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Lourenco Goncalves "We can create optionality, which is very important"


“When activists come to the door, pay attention,” the chairman, president and chief executive officer of the largest producer of iron ore It has taken veteran metals executive Lourenco Goncalves three-and-a-half years to lift Cleveland-Cliffs out of the deep hole it was in. Lourenco Goncalves tells Jo Isenberg-O’Loughlin how he implemented a ‘back-to-basics’ strategy rooted in the rise of EAF-based
steelmakingpellets in North America advised an audience gathered in late November at a global mining and metals conference hosted by the Goldman Sachs Group in New York. “Because we don’t come for fun,” he warned. “We come to change . . . real change.”

The metals industry veteran speaks from experience as a long-time activist himself. In the three-and-a-half years since Lourenco Goncalves took the reins of Cleveland-Cliffs, change has come fast and furious to the Cleveland, Ohio-based iron ore miner and operator.

Goncalves, 59 and a 38-year veteran of the metals business, arrived at Cliffs in August 2014, in the wake of a bruising, seven-month-long fight mounted by New York-based hedge fund Casablanca Capital LLP for control of the beleaguered miner. And there was no time to spare.

“My predecessors were trying to build a multi-metal type of mining company, something that would loosely emulate Rio Tinto or BHP,” he recalled in an interview with Metal Market Magazine conducted late last year. “And they crashed it to the ground. They spent $9 billion, give or take, in capex acquiring and developing assets,” he said.

Since earnings from that spending fell far short of expectations, the company ended up with enormous debt, which the balance sheet would not support.

Enormous may be an understatement. In fiscal 2014, Cliffs Natural Resources Inc, as the company was known at the time, recorded a loss of $7.24 billion due largely to asset and goodwill impairments and other charges totaling $7.5 billion.

“My challenge was to strengthen the balance sheet without filing for bankruptcy,” Goncalves reflects on his top priority from day one as Cliffs’ top executive. “And we were able to do that.

“We had to walk a very fine line between refocusing the company strategically and, at the same time, acting on all kinds of liability management exercises and financial transactions to bring the balance sheet back into balance,” he recalls. “And that is what we did.”

In a December 4, 2017 filing with the US Securities and Exchange Commission (SEC), Cleveland-Cliffs reported that it had reduced the principal of the company’s long-term debt by 40% since 2014 and decreased its overall average interest rate to 5.71%.

“Annualized interest expense, which at one point hovered around $230 million, has been reduced to just $96 million per year,” Timothy K. “Tim” Flanagan, chief financial officer and treasurer, told analysts in Cliffs’ 2017 third-quarter earnings conference call.

Broad experience
Prior to joining Cliffs, Goncalves served for ten years as chairman, president and chief executive officer of Metals USA Holdings Corp, a leading manufacturer and processor of steel and other metals. In April 2013, Los Angeles-based Reliance Steel and Aluminum Co acquired Metals USA for $786 million in cash and the assumption of $454 million of net debt.

Some sixteen months later and after studying various undervalued companies as part of an in-depth exercise to target his next career move, Goncalves found himself engaged full-tilt in an urgent mission to keep Cliffs Natural Resources from sliding off the edge and into insolvency.

“I more or less expected what I found,” he says in hindsight. “Of course, when you are on the outside looking in, it is a lot less complicated than having to deal with the issues on a day-to-day basis.”

Goncalves does, however, admit to encountering one surprise – an unexpected twist from an unlikely source: holders of Cliffs’ corporate bonds. He recalls that was “despite the fact that I always did exactly what I was telling everyone I would do.”

He recounts: “I said I would write-off assets and I wrote-off assets. I said I will sell coal and I sold coal. I said I will sell chromite and I sold chromite. And I said by doing what I’m doing, the company is not going to go bankrupt.

“The bondholders believed everything I said except that I would be able to avoid bankruptcy,” Goncalves reflects. So, some of them started shorting the bonds. 

He says that he did not expect that bondholders would short the bonds of a company that was executing a well thought-out strategy to climb out of a hole. “But they did and I took advantage of that,” Goncalves comments.

“It’s a lot easier to buy back bonds when they cost ten cents on the dollar than when they cost 80 cents on the dollar,” he explains. “At the end of the day, I was surprised but I didn’t feel bad. Looking back, it was actually a positive surprise because it kind of expedited my ability to refocus the company and execute our strategy.”

At its core, the “back-to-basics” strategy Goncalves is implementing at Cliffs involves returning the 170-year old company to its roots in North America and addressing head-on the rise of electric arc furnace (EAF) steelmakers that has dramatically reordered the North American steel production base.

“Cleveland-Cliffs was founded and was very successful doing one thing and one thing only,” Goncalves says. “And that was serving the steel industry in the United States with high-quality, customized iron units.

“Well, guess what?” he asks rhetorically. “The lineup of steelmakers that matter in North America has changed a lot in the last 25 or 30 years from all integrated or blast-furnace-based to vast-majority EAFs. So, for Cleveland-Cliffs to continue to supply the steelmakers of North America, we need – first and foremost – to adopt to what the customer base has become. We need to supply the EAFs.”

To that end, Cliffs announced plans in June 2017 to construct a $700 million, hot-briquetted iron (HBI) plant in Toledo, Ohio, to serve the EAF-based steel market in the Great Lakes region. At the time of the announcement, Cliffs expected to break ground on the facility, which will be capable of producing 1.6 million metric tons of HBI annually, early this year.

Midrex Technologies Inc, Charlotte, North Carolina, has been signed to design, engineer and procure core equipment for the project with commercial production of HBI tailored to customer specifications expected to begin in mid-2020.

Cliffs’ estimates peg the existing market for premium iron units in the US Midwest at 3 million metric tons annually. That market is currently being served by what Goncalves has described as “commercial-quality” material imported from “Venezuela, Brazil, Ukraine, Russia and more recently even India.” 

Although Cliffs had not announced specific clients and potential partners in the flagship HBI project at press time, the company previously identified more than 15 potential clients located in a radius of within 200 miles of Toledo.

“I am very happy that we are going to be selling a product in the US that is already better quality than the product being imported here,” Goncalves comments. “And the clients we are talking to already import, so they are excited to be able to buy customized feedstock domestically.”

HBI and DR pellet
Despite previously announced efforts by would-be domestic competitors, Cliffs’ top executive is confident that the Toledo plant will remain the sole source of home-grown HBI for Midwest region EAF steelmakers.

“In order to produce HBI, you need to have one thing that only Cleveland-Cliffs has,” Goncalves insists. “And that is the ability to produce DR-grade (Direct Reduction) pellets. You can’t produce HBI without having DR-grade pellets.”

Working in collaboration with Charlotte, North Carolina-based Nucor Corp, a premier EAF steelmaker, Cliffs developed DR-grade pellets some two years ago at its Northshore mining operation in Silver Bay, Minnesota.

“We are already producing and supplying DR-grade pellets very successfully to our two established clients, Nucor, and ArcelorMittal Canada,” Goncalves notes. “As a result, we now have certainty that we can produce an extremely good, customized DR-grade pellet.
“We are not going to sell DR-grade pellets to anyone other than our dedicated clients and use the material at our own facility in Toledo,” he vows. “That means zero tonnage for the merchant DR-grade pellet market. I am not going to export to the Middle East or anything like that,” Goncalves adds.

“That kind of limits the ability of any new entrant in the HBI/DRI (direct reduced iron) business in the Midwest, because without feedstock,” he points out, “you’re done.”

To ensure an adequate supply of material to meet anticipated demand for HBI and the DR-grade pellets required to produce it, Cliffs is undertaking an $80 million upgrade at its Northshore operation. The investment will equip the facility to produce 3 million metric tons of DR-grade pellets annually.

In a transaction finalized in late September 2017 and, also keyed to increase pellet supply, Cliffs purchased US Steel’s 15% equity interest in the Tilden Mining Co, Ishpeming, Michigan, for $105 million. The move added 1.2 million long tons of pellet production capacity and 55 million long tons of proven and probable crude ore reserves to Cliff’s raw material holdings.

Multi-pronged strategy
Both moves were pursued as part of a multi-pronged strategy tailored to bullet-proof the future of Cliffs’ HBI-powered drive into the raw materials arena serving the US EAF steelmaking sector. “We are the only one that produces DR-grade pellets,” Goncalves ticks off one key element of that strategy. “We do have gas in the Midwest. And we have clients,” he adds. “So, we have everything.”

Add to that “everything” the impact of the erosion of the US blast furnace base on the psychology and procurement options of consumers of high-value-added steels, namely the automotive sector. In the early 1990s, two-thirds of the steel produced in the US was processed via the blast furnace/basic oxygen furnace route and one-third was melted in EAFs. Today, the ratios are exactly the opposite.

“High-end steel consumers, such as automakers, are looking for partners that they can bet will still be around in the next ten, twenty years,” Goncalves fast forwards into the future. “And they will appreciate the stronger balance sheets of the EAFs and (their wherewithal) to become as important to them as the good integrated mills are right now.

“In order to get there, the EAFs know that they need virgin iron units in general,” he points out. “And what Cliffs can provide is a lot more than just virgin iron units. We can supply customized feedstock. 

 “We are going to play with these guys exactly like we have been playing with the integrateds for a long, long, time,” he says. “We are going to support the ones that are willing to become partners with these high-value-added end users and what these buyers want in terms of feedstock.

“We are going to be very selective with that,” Goncalves adds. “But we are going to be end-user oriented like we are with the integrated mills that we serve today.”

BFs and EAFs
While Cliffs’ top executive stops short of predicting the trajectory of US blast-furnace-based steelmaking over the next decade, he is confident in one thing. “I can say with full conviction that nobody will ever build a new blast furnace in the United States,” Goncalves states, pointing to Nucor’s decision to construct a 2.5-million ton-per-year DRI plant in St. James Parish, Louisiana, rather than build a pair of blast furnaces it had already secured permits to install.

“One thing I do know is the United States will continue to produce more or less the same amount of steel domestically,” he says. “And Cliffs will be supplying the mills.

“Whether we migrate some from supplying blast furnace operations to EAF/DRI facilities remains to be seen. We can go either way,” he points out. “That is part of our plan. We can create optionality, which is very important.”

Judge of character
One of a relatively small and elite corps of steel executives who has held top positions in steelmaking (Brazil’s Companhia Siderurgica Nacional (CSN) and California Steel), steel distribution (Metals USA) and now raw materials mining and processing (Cleveland-Cliffs), Goncalves, who turns 60 in February 2018, is reluctant to discuss the traits he has called on to propel his career.

“I do not like to brag much about me, but I think one characteristic that helps me in situations like I found myself here at Cliffs is the ability to read people very quickly,” Goncalves reflects. “I was able to identify very quickly here inside Cliffs who could learn, take to heart, and execute a new strategy and who was just faking or sometimes not even bothering to fake it.

“I feel that is one of my main characteristics, to identify who are the keepers and those who are not because they can’t absorb something new. That has never changed throughout my career,” Goncalves says.

“I try to find the right people to join me and together, one-plus-one equals three. The multiplying effect of working in teams is powerful,” he emphasizes. “And it has been like that since the very beginning of my career.”

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