Cleveland-Cliffs to acquire AK Steel in US$1.1B all-share deal

US iron ore producer Cleveland-Cliffs (NYSE: CLF) is acquiring AK Steel (NYSE: AKS) in an all-share transaction valued at US$1.1 billion.

Cliffs, North America’s largest producer of iron ore pellets, is offering shareholders of mid-tier steelmaker AK Steel 0.40 shares of Cliffs’ common stock for each common share they own of AK Steel.

Once the transaction is complete, Cliffs shareholders would own 68% of the combined company and AK Steel shareholders 32%.

The deal implies a consideration of US$3.36 per share of AK Steel common stock and represents a 16% premium based on the closing shares of both companies on Dec. 2, and a 27% premium based on the 30-day volume-weighted average price of AK Steel.

“The combination of AKS and Cliffs results in a vertically integrated steel producer with a strong position in iron ore markets as well as advanced strength and electrical steels,” Carol Cowan and Brian Oak, analysts at Moody’s Investors Services, commented in a note to clients. The analysts added that the merger “will provide AKS with a more competitive cost position in its steelmaking process and result in a more diversified producer across the iron ore and steel markets.”

Lourenco Goncalves, Cliffs’ chairman and CEO, stated that the combined entity will be “well-positioned to serve both the blast furnace and electric arc furnace segments.” He also noted the transaction allows Cliffs to “realize immediate growth and a long-desired objective of a more diversified customer base, as well as more predictable cash flow generation due to the contracted nature of AK Steel’s sales of high-end automotive steel.”

Moody’s analysts note that 63% of AK Steel’s business is contract business with the automotive industry, so the company “is not exposed to price movements in the spot market, and the contract position limits the degree of earning movement, particularly on the downside.”

AK Steel’s Research and Innovation Center in Middletown, Ohio. Credit: AK Steele.

The credit rating agency also noted that AK Steel’s “continued focus on high margin value-added products, through its Precision Partners and AK Tube segments … strengthen its position in the downstream business and improves its ability to realize better metal margins.”

The two companies expect the business combination will generate US$120 million in annual cost synergies within the first year, primarily from consolidating corporate functions, reducing duplicate overhead costs, procurement and energy savings, and operational and supply chain efficiencies.

Over the last year, the pro forma company has generated net revenue of US$8.2 billion, adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of US$1.3 billion, and unlevered free cash flow of US$923 million, Cliffs says.

The deal is expected to close in the first half of 2020.

Cliffs obtained a US$2-billion financing commitment from Credit Suisse in connection with a new asset-backed loan and the refinancing of AK Steel’s 2023 senior secured notes.

News of the acquisition sent Cliffs’ shares down 10.7% on the day, while AK Steel’s shares rose 4.2%.

“For AK Steel, this clearly solves the long-standing lack of iron ore vertical integration,” David Gagliano of BMO Capital Markets wrote in a note to clients. “It will also likely open up interesting asset optimization opportunities (that is, merchant pig iron), and it is a generous price for AKS shareholders, in our view.”

GlobalData Plc, a London-based data analytics and consulting firm, calculated that the deal “was executed at a price point more than 10 times the adjusted earnings before EBITDA of AKS, which also had close to US$2 billion in debt at the end of the third quarter of 2019.”

“Post-merger, the total debt of the combined entity will amount to approximately US$4 billion, which may increase risks multifold in case recession creeps in, affecting the demand for steel,” GlobalData continued. “At the outset, downside risks outweigh potential gains of the deal. Though it will be premature to predict future stock performance, business performance of the combined entity will remain the key for winning shareholders’ confidence.”