There's a bidding war taking place around United States Steel(NYSE: X). It was a bit of a shock to the market, but when you dig into the company's capital spending plans, the takeover interest makes complete sense. Here's why this steel maker's competitors are swarming like sharks, and what you should probably do about it.
U.S. Steel is doing things differently
United States Steel is a very old steel maker, which legitimately helped to build the United States into the country it is today. Although its history is impressive, it has also left the company with a bit of a legacy issue. U.S. Steel has long relied on blast furnaces for its steel production. This is an older technology that is very profitable when steel demand is strong, but because of the high fixed costs of running a blast furnace, the company tends to bleed red ink during lean years.
Image source: Getty Images.
This is why U.S. Steel has been starting to build out a fleet of electric arc mini-mills. That's a newer steel-making technology that is easier to ramp up and down along with demand. That allows mini-mills to be more profitable through the typical industry cycle. U.S. Steel isn't abandoning its blast furnaces -- it is simply trying to balance out its production so the business' peaks and valleys aren't quite as extreme in what is a highly cyclical industry.
The problem is that it costs a lot of money to acquire and build steel mills. U.S. Steel's capital spending has been on the high side for a little while. But that is about to change, with management explicitly stating during the third-quarter 2023 earnings call that its "strategy unlocks significant value, value we don't believe The Street is fully projecting into their expectations for next year."
That belief comes from two different places. First, the company's capital spending plans are starting to come to a close. That will mean as much as $1 billion less in costs in 2024. On top of that, the assets that have been under construction will start to produce revenues. That won't lead to an instant bump up in revenues and earnings, but it suggests that 2024 will be a key turning point for the business as those new assets begin to generate cash flows.
Everyone is looking at U.S. Steel
This is why many of the company's steel industry peers are eyeing a potential takeover of U.S. Steel. Basically, they have the chance to get in just as the company's business starts to exit a key period of development and redevelopment. That seems like a fairly good idea, but what about individual investors? That's less clear.
The first news of what has turned into a bidding war emerged in August 2023, which as you can see in the chart below resulted in a huge surge in U.S. Steel's stock price. Its closest peers haven't seen a similar price increase, and Cleveland Cliffs(NYSE: CLF) is actually one of the companies openly bidding for U.S. Steel. But look at the price gains on all of these stocks over the past six months. U.S. Steel's share price is up nearly 60% while its peers are up in the high single digits and teens, percentage-wise.
That suggests that investors have already priced in a lot of good news when it comes to U.S. Steel. At this point, an investor needs to believe that the final offer the steel company accepts will be materially above the current price, which is possible but seems unlikely given the already strong price run-up. In fact, there's even a chance that U.S. Steel will reject all the offers, in which case the stock would likely plummet back to Earth. The risk/reward balance for investors seems skewed in the wrong direction.
The opportunity is limited, for investors
Overall, the business opportunity for an acquirer seems attractive when it comes to U.S. Steel, given the shift from building new mills to having them come on line. But for investors, the takeover battle has likely discounted most of the benefit of any potential deal, given the swift stock price advance. This is a takeover fight that you'll probably want to watch from the sidelines.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
