Having too much money is generally considered a good problem. In that case, Arcelor Mittal has an excellent problem, worth about $7.5 billion (Rs32,250 crore) a year. That’s the amount of free cash flow the giant steel maker is generating, with no let-up in sight. It’s too much money for the Luxembourg-listed company, which has an enterprise value of $90 billion, to spend easily.
The cash-flow calculation is straightforward. It starts with the $16 billion total Ebitda (earnings before interest, tax, depreciation and amortization) that Arcelor and Mittal Steel have generated as separate companies in each of the last three years. The base is conservative, since the combined Arcelor Mittal is expected to provide $17.3 billion of Ebitda in 2007, according to JCF-Factset, and Merrill Lynch is calling for an average of $18.8 billion over the next three years.
Some of that money will be spent on normal business expenses: about $1.9 billion in taxes; $3 billion in maintenance capital expenditure; $1.2 billion in interest on the $20 billion or so of net debt; and $2.4 billion in dividends and share buybacks. In total, those expenses come to $8.6 billion, leaving $7.5 billion to burn a very large hole in pockets of the Mittal family, which controls the company. Obviously, the company could give more cash back to shareholders, but the company has committed to a growth-style earnings payout of 30%.
What will Arcelor Mittal do with all its money?
About half of the free cash flow can go into small acquisitions and expanding existing plants. But that still leaves $4 billion or so to spend annually. There’s no immediate issue, since Arcelor Mittal is set to buy out its Brazilian minority shareholders for $5 billion, as soon as the regulator agrees to the price.
The company could also pay down some of its debt. Steel used to be a highly cyclical industry in which Arcelor Mittal’s current leverage—debt of 1.25 times Ebitda—would have seemed high. But not any more, after several years of stable steel profits and the 5.4 debt-to-Ebitda ratio used in the financing of Tata Steel’s purchase of Corus.
So if Aditya Mittal, Arcelor Mittal’s finance director, decides to pay down debts, it will be mainly in order to increase the company’s borrowing power for future acquisitions. And of course, less debt will reduce the interest costs, increasing the quantity of free cash flow.
Spoilt for choice
That makes an excellent problem even more excellent. Some of the cash could go into building big new steel mills. Those cost billions of dollars each, but building them takes time.
Arcelor Mittal has a conceptual agreement to build one huge new facility in India, but it won’t require much more than $1bn a year. It could well require less, since local politics might slow the project down.
That leaves acquisitions, which have been the source of most of the Mittal family’s huge fortune. Rumours have been flying—Vallourec in France, Posco in South Korea, Hunan Valin and Laiwu in China. But buying significant growth won’t be easy.
Although Arcelor’s global steel market share is only about 10%, few targets are both substantial and available.
In western Europe, the company is already big enough to run into anti-trust problems if it tried to swallow up a big competitor. Vallourec, a $13 billion speciality steel maker, is just about the only sizeable candidate that probably wouldn’t cause too much trouble with the authorities.
The situation is similar in the US. Arcelor Mittal probably wouldn’t be allowed to buy US Steel or Nucor, the only sizeable competitors.
But the big growth is elsewhere anyway, in Russia, Latin America and, especially, Asia. The problem is that easy targets are scarce in all of these regions. Various sorts of nationalism get in the way.
In most countries, steel is still considered too important an industry to be trusted to foreigners. For example, Arcelor Mittal may be encouraged to build new plants in Brazil, but the locally owned CSN is not for sale.
The Russian government wants its steel oligarchs to expand overseas, not to be taken over. Posco, worth about $40 billion, and the Japanese companies are at best uneasy partners. They are far from being potential targets.
In China, the biggest and fastest growing steel market, even the optimistic Lakshmi Mittal, Arcelor Mittal’s chief executive, cautions that it will take years before a sizeable local producer will be allowed to fall into foreign hands.
So what should Arcelor Mittal do? It can keep on picking up relatively small companies, but the big targets need to be courted.
The Mittals have shown they are good at the usual techniques—promising investment and cosying up to governments.
But it is now time for them to add another tool. They need to show that being part of the Arcelor Mittal family makes such compelling economic sense that even nationalist concerns should be ignored.
That means making the not-yet-complete merger of Arcelor and Mittal an overwhelming success. With a market share three times higher than the next largest competitor, and a research budget to match, Arcelor Mittal should be able to leave the competition far behind in terms of profitability and product development.
If the promised returns are high enough, objections to being taken over could eventually melt away.