The steel industry may have finally reached a turning point. On Monday, ThyssenKrupp, one of Europe’s biggest steel makers, confirmed it is in talks to merge its Inoxum steel unit with rival Outokumpu of Finland. This is good for the industry. Years of debt-fuelled investment in capacity has left steel makers nursing high fixed costs. This lead weight has made deals with rivals difficult to arrange.
The market jumped at the news. Shares in Outokumpu itself jumped by 14 per cent. Rivals Aperam and Acerinox rose by 17 per cent and 9 per cent respectively. The reason is that Inoxum is a significant part of ThyssenKrupp’s business. Last year it generated about 14 per cent of the group’s sales. Valuing it is tricky as the implications of last year’s €800-million goodwill writedown are hard to judge, but it should generate €144-million of earnings before interest, tax, depreciation, and amortisation next year, says Macquarie. Using the enterprise value to ebitda ratio of its peers of about 11 times, the business could be worth up to €1.6-billion.
But despite good intentions, the deal still faces significant hurdles. Outokumpu is unlikely to be able to raise enough cash for a purchase, so a combination will probably involve stock compensation or ThyssenKrupp maintaining a chunk of equity ahead of an initial public offering. That would mean it would effectively keep on its books the €3.4-billion of capital it has invested in the unit - about one-eighth of the company’s total.
That is why investors should curb their excitement. In Europe, steel makers’ return on equity is about 3 per cent according to Bloomberg data. Poor demand means that is about one-seventh the return of the broader market. If the companies can finalise the deal, it may be the first step in reducing the capital intensity of the industry. But only then will investors regain their enthusiasm for steel.
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