International Steel Group ISG
December 07, 2004 - 7:52am EST by
2004 2005
Price: 40.02 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 4,000 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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This is a quasi-arbitrage pitch that allows controlled downside and substantial participation in steel industry upside over the next few months. ISG is being acquired by Ispat International (IST, soon to be renamed Mittal Steel). We’re recommending you buy ISG outright with no hedging. There is an annualized return of 15.6% if IST’s share price remains above $35 (currently $40), and an ability to participate in upside with IST above $43.

If you’ve wanted to own steel stocks, but are waiting for a correction on global growth fears or a yuan revaluation, this is a good way to participate for the next four months.

The deal should close near the end of the first quarter. Each ISG share gets $21 in cash and a fraction of an IST share determined by 21 divided by IST’s share price. The factor is capped at a maximum of 0.6087 and a minimum of 0.4793.

IST is currently $40.43. Based on the current ISG prices of $40.02, here are the annualized returns you could get for various IST prices.

IST price Annualized Return

32 3.5%
33 8.2%
34 13.1%
35 15.6%
36 15.6%
37 15.6%
38 15.6%
39 15.6%
40 15.6%
41 15.6%
42 15.6%
43 15.6%
44 16.3%
45 20.3%
46 24.5%
47 28.7%

This is actually a three-part deal, in which Ispat will first acquire Lakshmi Mittal’s LMN Holdings for stock and the new combination of Ispat/LMN (to be called Mittal Steel) will acquire ISG. The Mittal family controls LMN and Ispat, and the LMN/Ispat deal is expected to close by the end of this quarter. After ISG is acquired by Mittal Steel, the Mittal family will own 88% of the final combined entity.

This deal is also a partial exit for Wilbur Ross, the majority owner of ISG who built it up by rolling up U.S. steel makers Bethlehem, LTV, and Acme in bankruptcies after they had been stripped of many of their legacy liabilities. He is still going to have close to $1B at stake in Mittal.

There is little expectation that the DoJ will hold up the deal, and union approval has already been granted by the two major steel unions, including ISG employees. U.S. steel customers are still being protected by long term price contracts and U.S. steel producers have gone from alternatively being squeezed by Asian imports to being squeezed by coke and ore providers. There should be some sympathy for consolidation and shoring up the viability of the U.S. steel plants that allowed Wilbur Ross to make significant hires.

The new Mittal Steel will have roughly 25 million tons per year of U.S. production (comparable to U.S. Steel’s 20 million). The domestic production market is approximately 100 million tons with another 23 million tons of imports. In the world steel market, only 20% of the total production is controlled by the top six producers, and the new Mittal Steel will be comparable in size to Arcelor.

With the ending of the Bush steel tariffs, there has been a dramatic recovery of imports (from 15 million tons to the current 23 million ton range), but as Lindsay790 noted, we are still below pre-tariff levels in the high 20’s. Still, this deal will likely be seen by the administration as a way to protect the profitability of a large chunk of U.S. production.

An extended diatribe on the prospects for sustained high steel prices is not necessary for this trade. Good news has continued to flow since Lindsay790’s most recent write-up, which gives a good summary of the bull arguments. Suzuki (in addition to Nissan) is now announcing that they will have temporary plant shutdowns because of steel shortages. This level of demand protects U.S. producers from dumped imports. AK Steel recently raised prices and Indian producers are mulling raising prices. Tight Asian supply means that the new Mittal Steel will have opportunities to grow its export business, especially with U.S. production, which is off a very low U.S. export base. Mittal Steel will be 80% based in European and U.S. production areas, so it could potentially benefit from increased Asian importing and Asian currency appreciation.

With about $7B in run rate in pro-forma EBITDA and a $32B prospective EV, Mittal is close to the range of Lindsay790’s comps for Bayou. This should protect the value of the IST shares and could allow some of the upside shown in the table above if the current bullish news flow continues. You can use this conservative bet to make money in steel while you figure out which smaller US players you want to use to speculate on continued consolidation and domestic prices being sustained in the absence of excess imports.


Completion of acquisition by IST; continued steel demand newsflow
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