. “The emerging markets were most instrumental in deal-making and we expect that eastern Europe, Asia Pacific and Latin America will continue to be driving forces in the industry’s consolidation efforts.”

The report says there were 250 metals industry deals in 2005, far surpassing the 166 in 2004. However, the total value of the deals in 2005 was only US$35 billion, less than the US$37 billion in the previous year. The steel sector led the way in 2005 merger and acquisition activity in the sector, as it did in 2004, with 165 deals collectively worth US$27.4 billion.

Domestic transactions accounted for most of the metals industry merger and acquisition activity with 151 deals — up from 99 in 2004. However, the aggregate value of these deals was just US$17.6 billion, down 32% on the US$25.7 billion that was traded the year before. Conversely, both the volume of cross-border deals and their aggregate value rose sharply, with 99 transactions collectively worth US$17.2 billion — up 50% over 2004.

Companies based in central and eastern Europe, Asia Pacific and Latin America jointly accounted for US$17.7 billion — or 51% of the total value of industry transactions worldwide, up from 32% the previous year. This trend is expected to continue, given that industrial production in all three regions is growing much more rapidly than it is in North America and western Europe.

The steel sector

What the deals in the steel sector lacked in size in 2005 they made up in volume. In fact, there were no transactions comparable in size to the two that produced Mittal Steel in 2004. The single biggest deal — Mittal Steel’s acquisition of the Ukrainian steel producer KryvorizhStal — was worth about US$4.6 billion, barely a quarter of the US$17.8 billion that went into the making of Mittal.

“Global consolidation is by no means the only factor driving deal-making in the steel sector,” says Jim Forbes, global metals advisory leader with PwC. “Many of the largest deals of 2005 involved manufacturers eager to buy iron ore mines and reduce their raw materials costs.”

The acquisition of KryvorizhStal was one such example, as it produces 17.1 million tonnes per year of iron ore and has over a billion tonnes of iron ore reserves. Similarly, Ural Steel and Sitbon Investments bought Mikhailovsky, Russia’s second-biggest iron ore producer, for about US$1.7 billion.

Aluminum and other metals

While the leading steel producers continue to jostle for a larger piece of the global pie, the aluminum sector is already much more consolidated — and relatively calm. There were 41 completed transactions worth US$4.2 billion in 2005, down from the US$5.2 billion in 2004. The single biggest deal was the US$1.8-billion acquisition of Norwegian metals maker Elkem by Orkla, Norway’s largest consumer-goods company. In January 2005, Orkla increased its existing stake in Elkem above the 40% limit that triggers a mandatory offer. It subsequently bought the rest of the shares, ending a long-running battle with American firm Alcoa for control of the company.

Conversely, companies involved in the production of other base metals were much busier — with 45 deals collectively worth nearly US$3.4 billion — seven times more than the US$447 million changing hands in 2004.

China remains key

China now produces more crude steel than the next four largest steel-making nations combined. The central government has signalled its determination to rationalize the sector, with the top 10 domestic producers controlling 50% of domestic output by the end of the decade. Its new steel policy, launched in July 2005, resulted in eight transactions with an aggregate disclosed value of US$1.1 billion — 2% of the total value traded in the Asia-Pacific metals industry in 2005. China is also attracting great interest from overseas steelmakers eager to tap into its growth.

At the same time, China’s steel consumption has quadrupled since 1998, with the construction industry largely driving demand. In 2004, it accounted for 53% of total consumption, a pattern that is likely to persist for the next few years, as China invests in vast infrastructure projects like the Three Gorges Dam and gears up for the 2008 Beijing Olympics and 2010 Shanghai World Expo.

China’s steel consumption is forecast to rise by 4-5% a year for the next few years, significantly outpacing the 3% by which consumption is predicted to rise in the rest of the world.

China is heavily reliant on other countries, however, for high-quality iron ore and, as imports have soared, so prices have skyrocketed. Energy and transportation costs have also increased, and the domestic steel sector is highly fragmented and suffering from overcapacity in certain areas. All these factors have eroded the industry’s profitability — and, if it is to weather such difficulties, it must consolidate.

“The Chinese steel sector is sure to be a significant source of deal-making over the next few years,” Okes-Voysey says. “The central government has made it clear that the industry must consolidate, and that it wants the four leading domestic steelmakers to play a major role in this process. The big foreign steelmakers are equally eager to tap the opportunities China offers; they know that, as China reduces its imports and ramps up its capacity, it will have to improve its ties with domestic producers to cash in on its growth.”

Meanwhile, Mittal Steel’s hostile takeover bid for rival steel giant Arcelor has sparked interest everywhere. The next chapter of the story should unfold later this month, when the European Commission is due to rule on the antitrust implications of the proposed deal. It can either clear Mittal Steel to press on with the bid, or subject it to a deeper probe lasting up to four months.