PANKAJ GHEMAWAT RAVI MADHAVAN -DRAFTJANUARY 15, 2007 Mittal Steel in 2006: Changing the Global Steel Game On January 27, 2006, Laxmi Niwas Mittal (LNM) and his son, Aditya Mittal, Chairman & CEO and CFO respectively of Mittal Steel, prepared for the press conference at which they would announce Mittal Steel’s unsolicited $22.8 billion bid to acquire the European steelmaker Arcelor. Although Mittal Steel had been a prime mover behind the consolidation of the industry—and most participants and observers in 2006 seemed to accept the logic of consolidation—an offer for Arcelor was unlikely to have been anticipated by the industry. Arcelor had been created in 2001 by the merger of three European steelmakers—Usinor (France), Arbed (Luxembourg), and Aceralia (Spain)—that were themselves, in turn, the result of previous mergers in their respective countries. Mittal Steel and Arcelor were at that point the two largest and most global steel producers; it would have been far easier to imagine the two giants growing in parallel through other significant acquisitions. For example, World Steel Dynamics had sketched out a scenario in which Mittal Steel acquires the AngloDutch steelmaker Corus and Arcelor acquires ThyssenKrupp of Germany1. Yet, at the announcement of the offer on that winter day in London, LNM, described by the New York Times as having “never been bashful about his global ambitions2,” would present the combination of Mittal Steel and Arcelor as the next logical step in the evolution of the industry. “This is a great opportunity for us to take the steel industry to the next level. Our customers are becoming global; our suppliers are becoming global; everyone is looking for a stronger global player.”3 A torrent of deals The amount we will receive for this company [the Kryvorizhstal steel plant] will be 20 per cent higher than all the proceeds received in all the years of the Ukrainian privatization. — Ukrainian President Viktor Yushchenko4 I can say that the Ukrainian administration has been very lucky to receive this price. — Laxmi Mittal, Chairman of Mittal Steel, the winning bidder5 Arcelor will continue to seek to grow through strategically compelling acquisitions; however, management will not compromise shareholder value in the pursuit of this goal. — Guy Dollé, CEO of Arcelor, the losing bidder6 ________________________________________________________________________________________________________________ Professor Pankaj Ghemawat of IESE Business School and Professor Ravi Madhavan, of the University of Pittsburgh, prepared this case. This case was developed from published sources. Cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2009 . No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Pankaj Ghemawat. -DRAFT- Mittal Steel in 2006: Changing the Global Steel Game Barely 3 months had passed since Mittal Steel’s previous acquisition. On October 24, 2005, LNM had announced that Mittal Steel had won the bidding for Kryvorizhstal, Ukraine’s 10million tpy7 capacity steel plant, which produced one-fifth of the country’s steel output. Kryvorizhstal was a controversial privatization, having been sold in 2004 to former president Leonid Kuchma’s son-in-law and a business partner for around $800 million. The opposition, led by Viktor Yushchenko, called the sale a “theft” that gave away a very valuable industrial property and promised to annul it.8 After the Orange Revolution brought him to power, President Viktor Yuschenko kept that promise by organizing a second auction—despite resistance from the former owners who appealed to the European Court of Human Rights, mounting social skepticism about privatization because of past corruption, and a Parliamentary vote to halt the sale. The new government wanted to highlight the transparency of Ukraine’s new business culture to potential investors, and therefore arranged for the auction to be televised live, with President Yushchenko attending in person. Mittal Steel, the world’s largest steel company with 59 million tons of crude steel production in 2004, was an obvious bidder in the second auction: it had lost the first auction, in 2004, despite bidding $1.5 billion, or nearly twice as much as the winning partnership. The other competitors this time around were a consortium led by Arcelor, the world’s second largest steel producer with 51 million tons in crude steel production in 2004, and LLC-Smart Group, a local investor group reportedly controlled by a Russian businessman. LLC-Smart dropped out of the auction early on, leaving Mittal and Arcelor to go head-to-head. The $4.8 billion that Mittal ended up paying greatly exceeded expectations, with some reports suggesting that the Ukrainian government’s target price had been around $3 billion.9 The World Steel Industry10 In 2005, the global market for steel was estimated at around 998 million metric tons (mt).11 Although the market for steel comprised several thousand distinct products, they could largely be grouped into a few broad segments. Semifinished products were at least 8 inches thick and required further processing. Flat-rolling them yielded plates (more than 0.25 inches thick), or sheet and strip, thinner products that could be shipped in coils. Other kinds of products that could be formed from semifinished steel included bars and wire rods, that were even thinner; a wide variety of structural shapes that were used primarily in construction; and hollow pipes and tubes. Flat sheet was by far the most important of these segments, both because of the volumes and because it included the higher-value-added sheet steel for the automotive and appliance sectors. Other major customer groups included service centers and distributors, and the construction 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 the automobile companies. Higher price realizations typically reflected a focus on higher-end products, and tended to be accompanied by higher operating costs. From a technological perspective, there were three groups of steelmakers: integrated firms that produced steel by reducing iron ore, minimills that produced it by melting scrap, and specialty steelmakers that produced stainless steel and other special grades of steel for distinct submarkets and will not be considered further here. Integrated firms traditionally dominated the industry and followed a strategy of vertical integration, owning not only steel plants but also iron ore and coal mines, transportation networks, and downstream processing units. In recent decades, however, many 2 Mittal Steel in 2006: Changing the Global Steel Game -DRAFT- had reduced their holdings in upstream and downstream segments so as to focus on the core business of steelmaking. Minimills operated their scrap-based Electric Arc Furnaces (EAF) at much lower scales than integrated steelmakers’ blast furnaces, reducing their minimum efficient scale from millions of tons to several hundred thousand and their capital cost per ton of new capacity from $1000+ to the range of $200–$300. Minimills had historically had a significant cost advantage over integrated steelmakers, and had forced them out of low-end products, to the point where in the United States, the minimills held about 45% of the total market, but continued to face difficulties in meeting the exacting standards of automotive and appliance manufacturers. The constraints reflected, in part, minimills’ reliance on scrap steel as primary input: impurities in the scrap steel tended to reduce the quality of the finished steel and, furthermore, scrap prices had come under pressure even in markets where scrap had historically been abundant. In the 1970s, the new technology of Direct Reduced Iron (DRI) began to catch on—this process produced a scrap substitute from iron ore that could be used to feed the EAF. In its early years, DRI quality had been very variable, but had improved gradually, and was expected to eventually provide the same clean metallic feedstock for EAF as the blast furnace, but at a lower cost, and without scrap’s inherent price volatility and quality problems.12 On the whole, steel producers around the world had posted significant economic losses for decades. Thus, Marakon Associates, calculated that steel had persistently been the most unprofitable of the major U.S. industry groups between 1978 and 1996 (see Exhibit 1), although economic losses had since narrowed. The pattern was repeated in most other mature markets. Thus, Mittal Steel’s comparison of the return on invested capital (ROIC) and the weighted average cost of capital (WACC) of the 10 largest steel producers worldwide suggested narrower but still chronically negative spreads, with only the most recent year—2004—generating significant positive returns (see Exhibit 2). The reasons were various and included fragmentation, very high fixed costs and exit barriers, generally slow growth and induced excess capacity, limited product differentiation, intensified competition from minimills and imports as well as substitution threats (which included less-intensive use of steel as well as replacement by other materials), and the bargaining power of organized labor and large customers. Many observers in or interested in the steel industry thought that after some particularly bad years in the 1990s, steel industry stakeholders—producers, unions and governments in particular— had finally begun to move towards the end of the 1990s to bring about some much-needed rationalization through bankruptcy-linked closures and consolidations. However, demand growth had also taken a hand: after stagnating in the 700–800 million tpy range in the 1980s and the 1990s, consumption had steadily increased since 2000 toward the 1 billion tpy mark. But the very recent spike in industry profitability, in 2004, seemed to have more to do with China’s red-hot construction sector. China accounted for close to one-quarter of demand and, more importantly, most of the recent growth in demand (see Exhibit 3). Given the lags in building up domestic capacity to serve apparent domestic consumption growth rates that had often surpassed 20% in recent years, China had sucked in an enormous amount of imports. In particular, between spring 2003 and spring 2004, spot prices for a benchmark sheet product, basic hot-rolled band, had increased from less than $300/ton to nearly $500/ton in China, from $300/ton to slightly more than $500/ton in the European Union, and from $300/ton to closer to $600/ton in the United States.13 However, although Chinese demand continued to grow, prices had stabilized, signs of overbuilding were starting to appear in 2005, and academic experts predicted that Chinese capacity was likely to flood the world with cheap exports in all but the specialty grades.14 Longer-run demand forecasting exercises highlighted differences rather than similarities across regions. Thus, an analysis by Arcelor based on data through 2003 suggested that through 2010, 3 -DRAFT- Mittal Steel in 2006: Changing the Global Steel Game demand would stagnate in Japan, and grow at a 1% annual rate in the European Union, 2.5% in the United States (where demand in the base year of 2003 was particularly low), 4.1% in South America, 5.5% in China, and 6.5% in Asia excluding China and Japan.15 The steel industry presented a somewhat mixed picture along other dimensions of internationalization as well. 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 terms of prices rather than quantities, some increases in inter-regional integration had been apparent in recent years: according to calculations by Arcelor, the correlation of hot-rolled prices between the United States and the European Union had doubled from 37% over 1994–98 to 74% over 1998–02. Nonetheless, international price integration was expected to continue to be imperfect because of a variety of barriers to international trade. Transport costs were the most obvious natural barrier and were also subject to aggregate capacity constraints: thus, against the backdrop of a general boom in Chinese trade, the run-up in steel prices over 2003–4 had been accompanied by an escalation of the costs of ocean transportation to China, from $40/ton of steel to $60/ton. Other natural barriers included delivery lags and varied product preferences. Tariffs and other policy restraints on trade constituted the most obvious artificial barriers. While there had been significant reductions in average posted tariff levels over the previous decades, “temporary” countervailing duties, quotas, and other distortionary policies such as subsidization of domestic producers or bail-outs remained common. The general tendency of governments to support domestic producers reflected both concerns about preserving employment in a large sector with well-organized labor as well as the specifically “strategic” status that had historically been accorded to the steel industry. Steelmaking had long been considered a matter of national pride, as illustrated by the industry saw that the two major investments that were de rigueur for every newly independent nation were a national airline and a steel plant.16 As a result, 60% of the world’s steelmaking capacity was government-owned in the 1980s.17 Since then, much of this capacity had been privatized, especially in post-communist countries— part of a broader cross-industry privatization wave worldwide—and government-owned steel capacity had declined to 40% of the world total.18 These privatizations provided a basis for increased cross-border integration through foreign direct investment (FDI) instead of just trade. U.S. Steel’s acquisition of a steel plant in Kosice, Slovakia, supplied one example: the acquisition raised the share of non-U.S. production in the company’s total from virtually nothing to nearly 30%—and later helped keep the company afloat during difficult years at home. Arcelor, the European steel giant and the second largest steelmaker in the world was formed in 2002 when three formerly state-owned European steel companies from three different countries were combined: Aceralia (Spain), Arbed (Luxembourg), and Usilor (France). Arcelor also appeared, however, to be hedging its bets about inter-regional expansion: thus, it had formed an alliance with Nippon Steel of Japan, the fourth largest steelmaker in the world, to serve (high-end) global customers. By far the most dramatic example of growth by acquisition of (primarily) steelmakers being privatized, in terms of its geographic scope as well as absolute scale, was Mittal Steel, which had come from virtually nowhere to become the largest competitor in the steel industry with a strategy that emphasized acquisitions, particularly of steel mills that were being privatized. One perspective on the scale of Mittal’s M&A activities was provided by 2004, a record year for mergers and acquisitions in the steel industry as a whole, with a total of transactions worth $31.4 billion. Mittal Steel accounted for two-thirds of that with a two-stage transaction involving the $13.3 billion merger of LNM Holdings and Ispat International and the $4.5 billion acquisition of the International Steel 4 Mittal Steel in 2006: Changing the Global Steel Game -DRAFT- Group in the United States to create Mittal Steel (the top 2 steel deals of the year) as well as a number of smaller transactions.19 And while 2004 was an exceptional year, Mittal would clearly again top the 2005 transaction tables with its acquisition of Kryvorizhstal—as it had in most recent years. Exhibit 4 provides summary operating and financial data for Mittal Steel and its 9 largest competitors worldwide in 2004, and Exhibit 5 breaks out summary operating and financial for Mittal Steel by region over 2002–4. Exhibit 6 provides one industry consultant’s subjective summary assessment of Mittal’s competitive position relative to its largest competitors. The rest of this case describes Mittal Steel’s evolution over time, how it was managed and organized, and its vision as to how it would sustain superior performance in the future. Mittal Steel’s Evolution LNM’s father, Mohan Lal Mittal, had founded the Ispat Group—Ispat meant steel in Sanskrit—in Calcutta, India, to trade scrap metals.20 Upon graduating from college in 1970, LNM joined the family business and was involved in setting up a new steel plant in Calcutta before being asked to oversee the export business in South East Asia. In 1976, the elder Mr. Mittal had bought some land in Indonesia with the goal of building a steel mill there; however, he subsequently changed his mind, and dispatched LNM there with the charge of re-selling the land. When he arrived in Indonesia, however, LNM was struck by the prospects of imminent growth in the Indonesian economy, which would boost demand for steel; he successfully convinced his father to stick with the original plan of making steel there, and stayed on to take charge of the mill. However, the original idea of building a traditional scrap-based minimill did change under LNM, who had always worried that traditional minimills’ reliance on scrap steel as exclusive input would prove to be their Achilles’ heel. LNM decided to invest in a 65,000 tpy DRI (direct reduced iron) plant alongside the new minimill, even though DRI was a fledgling technology at the time that could not provide consistent quality levels. Over the years, as DRI technology improved and became more reliable, LNM’s trust in it as a viable alternative to scrap grew—indeed, he began to refer to his minimills as “integrated minimills,” i.e., mills that used electric arc furnaces but integrated backward into DRI production. By the late 1990s, one analyst described Ispat/Mittal’s lead in DRI as “virtually insurmountable for the foreseeable future,” given that DRI was complicated and hard to copy.21 As its steelmaking capacity was expanded, LNM’s Indonesian mill came to rely on external suppliers of DRI as well. One such supplier was Iscott, which was owned by the government of Trinidad and Tobago. Built in 1981 by the state at a cost of $460 million, Iscott was in severe financial trouble by 1988, with 25% capacity utilization, and weekly losses of $1 million since 1982. As a customer of Iscott’s, LNM was very familiar with its problems, but could also see the potential value that could be unlocked by better management. When the government of Trinidad & Tobago invited him to make a bid for the troubled plant, LNM had no hesitation in expressing interest. However, he did not have the funds to make an offer for outright purchase; instead, he suggested a 10-year lease at $11 million a year with the option to buy in the fifth year at an independently appraised price. The Trinidad government agreed, and LNM quickly embarked on his first turnaround. He brought in 55 DRI experts and managers from around the world, and pumped in nearly $10 million of new investment in the first three months. Production bottlenecks were remedied and quality rapidly improved; by the end of the first year, the operation made a small profit after paying for the lease. With viability regained, Caribbean Ispat was able to secure World Bank financing that allowed it to increase capacity by 50%. In May 1989, LNM acquired the plant for a price of $70 million. 5 -DRAFT- Mittal Steel in 2006: Changing the Global Steel Game The Trinidad experience taught Mittal that a SWAT team of managers and technology experts, along with a rapid investment program, could turn around such assets fairly quickly, even if the assets themselves had long lives. The next few acquisitions also focused on troubled state-owned steel plants using DRI/EAF technologies (see Exhibit 7 for a history of Ispat/Mittal’s major acquisitions and Exhibit 8 for a financial and operational history). The first, in Mexico, involved a 2.5 million ton steel mill that had cost $2.5 billion and had been started up in 1988, but was running at barely one-quarter of its capacity and losing $1 million per day. Mittal stepped in to run it, with the understanding that he would acquire it over time—which, having turned it around quickly, he did in January 1992, for $220 million. The large new plant in Mexico generated so much cash as to fund investments of comparable magnitude in state-owned DRI/EAF steelmakers in Canada and Germany in late 1994/early 1995. Roughly at that time, LNM and his father agreed to separate Ispat International, LNM’s operation, from Ispat Industries, the original family business in Calcutta.22 LNM moved his residence and his corporate office to London, registering the LNM group in Rotterdam. Also in 1995, he paid about $500 million for Kazakhstan’s Karmet mill, which had 6 million tons of truly integrated liquid steel capacity that came with not just blast furnaces but large iron ore and coal mines, power plants, and even some of the social infrastructure (e.g., trams and some schools) for a town with more than 100,000 inhabitants. Described by a Fortune magazine writer as a “Communist catastrophe,”23 the integrated complex employed 70,000 workers—making it Kazakhstan’s largest private employer— and produced low-quality steel for the Kazakh and Russian economies. The deal, LNM’s largest to date, won great attention, not all of it favorable. Robert Jones, the steel editor at Metal Bulletin was quoted as saying later: “When he went to Kazakhstan, I thought either he was nuts, or saw things very differently.”24 What Mittal saw at Karmet were very low labor costs ($250–$300/month), large, rich mineral deposits, location on a railway grid, a booming market in China, whose western border was just 400 miles away and intense personal interest by Kazakh President Nazarbayev, who had started his career as an engineer at the company, in ensuring that the privatization worked. An injection of working capital helped get the plant off the barter system to which it had been reduced as well as funding the payments of back wages to workers, significant investments were made to debottleneck and expand output, otherwise reduce costs, and upgrade the product mix, and new markets in China and Iran were developed (35% and 15% of 2003 sales, respectively). According to Mittal, it invested $700 million on top of the initial purchase price in Karmet by 2003 (some of it financed by development finance institutions). That year, Karmet shipped 3.75 million tons of steel products and reported generating $1,189 million in revenues while having pushed operating costs down to the amazingly low level of $126/ton.a And while mass layoffs had been ruled out by the terms of the deal, Karmet’s headcount had fallen gradually, to just over 50,000 employees. In 1997, Ispat International, comprising some of LNM’s steel assets, went public in an IPO but others, including the Karmet complex, were retained by his privately-held vehicle, LNM Holdings. A series of other acquisitions followed, initially through Ispat International but starting in 2001 via LNM Holdings, in apparent breach of an undertaking at the time of Ispat’s IPO that it would carry out all future acquisitions. In July 1998, in another transaction that dwarfed all previous ones, Ispat acquired Inland Steel in the United States, with 4 million tons of capacity, for $1.4 billion plus a planned $800 million in additional investment. While this acquisition brought Ispat higher-end business in and skills associated with the automotive sector in particular, its results were considered a The comparable total revenue and operating cost figures for 2002 were $869 million and $114/ton respective. Figures for 2004 were unavailable, but steel prices around the world were generally $100–$200 higher in 2004 than in 2003. 6 Mittal Steel in 2006: Changing the Global Steel Game -DRAFT- mixed. Part of the problem was that rivals such as Bethlehem managed to lighten the load of pensions and other liabilities through bankruptcy-based reorganizations. LNM Holdings went back on the acquisition trail in 2001, and looked outside the Americas: it focused on East Europe, with large acquisitions in Romania, the Czech Republic, and Poland, and smaller ones in Macedonia and Bosnia, but also made large acquisitions in Algeria and, especially, South Africa. One of the Romanian acquisitions also brought in its wake some unwelcome controversy. A few months after LNM Holding’s acquisition of Sidex, it was revealed that British Prime Minister Tony Blair had written a letter to his Romanian counterpart, Adrian Nastase, in support of LNM’s bid. According to some reports, Blair’s letter helped “trump” a bid by Usinor of France (one of Arcelor’s predecessors).25 This issue became a major political controversy in the United Kingdom, especially when it turned out that LNM had made a contribution worth $180,000 to Tony Blair’s Labor Party during the previous month. The Blair government denied any impropriety in the matter, arguing that the whole story began with a suggestion from the British Ambassador to Romania that they should support this British bid. This opened up a new area of debate, about whether LNM Holdings was indeed a British entity: it was registered in the Netherlands Antilles, had only 50 employees in London (out of a worldwide total of 100,000 across LNM and Ispat), and LNM Group turnover in the United Kingdom was not quite 2% of worldwide revenues. While declining to be formally interviewed, LNM was reportedly outraged by the negative press, insisting that: I have absolutely nothing to hide. I have a very strong British identity. I have British companies with a turnover of nearly £40m a year. What is more, I have settled here and raised my family here. I pay tax here. It’s true I run a multinational group but I have no business interests in India. So please tell me, what should my identity be?26 Ispat International and LNM Holdings were folded back together in the course of the merger with Wilbur Ross’s International Steel Group (ISG) in the United States, announced in 2004 and completed in 2005, that created the world’s largest steelmaker by volume. Wilbur Ross, a veteran investor in distressed properties, had assembled ISG in 2002 out of the bankrupt steelmaker LTV and other U.S. steelmakers. Taking advantage of bankruptcy regulations, ISG purchased the assets while only assuming specific liabilities—in particular, the buyer would be free of the legacy costs of pension liabilities and other post-employment benefits such as retiree healthcare. (The federal agency Pension Benefit Guaranty Corporation took over the pension liabilities, although not the retiree healthcare programs.) By 2004, ISG was one of the largest integrated steel producers in North America. ISG’s acquisition for $4.5 billion by what became Mittal Steel richly rewarded its investors: ISG shares, which had been trading at less than $30, were exchanged for $21 in cash and $21 in Mittal Steel shares. Concurrently, LNM Holdings was absorbed, along with Ispat International, into a publiclylisted entity, Mittal Steel. This involved the payment of a $2 billion dividend to the sellers of LNM Holdings. The Mittal family continued to own 88% of the shares of the merged entity. Management and Organization Mittal Steel emphasized discipline in the deal-making, turnaround, and value creation processes. Over the years, Mittal appeared to have introduced a number of managerial practices that were novel to the steel industry—aided by LNM’s injection of non-steel mindsets into his executive team, as illustrated by his choice of Roeland Baan from oil major Shell to run Mittal Steel Europe. The overall approach had been characterized as resembling that of a private equity firm more than a traditional steelmaker.27 7 -DRAFT- Mittal Steel in 2006: Changing the Global Steel Game Dealmaking Mittal focused its acquisitions on the steel industry (and stages upstream), despite the fact that Business Week had suggested that “the Mittal Method is less about steel than about smart practices.”28 Promising targets were subject to a rigorous due diligence process. A small team, highly experienced in steelmaking as well as dealmaking, would visit the company to assess the seller’s expectations and the viability of the assets. Unless the target demonstrated reliable labor and energy supply, Mittal would not proceed. The due diligence process focused, in addition, on people. In the words of, Johannes Sittard, a former COO, “We use due diligence to learn about the people who are running the company and to convince them that joining Ispat is an opportunity for them to grow. These conversations provide information you will never find in a data room.”29 In the next stage of this gated approach, Mittal Steel worked with the target’s management to develop a five-year business plan to provide an acceptable ROI. The deal team was drawn from a core team of 12–14 London-based professionals who had mostly worked together since 1991 and therefore knew each other well. The deal team managers developed a document that detailed the investment thesis and the strategic options; if the deal was approved, this document became the turnaround roadmap.30 And since the deal team managers (from Mittal Steel) knew that they might end up running the acquired unit, they had an incentive to remain realistic with respect to the assumptions made in their projections. Another noteworthy aspect of Mittal’s approach was a patient attitude to deal-making that emphasized a slow but steady build-up of credibility and relationships that often started well before any acquisition and could make Mittal the preferred suitor when a deal was near. Its first two acquisitions, in Trinidad and Mexico, fit this pattern as two relatively large recent ones, in South Africa and China. In 2002, Mittal Steel took a 35% stake in South Africa’s Iscor, agreeing to supply it with technology and services as well as to help support other South African government policies.31 Two years later, Mittal assumed full control. Mittal’s recent investment in China seemed to be following a similar sequence: a 37% stake in Hunan Valin Steel Tube & Wire Co. was obtained just before the Chinese government declared in a new policy that foreign control of a steelmaker would not be permitted “in principle.” Mittal Steel was hopeful that this restriction would be relaxed over time. In the words of Aditya Mittal, LNM’s son as well as Mittal Steel’s president and CFO, “We want to demonstrate to the Chinese government that we can be a responsible partner. Once they have seen how we behave and how we are improving the company, I’m sure there will be more opportunities for us.”32 Mittal sought to add value to this partnership through a variety of mechanisms, ranging from leveraging global purchasing clout to get Valin better iron ore prices to starting to give some Valin executives two-year postings at other Mittal Steel plants around the world. Mittal also promised to license technology for some of its best products, a key Chinese requirement, and donated $5 million to a university in Valin’s home town. But even while aggressively courting Valin in 2005, Mittal Steel had in place a nonbinding memorandum for a $100 million plant in the Northeast, which was being “evaluated.” Aditya Mittal was quoted as saying, “Valin is not exclusive. We see the possibility of other partners.”33 Turnaround and Integration Once the deal had closed formally, it was time to move on to the difficult task of turning around the acquired operation. Mittal Steel’s managers believed that they had established a solid track record at improving the efficiency of previously poorly managed steel mills (see Exhibit 9 for illustrative 8 Mittal Steel in 2006: Changing the Global Steel Game -DRAFT- cost reduction numbers). The turnaround team would oversee this part of the process as well, spending six months or more in each location, before handing over the stabilized operation to a new set of managers and moving on to the next acquisition—which gave it a broad understanding of the range of problems involved in steel turnarounds. Thus, Augustine Kochuparampil, CFO of Mittal Steel Poland, remarked that half the issues were similar across turnaround situations.34 In particular, the problems of previously state-run steel companies were typically concentrated in finance or marketing, not in technical or engineering areas. What Business Week termed the Mittal Method had six key steps:35 1. Mittal would replace most incumbent managers with his own executives, charged with rapidly stabilizing the company’s operations, except where management of the acquired company was willing to commit to and seemed capable of meeting very aggressive targets, set by benchmarking to international rather than local standards. 2. A substantial cash infusion would be made, and credit with suppliers re-established to ensure a steady flow of raw materials. In Poland, for example, the new CFO personally called on angry creditors and suppliers to regain their confidence. Eliminating barter deals, which, while common in many state-run economies, engender corruption and negatively impact cash flow, was another priority. 3. Once the commercial operations are stabilized, attention would turn to technical matters. Mittal Steel’s top engineers would be brought in to improve operations across the board, including reworking maintenance schedules to reduce downtime. 4. In terms of products and marketing, production was typically shifted to higher-value items, and there was an emphasis on selling to end-users rather than to middlemen. 5. In the next step, integration involved, first, connection of the new plant to global systems and, over a longer time frame, to the global network. 6. The final step, also often implemented over a longer time frame, was to prune the acquired assets, getting rid of non-core operations, as well as gradually cutting back on staff, often through buyout programs. Overall, there was a relentless emphasis on rapid, demonstrable results: on stabilizing operations and achieving profitability within months, rather than years. All of this took place in environments with which most Mittal managers, many of them originally from India, were unfamiliar. Among the executive team, the number of interpreters employed in a unit was an informal measure of how well the integration was going—the fewer the number of interpreters, the better.36 Thus, Mittal Steel Poland’s CFO, Kochuparampil tried to get all English-speaking managers to learn Polish, himself putting in two hours of lessons every weekend.37 Systematic efforts to learn from each acquisition were also part of the process; as Johannes Sittard put it: “We are a small team, and acquisitions are much of what we do, so post-acquisition assessments are a permanent part of our conversations.”38 Ongoing Value Creation The principal focus in the dealmaking and turnaround stages fell on one-time value creation, principally by “importing modern management techniques into previously inefficient state-run mills.”39 That left open the question of how, once each individual plant was running smoothly and profitably, Mittal might be able to add further value. Or as some observers put it, how was Mittal 9 -DRAFT- Mittal Steel in 2006: Changing the Global Steel Game going to progress beyond a private equity business model into becoming the world’s first true steel multinational: a company that added value on an ongoing basis by coordinating its operations across individual countries? Regional integration was one obvious answer: grouping operations in adjacent countries enabled them to extract better terms from suppliers of iron ore, coal, and power, helped ensure that they did not compete for the same customers, and enhanced the reliability of supply.40 The concentration of acquisitions by LNM Holdings in Eastern Europe between 2001 and 2004 had been premised on just such logic, and had started to be acted upon. Thus, after the acquisition of Polskie Huty Stali in Poland, LNM announced a common senior management team for the plants in Poland and the Czech Republic which, in addition to being in neighboring countries, relied on common iron ore sources from the Ukraine. Coordination at the global level was complicated by the 25-nation global footprint. Nevertheless, Mittal Steel had installed some coordination and communication tools that were beginning to attract broader attention, such as e-rooms: on line “war rooms” for managers worldwide to post problems and solutions. Even more important were regular conference calls, which would last for several hours.41 Every Monday, as many as 120 line managers from around the world would join Mittal’s top executives in London and discuss (and share information about) prices, customer issues, and performance. Malay Mukherjee, Mittal Steel’s COO, explained the rationale: We created the Monday call seven or eight years ago. We have 20 sites, and you have the manager taking the call and five or six of his people listening in. We made it the first day of the working week so everyone has to be fully prepared, even on events that have happened over the weekend.42 The conference call on Monday was followed by another on Tuesday that focused on operational problems—production, quality, maintenance, bottlenecks, etc. A forerunner of these calls was the Knowledge Integration Program (KIP), an early Mittal initiative to “keep stirring the whole organization.”43 The KIP involved twice-yearly meetings in which (operating and staff) functional representatives from all Mittal Steel plants would meet for 2–4 days to review performance against targets, highlight accomplishments and setbacks, discuss technical issues of common interest, update each other on developments in their respective areas, and jointly commit to future targets44 The venue would rotate among the various plants, and the agenda was set in consultation with the functional heads. Apart from being an informational forum, the KIP meetings facilitated the creation and nurturing of interpersonal networks. As one manager from Mexico put it: “If I have a question, I don’t have to wait until the next KIP meeting. I can make a phone call or send an email to Canada or Trinidad. I probably exchange at least one email every week with them.”45 An expanded Knowledge Management Program (KMP) also grew up out of KIP. In 2004, nearly 25 meetings, with over 500 managers attending, were held worldwide under the KMP.46 Of course, LNM himself served as a key coordinator: he routinely logged over 350,000 miles a year of travel. And yet, some of his executives were beginning to say that they didn’t see as much of him as they used to earlier.47 The personal as well as organizational costs of coordinating an increasingly far-flung operation were clearly multiplying. This sharpened the question of whether Mittal Steel was worth more than the sum of its parts once each piece had been restructured. 10 Mittal Steel in 2006: Changing the Global Steel Game -DRAFT- Strategic Vision While LNM had reason to be proud of his team’s track record at turnarounds, he knew that Mittal Steel had reached an important turning point in its evolution. Before he bought ISG in 2004, almost 75% of his then 40-million ton capacity was the result of privatization-related acquisitions of inefficient Soviet-era plants48 Overwhelming though their problems were, turning around such derelict operations was, by now, fairly straightforward to a team that had done it may times already. However, ISG was a different story altogether: Mittal had bought it from another master at turnarounds, Wilbur Ross, and it was not clear how much more stand-alone efficiencies could be squeezed out of ISG49. The 42% premium paid for ISG also raised the bar for transaction returns. Not surprisingly, some observers were privately beginning to wonder if Mittal had run out of “lowhanging fruit,” i.e., run out of quick-hit opportunities to create value through restructuring— speculation that was fuelled both by recent winning bids (e.g., Kryvorizhstal) and losing bids (e.g., Erdemir in Turkey where, despite owning 8% of the company, Mittal found itself beaten by a rival willing to bid more than $1,170/ton of steel production). Global Consolidation The principal strategic rationale that Mittal 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.”50 The benefits of being big were supposed to include risk-reduction as well as the improvement of the poor industry structure described in the “World Steel Industry” section of this case. Thus, according to LNM, “Consolidation of our industry has already started, but it is important that it continues so that we can move away from being seen as a volatile and erratic sector.” 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.51 He also provided some other indications of the role that consolidation might play in increasing industry attractiveness by increasing vertical bargaining power: Iron ore has for many years had pricing set on the basis of international benchmarks, which have been negotiated annually. In contrast, steel has no global benchmark pricing mechanism…One driver of the difference between iron ore and steel pricing is that the iron ore suppliers are much more consolidated and the major players treat the world as one market…The more fragmented a market, the less transparency and the greater the likelihood of poor capacity management.”52 Despite initial skepticism, there were some indications that other major steelmakers were beginning to buy into the logic of global consolidation. As Guy Dollé, CEO of Arcelor, who was broadly supportive, noted, “Mittal has had a vision for the industry that goes back a long way, well before the majority of his peers.”53 Support for this point of view derived from the fact that Mittal itself had boosted its share of global steel output from less than 1% in 1995 to 6% by 2004 as well as helping increase the share accounted by the top 5 steel producers from 13%—where it had more or less stagnated since 1980—to nearly 20%. Looking forward, LNM had increased the concentration levels associated with his “global consolidation” vision: while he had originally envisioned a handful of steelmakers with 50–60 million 11 -DRAFT- Mittal Steel in 2006: Changing the Global Steel Game tonnes of capacity each, as Mittal Steel grew past that level, his vision had shifted to an industry with 5–6 megamajors with 80–100 million tonnes of capacity each. And as he was fond of pointing out, Mittal Steel intended to be the first to get there. Vertical Integration Mittal Steel had always paid considerable attention to upstream inputs, as evidenced by its involvement from the beginning in the development of DRI as a substitute for scrap. But vertical integration had recently become far more visible in the company’s pronouncements about its strategy, partly because of the raw material price increases experienced by the steel industry in the course of the recent boom: between 1994 and 2004, the cost of coal increased from about $35 to $55 per ton, the cost of natural gas went from $90 to $160 per ton, and the cost of iron ore went from $27 to $38 per ton.54 Against this backdrop of high prices, LNM had recently begun to signal the need for “re-integrating” the industry vertically. In a May 2005 presentation to investors, Mittal Steel provided numbers suggesting a unique raw materials integration position relative to its peers—Mittal Steel’s iron ore integration level was 43% versus 12% average for the top global producers, and coal integration level was 52% versus a 1% average for the peer group (see Exhibit 10). Looking at the country level rather than at the company level seemed to suggest that such uniqueness might indeed be very valuable. Thus, Mittal Steel’s cross-country analyses indicated that variations in raw materials costs were key drivers of variation in steelmaking costs (see Exhibit 11). LNM also had a general sense that raw material considerations actually were beginning to drive steel firms’ strategies in ways that were unprecedented. Much of the world’s iron ore came from Brazil, India, and Australia. As economic development gathered pace, many of the traditional supplier nations were beginning to want to add more value at home, i.e., to beef up local steelmaking rather than export most of their iron ore. For instance, the ex-Soviet CIS nations held almost 34% of the world’s iron ore reserves, but accounted for only 10% of world steel production. In India, which was estimated to have significant reserves of high quality iron ore (5.3% of world reserves), but only produced about 36 mmt of steel, the government was negotiating with several steelmakers in parallel (including Mittal Steel and South Korea’s Posco) to build multiple 12 million ton capacity steel plants, with mineral rights being one of the key determining variables. Similarly, China’s steel producers were venturing abroad in a purposeful search for secure raw material suppliers. LNM noted that the purchase of Kryvorizhstal, in the Ukraine, could at least partially be justified in such terms. Kryvorizhstal was located within a large iron ore mine complex with over a billion tonnes of iron ore reserves. The plant was also almost fully self-sufficient in coke requirements. Thus, access to low-cost captive raw material sources was assured and, upon closing the acquisition, Mittal Steel would become the world’s fourth largest mining company if company-wide captive mining operations were added up. In addition, of course, there were the debottlenecking opportunities implied by imbalances and underutililized capacity at different vertical stages: although Kryvorizhstal’s crude steel capacity was 10 million tpy, it had a rolling capacity of only 6 million tpy and was currently rolling only 4 million tpy of 7.6 million tpy production level into finished steel; the rest was turned into less attractively priced “re-bar” (reinforcing bars) for construction and other markets. Mittal Steel also estimated initial synergies in the region of $206 million by about 2007, spread equally between marketing and purchasing, and the possibility of improving labor productivity at the rate of 5% per year up to 2010. One of the open questions that LNM had to deal with was about the value of vertical integration: Not all steel industry leaders were convinced of the merits of vertical integration. Thus, although Arcelor had secured the position of the leading producer in Brazil and was also focused on Russia, 12 Mittal Steel in 2006: Changing the Global Steel Game -DRAFT- India, and China (it planned to build up these four countries to more than 50% of its sales), it was dubious about vertical integration per se. In the words of CEO Guy Dollé, For steelmakers, it is worth[while] to distinguish access to raw materials from ownership of mines. One can, as we do at Arcelor, have a good and stable delivery of raw materials without owning the mines. This mining business faces much higher capital intensity than steel industry, and the business models are different. There is no need to increase the load of the steel vessel. There is no economic advantage to be integrated, unless transferring results from upstream to downstream. Arcelor’s own country-level analyses pointed to workforce costs being the largest drivers of variation in steelmaking costs (see Exhibit 12). Such skepticism was understandable since the steel industry had gone through previous cycles of vertical integration and de-integration. For example, in 2001, U.S. Steel had famously reversed a century of vertical integration by selling off many of its iron ore holdings. Moreover, LNM was aware that conventional wisdom held that vertical integration through financial ownership did not make much sense as a response to high input prices. Yet LNM worried that the problem might not reflect just a transient hike in raw material prices. Upon analysis, the steel industry’s bargaining position vis-à-vis its raw material suppliers seemed to him almost as disadvantaged as its bargaining position vis-à-vis its automotive customers. Thus, the top 5 iron ore producers accounted for over 40% of iron ore, while the top 5 steelmakers accounted for less than 20% of the market55 If this was a permanent problem, vertical integration seemed to be the obvious solution, at least to him. However, he needed to consider carefully how to craft his message to investors and analysts. Girding for the fight ahead It was clear, however, that the implications of the Kryvorizhstal acquisition would pale in comparison to the hostile bid that was about to be announced. LNM had approached Arcelor’s chief executive, Guy Dollé, on January 13—at dinner in Mittal’s palatial London home—with a proposal for a friendly deal, which was rebuffed. Mr. Dolle “saw difficulties with the plan.” Subsequently, Mr. Dolle canceled their next meeting and then did not return his phone call.56 Moreover, although Arcelor shareholders were mainly institutions—who were in general quite willing to swap shares at the right price—its ownership and employment stakes were diffused through Luxembourg, France and Belgium. Indeed, some French officials showed concern right away, saying they heard the surprise news on the morning of January 27, with no prior warning.57 Mittal Steel’s investment ratings could be adversely affected if it ended up paying too much for Arcelor. A Fitch Ratings note later pointed out that while Mittal’s ratings were high for the steel industry, “there are numerous risks surrounding the acquisition plans, including the high likelihood the price will need to be raised.”58 If a higher price had to be paid, it was not clear how much additional money Mittal Steel would be able to raise. The initial offer was based on a €5 billion bank loan put together by Goldman Sachs and Citigroup, and the company would have $14 billion in debt if the deal went through59. Finally, there was the issue of Dofasco, the Canadian steelmaker that Arcelor had recently acquired after beating out ThyssenKrupp in a bidding competition. Given that Mittal Steel already had a high market share in North America, the combination would almost certainly face anti-trust hurdles in the US and Canada. One solution would be to sell Dofasco upon the completion of the proposed merger. At the press conference announcing the bid for Arcelor, it was revealed that LNM had called Ekkehard Schulz, ThyssenKrupp’s chief executive, on Tuesday, January 24—after learning that Arcelor had won the Dofasco bid—to offer Dofasco to Thyssen for 68 Canadian dollars a share (as against the 71 Canadian dollars that Arcelor had paid), assuming that Mittal gains control of 13 -DRAFT- Mittal Steel in 2006: Changing the Global Steel Game Arcelor—which was by no means a certainty. Whatever the eventual outcome, the next few months were sure to be interesting. 14 Mittal Steel in 2006: Changing the Global Steel Game Exhibit 1 -DRAFT- Value Line Industry Groups ROE-Ke Spread Toiletries/Cosmetics Drug Soft Drink 20% 15% Tobacco Food Processing Household Products Electrical Equipment Financial Services Specialty Chemicals Newspaper Integrated Petroleum Electric Utility - East Bank Retail Store Telecom 10% 5% 0% (5%) (10%) (15%) 0 100 200 300 Tire & Rubber Electric Utility - Central Medical Services Machinery Auto & Truck Computer & Peripheral Paper & Forest Air Transport Average Invested Equity ($B) Steel 400 500 600 700 800 900 1,000 1,100 1,200 1,300 Source: Compustat, Value Line, and Marakon Associates analysis, as reproduced in Ghemawat, Strategy and the Business Landscape, 1999. Exhibit 2 Top 10 Steel Producers’ Return on Invested Capital (ROIC) and Weighted Average Cost of Capital (WACC) 30 25 ROIC WACC Percent 20 15 10 5 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Source: Mittal Steel Fact Book 2004. 15 DRAFT Exhibit 3 Apparent Steel Consumption Growth Rates (year-on-year changes) Hot-Rolled Band: China Hot-Rolled Band: Rest of World Long Products: China Long Products: Rest of World Source: Peter F. Marcus and Karlis M. Kirsis, “Chinese Steel: Facts and Forecasts, 2002-2010,” World Steel Dynamics, April 2004, p. 18. -16- Mittal Steel in 2005: Changing the Global Steel Game Exhibit 4 DRAFT Top 10 Steel Producers, 2004 Crude steel production (m tonnes) Revenues/ton ($) Implied operating costs/ton ($) Operating income/ton ($) Mittal 59 542 421 121 Arcelor 50.6 849 759 90 Nippon 31.4 826 707 119 JFE 31.1 787 687 100 POSCO 31.1 766 596 170 Crude steel production (m tonnes) Revenues/ton ($) Implied operating costs/ton ($) Operating income/ton ($) Bao Steel 21.4 609 464 145 U.S. Steel 20.8 652 579 73 Corus 19.9 597 557 40 Nucor 17.9 586 491 95 Thyssen Krupp 17.6 1035 946 89 Source: Mittal Steel. Exhibit 5 Mittal Steel’s Operations by Region, 2002–4 Crude steel production (m tonnes) Revenues/ton ($) Implied operating costs/ton ($) Operating income/ton ($) Americas 2002 2003 2004 10.7 10.6 28.2 356 383 543 343 370 412 13 13 131 Europe 2002 2003 8.2 10.8 263 353 262 324 1 29 2004 17.6 562 450 112 Asia/Africa 2002 2003 2004 5.9 6.0 13.2 251 382 581 170 264 399 81 118 182 Source: Mittal Steel. 17 DRAFT Exhibit 6 -18- April 2004 Positioning of 10 World-Class Steelmakers by Factor Weight LNM Group† POSCO S.K. 31 29 Country Annual Steel Shipments (million tonnes) Factor Cash operating costs Profitability in 2000-2003+A9 Balance sheet Dominance country/region Domestic market growth Harnessing technological revolution Access to outside funds Cost-cutting efforts Downstream businesses Environment and safety Expanding capacity Iron ore and coking coal mines Liabilities for retired workers Location to procure raw materials Alliances, mergers, acquisitions and JVs "Pricing Power" with large buyers Product quality Skilled and productive workforce Stock market performance (3-year) Threat from nearby competitors Weight 11% 8% 7% 7% 6% 5% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 6 5 3 6 6 5 4 10 3 9 7 4 4 5 10 6 5 6 5 5 9 10 9 10 6 9 10 6 6 9 4 3 7 8 8 10 10 10 7 8 Nippon Steel JFE Japan Japan 26 23 6 3 5 7 2 7 7 9 10 9 1 3 4 8 9 8 10 10 5 7 6 3 3 6 2 7 6 10 9 9 1 2 4 8 10 8 10 10 5 7 U.S. Steel USA 18 4 2 5 5 2 5 4 8 3 9 2 7 5 7 10 5 8 8 9 5 Thyssen/Krupp Nucor ISG Bao-Steel Anshan Steel Avg. Germany USA USA China China 16 15 14 11 10 19.3 4 4 4 4 3 7 5 7 7 9 1 2 6 5 9 6 9 9 3 4 1 = least favorable* 10 = most favorable* * Many of these ratings are subjective and some are duplicative. Plants in many countries, includes Ispat International. † Source: Adapted from Peter F. Marcus and Karlis M. Kirsis, “Chinese Steel: Facts and Forecasts, 2002-2010,” World Steel Dynamics, April 2004, p. 13–14. 5 6 10 5 2 10 10 6 9 9 10 10 6 10 3 6 10 6 4 7 3 8 5 2 5 8 8 2 9 3 4 10 5 10 5 7 8 6 5 8 10 8 7 10 7 9 7 2 9 8 4 8 7 9 8 8 7 7 5 7 6 5 4 10 7 7 9 2 9 10 6 6 7 5 4 5 6 9 4 6.2 5.2 6.0 5.9 4.5 6.9 7.0 8.0 5.3 9.0 4.7 3.9 6.4 6.6 9.0 6.3 7.8 8.4 6.2 5.4 DRAFT Exhibit 7 History of Mittal Steel Acquisitions 1 ID # Acquisition (Current name) 1 Trinidad (Mittal Steel Point Lisas) Additional Investment, Planned Ownership Acquisition Price or Actual (USD Share Million) Year (USD Million) May-89 100% 70 413 Crude Steel Output at 2004 Crude Steel Acquisition* Capacity* 0.36 1.09 2 Sibalsa (Mittal Steel Lazaro Cardenas) 100% 220 525 0.48 3.63 3.63 3 Sidbec ( Mittal Steel Canada) 4 Hamburger (Mittal Steel Hamburg) 5 Karmet (Mittal Steel Termitau) 6 Irish Steel (Irish Ispat, shut down in 2001) Canada Germany Kazakhstan Ireland EAF and DRI technologies Ispat EAF and DRI technologies; purchased from IHSW Ispat/ LNM Integrated (blast furnace) technology LNM Holdings Purchased from the Irish Government; shut down in 2001 due to poor prospIspat of Irish market for steel and inability (due to trade union resistance) to impl necessary cost reduction EAF and DRI technologies; purchased from Thyssen Stahl AG Ispat Aug-94 Jan-95 Nov-95 May-96 100% 100% 100% 100% 186 45 500 51 193 95 500 30 1.18 0.85 2.30 0.45 1.63 Undetermined 4.72 N. A. 1.45 0.86 4.64 N. A Oct-97 100% 78 1.36 Undetermined 1.27 2 Integrated (blast furnace) and EAF technologies Ispat International EAF and DRI technologies Ispat International Integrated (blast furnace) technology LNM Holdings Integrated (blast furnace) and EAF technologies LNM Holdings Integrated (blast furnace) technology LNM Holdings Downstream operations only (Tubes manufacturer) LNM Holdings Downstream operations only (Pipe manufacturer) LNM Holdings Integrated (blast furnace) technology Downstream operations only (Hot rolling and Cold rolling mills) EAF technology LNM Holdings Integrated (blast furnace) and EAF technologies LNM Holdings Integrated (blast furnace) and EAF technologies LNM Holdings Integrated (blast furnace) and EAF technologies Mittal Steel Hunan Valin is one of the largest steelmakers in China Mittal Steel Integrated (blast furnace) technology; significant coal and iron ore reserves Mittal Steel (More than 900M tonnes of iron ore reserves) Jul-98 Jul-99 Jul-01 Oct-01 Jan-03 Jul-03 Dec-03 Mar-04 Mar-04 Apr-04 Jun-04 Dec-04 Apr-05 Sep-05 Oct-05 100% 100% 99% 70% 76% 71% 70% 97% 83% 81% 50.10% 100% 100% 36.67% 93.02% 4.81 1.27 2.72 0.83 2.54 N.A. N.A. 5.44 N.A. 0.68 6.43 0.18 14.15 6.05 6.99 5.91 Undetermined 6.40 1.80 3.30 N. A. N.A. 7.60 N. A. 0.54 8.37 1.22 20.87 7.71 9.07 5.64 1.09 4.68 1.01 3.21 N. A N.A 5.59 N. A 0.29 6.88 0.07 16.15 6.05 6.99 59.07 83.87 70.31 7 Rurhort & Hochfield (Mittal Steel Rurhort & Mittal Steel Hochfield) Germany USA France Romania Algeria Czech Republic Romania Romania Poland Macedonia Romania South Africa Bosnia USA China Ukraine 88 1399 107 500 Undetermined 549 1.13 16 532.85 Undetermined 54 1708 178 4500 922 5151 811.5 57 351 Undetermined 356 Undetermined 72 Undetermined Undetermined Undetermined Undetermined 135 Undetermined Undetermined Undetermined TOTAL * ( Million Metric Tonnes) List of acquisitions from Mittal Steel Fact Book 2004, "Company History," p. 31, updated from other company sources and news reports in October-November 2005. Ispat International was floated in 1997; prior to that, the acquisition vehicles appear to have been locally established companies owned by LNM. After 1997, the acquisition vehicles were either LNM Holdings, a private company, or Ispat istedInt'l, company. a publicly Balance sheet information pertains to Ispat International or, after 2004, to Mittal Steel. LNM debt and equity information is not publicly available. 2 3 2004 Crude Steel Output* 0.82 Country Description Acquiring Entity Trinidad & Tobago Electric Arc Furnace (EAF) and Direct Reduced Iron (DRI) technologies; Caribbean Ispat previously leased from government of Trinidad & Tobago Mexico EAF and DRI technologies Caribbean Ispat/ LNM Jan-92 8 Inland Steel Company (Mittal Steel USA) 9 Unimetal (Mittal Steel Gandrange) 10 Sidex (Mittal Steel Galati) 11 Alfasid (Mittal Steel Annaba) 12 Nova Hut (Mittal Steel Ostrava) 13 Tepro (Mittal Steel Iasi) 14 Petrotub Roman (Mittal Steel Roman) 15 Polskie Huty Stali (Mittal Steel Poland) 16 Balkan Steel (Mittal Steel Skopje) 17 Sidergica Hunedoara (Mittal Steel Hunedoara) 18 Iscor (Mittal Steel South Africa) 19 BH Steel (Mittal Steel Zenica) 20 International Steel Group (Mittal Steel USA) 21 Hunan Valin Steel Tube & Wire Ltd. 22 Kyvorizhstal 1 -19- DRAFT Exhibit 8 Ispat/Mittal Financial and Operating History Shipments (million MT) 1993 1.74 1994 2.66 1995 4.87 1996 5.38 1997 6.58 Sales (million US$) EBITDA** (million US$) Operating income (million US$) Financing cost (million US$) Net income (million US$) Net cash provided by operating activities (million US$) Net cash used in investing activities (million US$) Cash and short term investments (million US$) Property, plant & equipment-net (million US$) Total assets (million US$) Short term debt (million US$) Long term debt-including affiliates(million US$) Shareholders' equity (million US$) 427 N.A -4 -33 314 N.A. N.A. 167 1836 2479 588 248 442 784 -37 138 -34 -81 N.A. N.A. 41 485 1025 255 422 -226 1704 158 337 -29 83 N.A. N.A. 63 606 1452 299 555 -133 1732 361 268 -41 234 82 -93 279 759 1953 338 877 59 2171 3492 367 511 324 404 -55 -132 236 237 -95 253 -296 -1474 804 525 942 3179 2882 5927 436 549 1104 2400 662 801 Average share price (US$) Book value per share (US$) Earnings per share (US$) N.A. N.A. 2.83 N.A. N.A. -0.73 N.A. N.A. 0.75 N.A. N.A. 2.11 N.A. N.A. 2.02 EBITDA margin Operating margin Interest cover*** No. of employees ('000) No. of countries with major steelmaking operations New countries added N.A. -4.72% -0.90% 17.60% 0.12 4.06 N.A. 3 Trinidad Tobago (198 Mexico (19 1998 1999 9.79 14.00 N.A. N.A. 1.93 2000 18.42 2001 16.905 2002 22.269 2003 24.899 20042005 (Estimate) 38.167 54.432 4898 476 308 -184 85 599 -184 317 3333 5966 457 2184 854 6274 887 623 -242 398 740 -281 339 3914 6826 403 2187 1530 5423 212 -37 -235 -199 237 -214 225 4138 7161 470 2262 1106 7080 1125 702 -207 595 539 -360 417 4094 7909 546 2187 1442 9567 1905 1299 -131 1182 1438 -814 900 4654 10137 780 2287 2516 22197 6872 6146 -207 4701 4611 -801 2634 7562 19153 341 1639 5846 N.A. N.A. 0.71 9.04 2.37 0.62 2.58 1.71 -0.31 2.56 2.23 0.92 4.5 3.89 1.83 17.77 9.09 7.31 3.90% 15.90% -0.70% 9.90% -0.2 3.4 19.90% 13.60% 9.9 31.00% 27.70% 29.7 N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A N.A 116.3 11 179.4 14 N.A 16 Czech Poland, Sou Republ Africa, Bos China, Ukra 9.27% 20.84% 16.90% 14.63% 9.72% 14.10% 19.80% 15.47% 14.92% 11.57% 6.29% 9.90% 11.62 6.54 5.89 3.06 1.67 2.6 N.A. N.A. N.A. 3 6 7 Canada, Germany, Kazakhstan Ireland Sources: Mittal Steel Annual Reports; Mittal Steel Fact Book, 2004; Company press releases * Figures relate to various Ispat/Mittal entities as they existed in each period reported ** Operating income+Depreciation+Other income+FOREX ***Operating profit/Financing cost N.A. 7 N.A. 8 N.A. 9 USA France N.A. 9 16.34 10 Romani Algeria, e from Irela 79.7 10 -20- Mittal Steel in 2006: Changing the Global Steel Game Exhibit 9 DRAFT Post-Acquisition Cost Reductions Shipments Ō000 mt Operating Subsidiary Ispat Nova Hut* Ispat Annaba Ispat Sidex Ispat Unimˇtal ** Ispat Inland Ispat Duisburg Ispat Hamburg Ispat Karmet Ispat Sidbec Ispat Mexicana Caribbean Ispat Year Prior to Country Year Acquired Acquisition Czech Republic 2003 2544 Algeria 2001 828 Romania 2001 3 041 France 1999 1 313 USA 1998 4 772 Germany 1997 1 397 Germany 1995 849 Kazakhstan 1995 2 297 Canada 1994 1 174 Mexico 1992 479 Trinidad 1989 358 Cost US$ / MT 2003 Year Prior to Acquisition 2003 2 868 915 3 837 1 082 4 807 1 280 861 3 750 1 414 3 400 909 237 322 255 322 489 347 309 268 349 279 257 270 259 222 520 425 309 279 126 368 211 206 Source: Company presentation. * Ispat Nova Hut 2003 Shipments annualized from 11 months data. Acquisition completed on 31st Jan 2003. ** Including Trefineeurope shipments. Exhibit 10 Raw Material Positions in 2004 60% Mittal 50% Average of Top Global Producers 52% 43% 40% 30% 20% 12% 10% 1% 0% Iron ore integration level Coal integration level Source: Mittal Steel Investor Roadshow Presentation, May 5th 2005. * Top global steel producers, excluding MittalSteel and Nucor, includes Arcelor, Nippon Steel, JFE, POSCO, Baosteel, CorusGroup, U.S. Steel, and ThyssenKrupp **MittalSteel 2004 excludes ISG. 21 DRAFT Mittal Steel in 2006: Changing the Global Steel Game Exhibit 11 Mittal Steel Assessment of Across-Country Cost Differences Source: Mittal Steel Investor Roadshow Presentation, November 10th, 2005. Exhibit 12 Arcelor’s Assessment of Across-Country Cost Differences Cost Structure across Locations 250 221 215 209 198 200 29% 28% 30% 19% 13% 26% 192 188 33% 28% 155 150 21% 3% 20% 8% 100 166 1% 1% 1% 25% 33% 1% 9% 1% 1% 141 33% 1% 9% 1% 7% 53% 57% 68% 57% 65% Brazil & Argentina 56% Centr. & E. Eur 52% Japan 49% EE (€ zone) 50 EU-15 1% 59% Production Location Raw materials 22 Electricity Workforce Other Russia China India NAFTA 0 Mittal Steel in 2006: Changing the Global Steel Game DRAFT Source: Adapted from Marc Lacroix, “Steel a long way from globalization,” presentation made at University of Pittsburgh conference on globalization in the steel industry, April 2004. End Notes 1 World Steel Dynamics, Truth or Consequences #28, page 51. 2 New York Times, January 28, 2006, “Mittal Steel makes bid for a rival.” 3 New York Times, January 28, 2006, ibid. 4 The Independent, October 25, 2005, “Mittal Splashes out £2.7 billion for Ukraine’s Biggest Steel Producer.” 5 The Independent, October 25, 2005, ibid. 6 Arcelor press release, 24 October 2005. 7 Metric tonnes per year. 8 http://biz.yahoo.com/ap/051024/ukraine_privatization.html?.v%3D17, last accessed November 30, 2005. 9 http://www.guardian.co.uk/ukraine/story/0,15569,1599972,00.html, last accessed November 30, 2005. 10 This section draws heavily on HBS case 9-793-039 “Nucor at a Crossroads,” by Pankaj Ghemawat and Henricus J. Stander III. 11 Wall Street Journal, October 5, 2005, p. B3J, “Mittal Steel Plans Plant in India After Buying Part of Chinese Firm.” 12 Ispat International, 1997 Annual Report, p. 14. 13 Peter F. Marcus and Karlis M. Kirsis, “Chinese Steel: Facts and Forecasts, 2002–2010,” World Steel Dynamics, April 2004. 14 Jinghai Liu, presentation on Chinese steel markets, University of Pittsburgh Workshop on the Globalization of the Steel Industry, April 2004. 15 “World Steel Demand,” presentation by Armand Sadler, Chief Economist, Arcelor, at University of Pittsburgh Workshop on the Globalization of the Steel Industry, April 2004. 16 Wall Street Journal, November 21, 2005, p. R9, “Steel: Putting the Pedal to the Metal.” 17 Wall Street Journal, November 21, 2005, ibid. 18 Wall Street Journal, November 21, 2005, ibid. PriceWaterhouseCoopers, “Forging Ahead: Mergers and Acquisitions Activity in the Global Metals Industry, 2004.” 19 20 LNM’s early history is based on Don Sull (1999), “Spinning steel into gold: The case of Ispat International NV,” European Management Journal, August 1999, 17(4), pp. 368-78. 21 The Economist, January 10, 1998, “Making steel.” 22 Fortune, February 7, 2005, “Metal man.” 23 Fortune, 2005, ibid. 24 Businessworld, August 15, 2005, “Once an outsider, Lakshmi Mittal is now changing the face of the global steel industry,” p. 34. 23 DRAFT Mittal Steel in 2006: Changing the Global Steel Game 25 Steel Times International, 2002, Vol. 26(3): 4, “Controversy over Sidex bid.” 26 The Economist, 2002, February 23, 2002, “The Mittal way.” 27 Robert J. Aiello & Michael D. Watkins, 2000, “The fine art of friendly acquisition,” Harvard Business Review, November-December 2000. Emphasis added. 28 Business Week, December 20, 2004, “Raja of steel,” p. 51. 29 Aiello & Watkins, 2000, ibid, p. 107. 30 Businessworld, August 15, 2005, “Inside the empire,”p. 40. 31 Wall Street Journa,lOctober 19, 2005, “Mittal raises bar for China growth.” 32 Wall Street Journal October 19, 2005, ibid. 33 Wall Street Journal October 19, 2005, ibid. 34 Businessworld, 2005, ibid (“Inside the empire”), p. 41. 35 Business Week, 2004, ibid, p. 52. 36 Businessworld, 2005, ibid (“Inside the empire”), p. 41. 37 Businessworld, 2005, ibid (“Inside the empire”), p. 41. 38 Aiello & Watkins, 2000, ibid, p. 107. 39 Business Week 2004, ibid, p. 47/48. 40 Business Week, 2004, ibid, p. 51. 41 www.timesonline.co.uk, October 12, 2005, last accessed November 30, 2005. 42 www.timesonline.co.uk, October 12, 2005, ibid. 43 Sull, 1999, ibid, p. 9. 44 Sull, 1999, ibid, p. 9. 45 Sull, 1999, ibid, p. 9. 46 Mittal Steel May 2005 investor presentation. 47 Businessworld, 2005, ibid, p. 35. 48 Businessworld, 2005, ibid, p. 33. 49 Business Week, 2004, ibid, p. 47/48. 50 Mittal Steel company website. 51 Businessworld, 2005, ibid, p. 34. 52 Malay Mukherjee, “A view on the global steel market,” speech at Stahlmarket 2004. Available at http://www.mittalsteel.com/mittalMain/attachments/MM%20Stahlmarkt%20speech%20v2.pdf, last accessed November 30, 2005 24 53 Business Week, 2004, ibid, p.50. 54 PriceWaterhouseCoopers, 2004, ibid, p. 14. 55 PriceWaterhouseCoopers, 2004, ibid, p. 14. 56 New York Times, January 28, 2006, ibid. 57 New York Times, January 28, 2006, ibid. Mittal Steel in 2006: Changing the Global Steel Game 58 New York Times, January 28, 2006, ibid. 59 New York Times, January 28, 2006, ibid. DRAFT 25 Strategic Management Session 2 Alireza Ahmadsimab alireza.ahmadsimab@smu.ca 1 What is Strategy? Strategy: Set of managerial decisions and actions that determines the long-run performance of a firm Strategy formulation: Development of long-range plans for effective management of opportunities and threats in light of corporate strengths and weaknesses 2 The Components of Strategy Diamond Framework: The Five Strategy Element Hambrick and Fredrickson,“Are You Sure You Havea Strategy?”AME2001 3 Diamond Framework ➢Arenas ( Where will we be active ?) ➢Vehicles (How we will get there ?) ➢Differentiators (How will we win in the marketplace ?) ➢Staging (What will be our speed and sequence of moves ?) ➢Economic logic (How will we make money ?) (How will we obtain our resources ?) 4 Strategic Management Process • Strategy for an organization • Organizations usually devised a process to formulate and implement strategy External Analysis Vision/ Mission Strategic Choice Objectives Strategy Implementation Internal Analysis 5 Strategic Management Process External Analysis Vision/ Mission Strategic Choice Objectives Strategy Implementation Competitive Advantage Internal Analysis 66 Competitive Advantage What do we gain by having a strategy? • Answer: to be different from competitors to create value for the customer in a durable fashion. 77 Competitive Advantage in Economic Models Imperfect Competition Perfect Competition ATC ATC MC P MC D P D MR Q Q (D=MR=Price) Competitive Advantage 8 Measuring Competitive Advantage • Measuring the source of the advantage per se is typically impossible (It’s difficult to‘measure’ technology) • It is rather easy to see the evidence of competitive advantage • Superior economic performance is viewed as evidence of competitive advantage • Return On Equity • Market share 9 Return on Equity (RoE) RoE = • • • • Net Profit after Tax —————————— Shareholders’ Equity ROE is the most popular accounting measure of firm performance among investors and senior managers It indicates how well managers are employing the funds invested by the firm’s shareholders Captures the results of the company in a nutshell Enables capital allocation decisions 10 Measuring Economic Performance • The limitations of the ROE perspective • Short term vision of business • Too simplistic: it ignores all developments, e.g. new technology, market trends, etc • Supposes linearity in development of activity: more investments = more returns • Company average performance varies at industry level (services vs. automobile) • Company performance varies within industry 11 Profitability & growth analysis ROE 2001 Apple 24.2% Dell Compaq 27.5% 6.8% • A company’s RoE is affected by 3 factors: – Operating Margin (OM) – Total Asset Turnover (TAT) – Levarage (LEV) 12 12 DuPont analysis RoE Oper. Margin (OM) x Total Asset Turnover (TAT) x Leverage (LEV) 2001 OM Apple 7.48% Dell 5.05% Compaq 4.0% TAT 1.68 2.17 1.16 LEV 1.93 2.51 1.46 RoE 24.2% 27.5% 6.8% 13 Cost cutting - Improving OM Cost of Goods Sold Selling/ Distribution overheads Administration overheads Sales - Net Profit Total Cost ÷ Net Profit Margin R&D expenses Sales Depreciation 14 Average performance will vary depending on the industry Average Return on Equity in US Industries, 1982-1993 16.5% 90 13.8% 11.7% 100 80 First Quartile Average 22.2% Fourth Quartile Average 9.3% 70 60 Number of 50 Industries 40 Average = 14.7% Median = 13.8% 30 20 10 0 32% 30% 28% 26% 24% 22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% Return on Equity (Percent) Source: Jan W. Rivkin’s Analysis Based on Dun and Bradstreet Data Note: Return on Equity = Net Income / Year End Shareholders’ Equity; Analysis based on sample of 593 industries 15 Market share • The role of market share is based on its relation with • Market control, e.g. price leadership • Profitability • Firms with dominating market share are more profitable, statistically (e.g., Nestle, Microsoft) 16 Market share Limitations: • Market share remains hard to define • broadly defined, a product line’s share is minor • locally or narrowly defined… 17 Competitive Advantage Competitive Advantage Economic Returns Advantage To be successful, a Above Normal firm doesn’t need to have • exceeding expectations an advantage over all of its competitors. However, generally, a firm will do better if its Parity Normal source of competitive advantage is unique. • meeting expectations Disadvantage Below Normal • failing expectations 18 19 The World Automobile Industry: Adapted from Exhibit 2.8 The World Automobile Industry: Strategic Groups 20 Michael Porter • Born: 1947 • Professor at Harvard Business School • Porter, M.E. (1979) "How Competitive Forces Shape Strategy", Harvard Business Review, March/April 1979. • Porter, M.E. (1980)Competitive Strategy, Free Press, New York, 1980. The book was voted the ninth most influential management book of the 20th century • Porter, M.E. (1985) Competitive Advantage, Free Press, New York, 1985. 21 21 Porter’s Generic Strategies Matrix Michael Porter sees three ways in which a firm can gain a competitive advantage: ➢ Cost leadership ➢ Differentiation ➢ Focused Competitive Advantage Competitive Scope Cost Differentiation Industry wide Cost Leadership Differentiation Single Segment Focused Cost Leadership Focused Differentiation 22 22 Cost Leadership Strategy Characteristics • Use knowledge gained from past production to lower production costs • Aim for average customer • Few product features 23 Cost Leadership Strategy Cost of Goods Sold Selling/ Distribution overheads Administration overheads Sales - Net Profit Total Cost ÷ Net Profit Margin R&D expenses Sales Depreciation 24 Air Line Industry ROE-Ke Spread Toiletries/Cosmetics Pharmaceuticals Soft Drink 20% 15% Tobacco Food Processing Household Products Electrical Equipment Financial Services Specialty Chemicals Newspaper Integrated Petroleum Electric Utility - East Bank Retail Store Telecom 10% Potential 5% entrants 0% Competitive rivalry (5%) (10%) (15%) Buyers 0 100 200 300 Substitutes Tire & Rubber Electric Utility - Central Medical Services Machinery Auto & Truck Computer & Peripheral Paper & Forest Air Transport Average Invested Equity ($B) Steel 400 500 600 700 800 900 1,000 1,100 1,200 1,300 Suppliers 25 EasyJet flight London  Geneva Cost item £ % of total cost Airport charges Aircraft ownership Air-traffic control charges Crew Marketing/sales Fuel Maintenance Overheads Ground handling TOTAL 600 560 480 400 400 400 400 400 360 4000 15% 14% 12% 10% 10% 10% 10% 10% 9% 100% EasyJet cost advantage? 26 Case of Low-cost Airlines Operational effectiveness by: ✓ Internet ticket sales and rapid gate turnaround • Allows frequent departures and greater use of aircraft, is essential to its high-convenience and low-cost ✓ No meals, no seat assignment, and no interline baggage transfers • Avoids activities that slow down other airlines ✓ Airports and routes • To avoid congestion that introduces delays. ✓ Standardized aircraft 27 Typical cost drivers ➢ Economies of scale o The increases in the amounts of inputs employed in a production process result in lower unit costs • Specialization • Division of labor ➢ Economies of scope o It refers to lowering the average cost for a firm in producing two or more products. Economies of scope are efficiencies brought by variety, not volume • Common inputs • Common production facilities • Common support activities in the 28 Typical Cost Drivers ➢ Experience (learning curve) o The time required to complete a specified task or unit of a product or item decreases each time the task is performed and the unit time will reduce at a decreasing rate ➢ Product design o It can offer substantial cost savings, especially when coupled with the introduction of new process technology: • Platforms • Modularity 29 Typical Cost Drivers ➢ Production techniques: New production techniques may radically reduce costs: o Process innovation (e.g., assembly line) o Reengineering business processes (e.g., JIT) 30 Differentiation strategy Meet unique customer needs and charge premium prices ➢ Perceived quality (product quality + timely delivery + level of after-sales service) ➢ Design/Technology ➢ Customisation (style /color) ➢ Brand/reputation 31 31 Economist Case Subscription prices o Economist: $2.50 per issue o Newsweek: $0.47 per issue o Business Week: $0.77 per issue Economist strategy: ➢ Mass Intelligence 32 33 The Strategy Of The “Economist” Intangible differentiation: Unobservable and subjective differentiation Characteristics that appeal to customer’s image, status, identity and desire for exclusivity 34 Focus Strategy (or Niche Strategy) ➢ Concentrate on a narrow segment to achieve competitive advantage ➢ Market ➢Customer ➢Geographical location ➢ Selected segment has to be narrow enough not to attract too many competitors ➢ Required internal strengths to achieve focalisation o Ability to identify suitable target market (segmentation) and the unique needs of customers 35 35 36 Common Pitfalls Differentiation • Creating • differentiation that buyers do not value • Charging an excessive price premium • • Failing to understand costs of • differentiation • Creating differentiation that • competitors can imitate quickly or cheaply Cost leadership Focus • Failing to recognize buyer segments Poor implementation of cost management • program Misunderstanding of cost drivers Focus exclusively on operation ignoring competitor behavior • Competitors may • imitate your technology/business model nullifying your cost advantage Small volume means higher production costs (too narrow to be profitable) Consumer tastes may change Cost leaders or big differentiators may offer similar 37 37 products 38 The “stuck in the middle” Dilemma Michael Porter’s view: To be successful over the long-term, an organisation must select only one of these three generic strategies. Otherwise, with more than one single generic strategy, the firm will be "stuck in the middle" and will not achieve a competitive advantage. 39 Mixing Low Cost and Differentiation Price $ Cost per unit Industry average competitor Successful differentiated competitor Successful low-cost competitor Competitor with dual advantage 40 Being ‘Stuck in the Middle’ Price $ Cost Industry average competitor Successful differentiated competitor Successful low-cost competitor Competitor stuck in the middle 41 “Warm Beer, Bad Service, Moderate Prices” RoE Focus Cost leadership Stuck in the middle Market share 42 The “stuck in the middle” dilemma • Combining Cost leadership and Differentiation is hard (but not impossible) to implement due to the potential conflict between cost minimization and extra costs of value-added differentiation (but thanks to technological advances mass-customization strategies are increasingly common) • To succeed in multiple strategies implementation: ➢ Porter suggests the creation of separate business units for each strategy ➢ Examples of successful hybrid strategy question Porter’s view 43 Madonna (Queen of Pop) - 1980s 1990s 2000-2012 2012-? 44 44 Good Questions • It is OPEN for discussion, and can’t just be googled • It SHARES intresting Knowledge, source or ideas • It BUILDS connection between the case and lectures (and the real world) 45 Examples Pick the Best question to ask: • What color is the sky? • Why does the sky appear blue? • What color do you think the sky would be on a planet with a different atmospheric composition? And why? 46 More examples Why is Zara so successful? 47 Examples • Zara utilizes a very short develop cycle of 5 weeks for new designs (compared to industry norms of up to 6 months). What advantages does this provide Zara? • Will Zara's approach to customer data gathering be effective in the age of social media? 48 Examples • Zara only spends 0.3% of its revenue on media advertising, well below the industry average of 3-4%. This is in part strategic, as it allows Zara to maintain a lower profile and increases its allure as a high fashion European brand (rather than Spanish retailer, which carries less cultural clout among the fashion set). However, if expansion is to occur outside of Zara’s home market (Spain and increasingly, Western Europe), more of a media presence might be warranted. Should Zara consider increasing its spending on advertising and marketing ahead of expansion into a new market, and if so how should it go about determining the optimal marketing mix? 49 Thanks 50
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