Cleveland-Cliffs steels some thunder with purchase of AK Steel (CLF)
There was some big M&A news in the steel space this morning as Cleveland-Cliffs (CLF -12%) announced it will acquire AK Steel (AKS) in an all-stock deal valued at $1.1 bln to AKS shareholders ($3 bln in enterprise value when AKS debt and pension obligations are included). The deal is expected to close in 1H20.
AKS shareholders will receive 0.40 shares of CLF with CLF shareholders owning 68% of the combined company and AKS shareholders owning 32%. Based on yesterday's close, that computes to a price of $3.36 per AKS share, or a 16% premium. However, CLF is trading lower on the news, so it's in the $3.04 range currently.
What makes the deal a bit unusual is that, while Cleveland-Cliffs is rightfully lumped in when investors discuss the steel sector, it does not make steel. Cleveland-Cliffs is the largest independent iron ore mining company in the US. It's a major supplier of iron ore pellets, which is a key raw material used by steel producers (both integrated producers like AKS, MT, X, and mini-mills like NUE, STLD) to produce steel.
So why does this deal make sense? Despite its sub-$3 stock price as of yesterday's close, AK Steel is a major producer of steel. What makes it attractive is that AKS has modern facilities and focuses more on higher value-added steel applications, such as automotive. Steel made for construction, rebar, industrial uses does not need to be perfect. But for autos, as any car owner will tell you, there better not be any imperfections. This is a more intensive and exacting process and AKS can charge more for it.
If AKS is so great, why is the stock at $3? The main reason is that it has a lot of debt and its labor is union-based, so it also has a lot of pension obligation liabilities on the books. Also, it's an integrated producer, which is less efficient than a mini-mill. Finally, there are concerns about a weakening automotive market and the recent GM strike did not help.
We wonder if this bothers other steelmakers who are CLF customers. MT and X are ticking lower on this news. Perhaps there are concerns that CLF will favor its own steelmaking operations over these other customers.
Overall, we think the deal makes sense for both sides. For AKS shareholders, while it's just a slight premium and it's all-stock, at least it's some premium as the stock has been in the $2-3 range for the past year. Also, the deal provides a steady stream of iron ore pellets at presumably better prices.
For CLF, it's buying a company when it's down and it gets some quality steelmaking assets. As a fully integrated steel producer (from mining to finished steel), its results should be more consistent during all market cycles, with less emphasis on commodity contracts and more contracted-based sales (AKS). CLF also estimates that the deal will generate $120 mln of annual cost synergies.
Finally, CLF has a stronger balance sheet to absorb AKS' debt/obligations. Plus, CLF is announcing with this deal that it also has obtained a $2 bln financing commitment from Credit Suisse in connection with a new Asset Backed Loan and the refinancing of AK Steel's 2023 senior secured notes.
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