Why did Mittal Steel merge with Arcelor?

Creating the world’s largest steel company, Mittal Steel and Arcelor reached an agreement in
June 2006 to combine the two companies in a merger of equals. The terms of the transaction
were reviewed by the Boards of Arcelor and Mittal Steel which each recommended the
transaction to their shareholders. The final price paid by Mittal Steel valued Arcelor at €12.8
billion more than its stock market valuation at that time.
Arcelor and Mittal Steel both belonged to the global steel industry. However, they were
inherently different companies. While Mittal Steel was mainly a low-cost producer of lower-
end products, Arcelor had the most advanced plants in the industry and spent 10 times more
than Mittal Steel on R&D. Mittal Steel’s ownership of its iron ore supply was 43% versus 12%
average for the top global manufacturers, and the same for coal was 52%. Arcelor, on the other
hand, did not own substantial mining reserves. A few days after Mittal Steel announced plans
to take over Arcelor, CEO of Arcelor, Guy Dolle said: “Arcelor is producing aristocratic
perfume whilst Mittal is making plebeian eau de cologne”. He suggested there was no industrial
logic to the takeover plan. He even said he did not want his shareholders to be paid with the
Indian-born Mr Mittal's “monkey money”.
On the whole, steel producers around the world had posted significant economic losses for
decades. In the US, steel had persistently been most unprofitable of the major US industry
groups between 1978 and 1996. The pattern was repeated in most major mature markets across
the world. However, 2004 and 2005 were exceptions because of huge demand from a rising
Chinese economy, which had emerged as the biggest importer of steel worldwide. The Chinese
growth story was expected to continue in the short to middle term.
The prices of steel varied considerably across countries due to a host of reasons. These reasons
included difference in raw material prices, governmental tariffs, transport costs etc. Cyclicality
of global demand was also a major issue facing the industry.
Iron ore, for many years, was priced on the basis of international benchmarks, which were
negotiated annually. In contrast, steel had no global benchmark pricing mechanism. One driver
of the difference between iron ore and steel pricing was that the iron ore suppliers were much
more consolidated, and the major players treated the world as one market. Between 1994 and
2004, the cost of coal increased from €28 to €44 per ton while cost of iron ore went from €22
to €31 per ton. The prices of raw materials were expected to continuously rise in the near future.
The market for steel consisted of several thousand distinct products. Some of the major
products were flat rolled plates, or sheet and strip, (largely used by the automobile and
appliance sector), bars and wire rods (largely used in construction) and hollow pipes and tubes.
Flat sheet was by far the most important product, both because of volume as well as higher
value-add required in automotive and appliance sector. Price, quality and dependability were
considered the three most important buyer purchasing criteria, although it was difficult to get
qualified by major buyers such as automobile companies.
International trade in the steel industry was substantial – close to 40% of all steel production
was exported in some years – but close to one-half of it was intra-regional. In the past, there
had been many international merger and acquisition (M&A) activities in the steel industry.
However, Mittal Steel’s story was the most prolific. During 2004, out of all the M&A activity
in the steel industry in the record breaking year (€25.3 billion), Mittal Steel contributed 66%
(more than €14.3 billion) of the same by merger of International Steel Group (US), Ispat
International and LNM Holdings and acquisition of Kryvorizhstal (Ukraine). Interestingly, in
the Kryvorizhstal case, Arcelor and Mittal Steel had engaged in a bidding war leading to a final
price of $4.8 billion (versus the Ukranian government expected price of ~ $3 billion).
Mittal Steel was known to acquire loss making integrated steel firms across the world and
transforming their profitability through the use of shared best practices. It was known for its
discipline in deal-making, turnaround, and value creation processes. However, Mittal Steel had
till now largely focused on small, developing, previously communist ruled countries. These
countries’ steel firms had traditionally suffered from inefficient management systems. Arcelor
on the other hand presented a different challenge. Arcelor, many believed, had better
technological and management capabilities than Mittal Steel.
The principal strategic rationale that Mittal Steel had long offered for its international
expansion had to do with the importance of global scale and scope, broadly defined: according
to the company’s website, it was founded on the philosophy “that to be able to deliver the range
and quality of products customers demand the modern steel maker must have the scale and
worldwide presence to do so competitively.” The benefits of being big were supposed to
include risk-reduction as well. COO Malay Mukherjee noted that a company with one blast
furnace would have trouble shutting it in a downturn but that a company with 20 might be able
to idle one or two.

Appendix

Some parameters compared across top steel manufacturers in 2004

Top steel producers (2004)
Mittal Arcelor Nippon JFE POSCO Corus Nucor Thyssen Krupp
Crude Steel Production (m tonnes) 59 50.6 31.4 31.1 31.1 19.9 17.9 17.6
Revenue/Ton (€) 436 684 665 634 617 481 472 833
Implied Operating Cost/ Tonne (€) 339 611 569 553 480 448 395 762
Operating Income/Tonne (€) 97 72 96 81 137 32 76 72
Sources of expected cost synergies for ArcelorMittal as per Mittal Steel

Assume a 10% cost of capital.

Source: http://euacademic.org/uploadarticle/358.pdf

Raw material positions in 2004

Source: OECD 2005 Steel Outlook Report

Operating Costs/Tonne versus Output

1000
ThyssenKrupp
900
800
Arcelor
700 Nippon
JPE
600 US Steel POSCO
Corus
500 Nucor
Bao Steel
400 Mittal

300
200
100
0
0 10 20 30 40 50 60 70