USX Case

Steel troubled industry

Energy greater growth prospects but volatile industry subject to various forces
which USX had limited control
Background
Very large vertically integrated firm
By 1!"#s domestic mar$et share fell from %%& to '"&
o (esult of increasing dom competition ) operating costs
*istroy mar$ed by many ac+uisitions ) labour disputes
,ots of forgein comp rising US share of world production falling
US steel needed moderni-ation significant ./0EX
o 1.ontinous casting2 in early 3"#s 4 5"& US6 7!& Europe6 8!& 9apan
Restructuring
#8: ;ew .E< ) lots of restructuring closed plants6 wrote off assets6 sold or leased
properties
#35: =iversitifaciton into Energy 0roviding opering ) financial benefits
>ntended to ma$e firm 1less vulnerable to a downturn2
Steel very cyclical 1Steel usually up when energy down2
/lso6 some operating benefits as well as diversification
0rovided 1energy hedge2 for energy dependent steel business ) raw material support
for chemical business
Steel provided drilling e+uipment for energy business
USX Energy business itself diversified
13!:
o Steel?ma$ing capacity reduced by @'"&
o !7& of white?collar jobs cut
o 1""$ production wor$ers fired
o A'bn assets sold
#3%: .ontinued diversification Bought BeCas oil ) gas
1986 Extraordinary Year
77$ Employees stri$e ,ongest stri$e in US
.ompany stoc$ falls to A17D!"
Debt ro!ision c"ange Debt re#uired i$$ediate reay$ent i% USX
under&ent a 'c"ange in contro()
Continued C"a((enge %ro$ *ca"n
>cahn believed problem of steel business and steel industry in general depressing
value of its energy business
133 Eerger with Bethlehem steel considered
/lso considered selling 5"& of steel via >0< FE+uity carve?outG
But6 couldn#t get acceptable price low point in cycleH
Iould consider again when mar$et for steel e+uity better
*ca"n +roosa(,
USX spins steel business from energy
USX shareholders receive dividend of US steel stoc$ 5 legally separate entities
>cahn argued EV of stand?alone business# 4 A' and A6 vs current A'!
+ros - Cons o% Sino%%
.axabi(ity
Ihether spin?off 4 BaC free unclear
5 Eajor stumbling bloc$s:
1D *ave to demonstrate done for 1valid business purpose2 .ould be difficult for USX
to prove
5D >ssue of .ontrol
*ssue o% contro(,
Eanagement wanted to be able to oversee resolution of of possible environmental
liabilities6 etcD associated with US steel
.ommentator 1Very little USX could do to avoid liability for past acts by steel
business that was once part of parent company2
o Even if steel business sold outright plaintiffs could come after parent for
past acts of enviroD damage if steel business or new owners couldn#t satisfy
the claims
Unclear whether USX would have to retain 1practical control2 of US steel Fsignificant
minority stoc$G to resolve this
USX management view Jes 6 >cahn ;o
>f spin?off became taCable double taCation at both .orporate and Shareholder
levels
o /t .orporate level BaC on diff between fair EV of net assets of US steel and
taC 1basis2 of those assets Fsimilar to boo$ valueG
o /t Shareholder level =ist of US steel stoc$ treated as dividend and taC
based on initial trading value of US steel stoc$
*ncre$enta( Costs,
=espite few covenants debt couldn#t be reassigned without consent
=ebt would have to be refinanced at current mar$et rates and mar$et conditions
.urrently rated BBB avg yield 4 11D8& Firrespective of maturityG
A'"m annual ad$in costs ,oss of econs of scale
A5"m annual additional taxes separate entities lose benefit of available net
operating losses
A1!m annual insurance cost additional insurance lenders to separate steel comp
re+uire
/t"er 0rgu$ents,
Kinancial benefits of diversification lost
Spin?off irreversible
USX management demonstrated for year commitemnet to restructuring
Eanagement argued >cahn estimates way off
Energy ) Steel best valued on .K6 Earnings6 =ividend yield
>cahn reliance on 1industry values2 simplistic <mitted factors li$e location6 operating
costs6 future recoverability and actual recent transactions
>f >cahn methodology applied to comparable stand?alone companies Energy
compaies 4 115& higher than actual EV ) Steel companies 4 "& higher than
actual EV
*ca"n argu$ent %or Sin1o%%,
>cahn argued separating energy ) steel increase operating efficiency
Eanagers more accountable for performance
>ncrease efficiency which investment community value the 5 businesses given their
different growth prospects ) strategic directions
Energy companies higher multiples than steel6 because less cyclical ) better
business prospects
Because USX not pure?play in either6 steel business dragged down multiple for whole
corporation
Spin?off could increase business entity#s eCposure to mar$et 0ossibility of
ta$eover premium
+artia( *+/ E#uity Car!e1out,
(aise cash ) provide mar$et for steel e+uity
,imtation USX must maintain 3"& sta$e to maintain benefit of taC consolidation )
to the eCtent that steel and energy moved in different cycles important consideration
Because USX was capital intensive pleasing bond?holders very important to .E<
.argeted Stock
Eanagement believed would maintain company#s credibility with bond mar$et whilst
propping up value in stoc$ mar$et
C"aracteristics,
=istinct classes of parent company common trac$s performances of distinct
businesses
(evenues ) earnings reported separately
=ividends determined based on separate performances
/ssets ) liabilities formally allocated BUB only for financial reporting Flegal title not
affectedG
Bene%its,
/llows shareholders to eCercise investment preferences
Live company greater fleCibility in raising capital and ability to ma$e ac+uisitions with
stoc$ having higher multiple
/llow company to establish eCecutive incentive plans tied to specific businesses
where people wor$ed
Lreater efficient and better coverage by investment analysts
o Bargeted stoc$ solves problem of investment analyst difficulties in valuing
conglomerate
>ssuance ;<B taCable at either corporate or S* level
+ossib(e *ssues,
Voting rights fiCed at issuance
.ash?flows could become miCed up over time
Share & of firm stays fiCed but cash flow contribution could change very significantly
over time
eDgD B#s cash flows fall to 5"& of /)B 6 but still %"& of total shares
Uncertainties of .orporate ,aw:
o 0otential conflicts of interest between different classes of S*
o ;o precedent under =elaware law to determine fiduciary duties of directors of
corporations with ttargeted stoc$
o B<= effectively presumed innocent unless clearly proven guilty
o Bended to grant considerable discretion to B<=
o .onflicts could arise in connection with merger or recapitali-ation proposals
that favour one class over another6 or in connection with a corporations
internal allocation of investment capital
Ihat ro!isions could B<= ma$e in cororate go!ernance to satisfy
ShareholdersH
Di!idend +aying Caabi(ity,
Bhat of a separate steel company big concern
=ue to new accounting standard re+uiring companies to accrue full amount of
obligation for retiree healthcare costs on the BS
(ecognised by s$yroc$eting cost of healthcare and recognition that many6
particularly old and unioni-ed companies6 made promises to wor$er to pay most of
their health care costs during retirement who were %ai(ing to recognise
substantia( (iabi(ity ."ere%ore2 bad(y o!erstating t"eir 3et 4ort"
USX management believed wouldn#t affect energy business
Kor Steel business 0V of liability6 as of end 1"6 between A1D3 ? A5D8bn
0lus6 neCt couple of years at least Stee( business on do&n side o% industry cyc(e
Under law6 cannot pay dividend if fair EV of net worth less than "
Bhus6 recogni-ing liability of healthcare dividend paying capability could be
seriously affected
Conso(idated company would be better able to support the healthcare liability than
stand1a(one Steel company
."e Directors5 Decision
<ther issues to consider in possible restructuring decision:
>mmediate 0rospects for USX#s businesses ;ot clear and potentially very difficult
Stee( +rosects,
Steel Lroup Still (argest FintegratedG steel producer in US
>nvested heavily in 1continuous casting26 !'& produced via this method @Europe
Since 13'6 cut steel production capacity in half
(educed noD man hours per ton from 11 to 'D%
;ow one of (o&est cost steel producers in country
Steel industry still very competitive
;oD of competitors faced serious financial difficulties ) others operating in
bankrutcy
Steel prices declined in 1" ) eCpected to decline further in #1 with recession in
US
0ossible stri$e contract with union eCpires 9an 1 ;ot yet renegotiated
+rosects %or Energy,
<ne of larger oil ) gas companies in US
0rospects very subject to !o(ati(ity in world oil ) gas prices6 ) to <utcomes of its
various ex(oration and production activities
5M' of production do$estic
<verseas production mostly in ;orth Sea
;< eCploration or production in >ra+6 Nuwait or Saudi Lulf war period
.ompetitors sufferH