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Cliffs-AK combo to resurrect Ashland Works

Dec 03, 2019 | 05:58 PM | New York | Dom Yanchunas

Tags  Cleveland-Cliffs, AK Steel Holding, M&A, Ashland Works, iron ore, pellets, pig iron, automotive steel Dom Yanchunas

Cleveland-Cliffs' acquisition of AK Steel Holding will forge a more cost-efficient steelmaking partnership in the US Midwest, with new plans to produce pig iron at the shuttered Ashland Works in Kentucky.

The companies announced the $1.1-billion all-stock merger on Tuesday December 3, in a transaction scheduled to close in the first half of 2020. The 172-year-old Cleveland-based iron ore miner would own steel mills for the first time in its history and boost its participation in end markets for high-value-added automotive and electrical steels. The operations of West Chester, Ohio-based AK Steel would benefit from the vertical integration and greater financial stability.  

In a slide presentation after Tuesday morning's announcement, Cleveland-Cliffs said the acquisition de-risks its future pellet offtake - up to 9 million long tons - by eliminating the uncertainty inherent in future supply contract renewals with AK's blast furnaces.  

Ironically, the miner's foray into integrated steel production can spur the company's expansion into the electric-arc-furnace (EAF) segment - and at a relatively low capital expenditure. Cleveland-Cliffs plans to produce merchant pig iron at AK's Ashland Works, which had been slated for permanent closure this month.  

For all those reasons, some analysts suggested on Tuesday that the combined enterprise will somewhat emulate the structure and strategy of another century-old name in American industry: U.S. Steel. 

In Tuesday's slide presentation, Cleveland-Cliffs said the acquisition "turns Ashland from a negative to a positive." The proposed venture at the now-cold Kentucky blast furnace "potentially provides a compelling, low-capex, high-return opportunity to be a significant merchant pig iron supplier in the Great Lakes," fed by a kindred pellet source, also producing hot-briquetted iron (HBI) at Toledo, Ohio. 

Avoiding AK's irrevocable shutdown of Ashland Works would eliminate $60 million in discontinuation costs. Cleveland-Cliffs management estimates $120 million in total annual cost synergies from combining the businesses. 

Market participants generally reacted positively.

The merger "should be good for Cliffs to offload product and make AK more stable from a cash standpoint," one steel buyer told Fastmarkets. 

Said an Ohio scrap broker: "AK has been getting leaner because integrateds have not been that profitable, and Cliffs wants a closed loop for its pellets."

And a Pittsburgh scrap source noted: “This is a good thing. They suggested [that] they will make pig iron in Ashland and are building an HBI plant... It is a win-win if the domestic steel industry stays strong."

A midwestern flat-roll market participant said the announcement was surprising but Cleveland-Cliffs is a shrewd operator and will make the marriage work, notwithstanding divergent attitudes toward fiscal discipline and labor relations. Cleveland-Cliffs doesn’t like to take on debt, while AK is debt-ridden, that source noted. Cleveland-Cliffs seems to have a friendly relationship with its union, while AK has clashed with its union at times.

“It was a shocker because they are two totally different cultures and they are taking on all that debt, but there are synergies and they can use a blast furnace to make pig iron," the midwestern source said. "Cliffs will have a home for its HBI and AK Steel will have a guaranteed pellet supplier. It strengthens Cliffs in their iron ore positions."

The combined enterprise will benefit from a more diversified customer base and a reduced reliance on commodity-linked contracts, the companies said in Tuesday's initial news release. Combined revenue over the past 12 months would have been an estimated $8.2 billion.

"Our track record of providing high-grade iron ore, combined with AK Steel’s recognized ability to produce the highest quality steel grades, creates a highly complementary and compelling business model," Lourenco Goncalves, Cleveland-Cliffs chairman, president and chief executive officer, said in the statement.

Cleveland-Cliffs said it is well-positioned to address AK Steel's near-term debt maturities, and there will be a new $2-billion credit facility. The slide presentation said "significant interest savings" are possible after the refinancing of AK Steel's 2012 unsecured and 2023 secured notes. 

The freshly recast Cleveland-Cliffs is already being compared to U.S. Steel, a traditional integrated steel producer that has long mined its own feedstock and in 2019 additionally set its sights on the EAF model with its new ownership stake in Big River Steel. 

"Potential synergies aside, the consolidated... entity may resemble a business structure similar to U.S. Steel, in our view, with upstream integrated iron ore mines and processing facilities coupled with downstream blast furnaces," UBS Global Research analysts wrote in a research note. 

Emulating U.S. Steel may seem counterintuitive, and Tuesday's historic move by Cleveland-Cliffs can be viewed as a negative harbinger for the US supply chain by "effectively keeping irrational steel capacity in the market," analyst Gordon Johnson at GLJ Research said.

"The risk of AKS going under was a real threat to CLF's share price," Johnson wrote, using the companies' ticker symbols. "We see this as a defensive move by CLF to support its share price."

The news release said AK Steel stockholders will receive the current market equivalent of $3.36 for each share owned. That's a 27% premium based on a 30-day rolling average of each company's stock price, but it's less than the value of AK shares at almost any point in 2016-18.

Lisa Gordon in Pittsburgh and Muyao Shen in New York contributed to this report.


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