Mittal Steel Bids For Arcelor - Why?

The New Year has not been particularly good for the board executives of Arcelor. Just days after winning a tough fight with ThyssenKrupp AG for buying out the Canadian steel maker Dofasco Inc, they are again huddling in their boardroom in less than 12 hours from now. This time the predator has been turned into prey.

The bid of Rotterdam-based Mittal Steel has stunned everyone, including Arcelor, which has termed it as 'hostile'. Mittal Steel, 88% of which is controlled by the family of L.N. Mittal, has offered to buy shares of Arcelor for 18.6 billion euros in cash and shares. The steel industry has seen a lot of mergers and consolidation in the past few years, Arcelor itself being a result of the merger of steel companies in France, Luxembourg and Spain. But this bid outshines all of them.

If successful, the combined entity will have total annual capacity of 115mn tones with the next biggest being Nippon Steel of Japan, which has a capacity of 30mn tones. The hectic merger activity in the steel industry started after Chinese demand lifted it from a multi-year slump. Since then, the insatiable Chinese hunger has seen soaring prices and profits increasing by 30% to 35% for most of the companies. At its peak, the benchmark hot rolled coil steel jumped from $200 per ton to $600 per ton, which has since fallen to around $500.

But this Chinese demand is also supported by huge production from Chinese companies. The output of China in 2005 was 349mn tons. It is estimated that by 2010 Chinese total production will be much higher than its total demand. This would lead to a glut coupled with the possibility of a slump due to the cyclical nature of steel market. This leads us to a question: Why is Mittal Steel trying to snap up Arcelor?

There are a few reasons. Though Chinese production capacity is increasing by leaps and bounds, it lacks good quality iron ore. It purchases most of the raw material from Brazil and Australia. In the merged company, due to its sheer size, Mittal Steel will have greater bargaining power over suppliers, who have increased their prices by 72% in recent times. This will give them an edge over Chinese producers of steel. Secondly, the steel industry has traditionally been a seller-driven market and Mittal would be able to restore it to that level so that they can tide over any slump. Thirdly, with economies of scale it could lower overall operating expenses and resist price hikes (Arcelor has a considerable mining presence).

The other reason could be that Arcelor and Mittal were competing with each other (Ukraine's state-owned Kryvorizhstal bid) in buying out other steel companies, thereby increasing the price. This problem would be solved for Mittal with the takeover.

Chances are high for the takeover to go through as most of the share holders of Arcelor are institutions that don't love individual companies. There could be a few hiccups such as opposition from the French and Luxembourg governments. Mittal might also have to raise the price it is offering per share. Despite these hurdles, the merger will create an entity of considerable heft.