Jeff Zappone: Steel Industry Mergers And Acquisitions Slows – American Recycler
American Recycler features Jeff Zappone and Brian Grant in its article titled “Steel Industry Mergers And Acquisitions Slows.”
According to Brian Grant, managing director at Conway MacKenzie Inc., an international consulting and financial advisory firm, merger and acquisition (M&A) activity in the steel industry has been down for a few years now.
“Despite the need for further consolidation in the industry and relatively low valuations, the continued uncertainty in the outlook for steel and financial challenges of would-be acquirers has contributed to low M&A activity,” Grant said. “However, the mini-mills have fared much better than the integrated steel mills have over the past several years and are starting to use their cash and relatively strong balance sheets to vertically integrate.”
“In 2015 China produced 50 percent of global crude steel while also fulfilling slightly over 51 percent of demand,” said Jeffrey Zappone, senior managing director at Conway MacKenzie, Zappone is a certified turnaround professional and a member of the Turnaround Management Association, American Bankruptcy Institute and the Association for Corporate Growth. “In recent years, China has scaled back real estate and infrastructure investments, reducing their demand for steel. Falling demand coupled with falling prices, partially due to oversupply in the market, has the country’s steel industry poised for further consolidation.”
The metals deals market remained relatively slow in the third quarter of 2016. Zappone said that while the average deal size increased slightly during the quarter, this was largely driven by two transactions, which accounted for 78 percent of total value. “Overall, the value and number of deals continues to trend well behind historic levels. Depressed metal prices, global demand and economic uncertainty continue to plague the relevant deal markets,” Zappone said.
“Consolidation and vertical integration have become the solution for many companies as larger and more diversified operations can recognize cost savings through economies of scale and are able to mitigate the risk of negative product or market segment conditions,” Zappone said.
Grant agrees. “The steel industry is consolidating,” Grant said. “Steel has always been a highly cyclical industry with periods of excess production capacity, but the present state of the industry is different than previous downturns.”
Grant said that there is far too much under-utilized global capacity and the industry needs to adjust; by consolidating, costs can be lowered and production can be distributed to the most efficient assets. Unfortunately, because many companies in the industry are financially suffering, this means that a number of them won’t make it through this consolidation process.
“Consolidation lends itself to vertical integration as companies look to cut costs and boost sales via expanded product offerings and customer bases,” Zappone said. “The number of U.S. enterprises in the steel industry is expected to decrease at an annualized rate of 1.1 percent through 2021.”
“Steel producers and metal service centers have had their EV/EBITDA multiples drop 16 percent and 9 percent respectively since the beginning of 2016,” Zappone said. “Within the U.S., multiples are down because cheap scrap has given electric arc furnaces a cost edge versus integrated producers using blast furnaces which suffer higher variable and fixed costs from labor and raw materials.”
“However these markets have struggled with their own issues – auto sales slowing and aluminum substitution and declining oil prices,” Zappone said. “Current steel prices would indicate that many steel producers are cash flow negative. Declining revenues and pricing have also negatively impacted the steel industry.”
According to Zappone, due to high transportation costs, industry operators position themselves to be as close to clients as possible. As such, scrap metal recyclers tend to be located in manufacturing regions as well as highly populated urban areas. For example the Great Lakes region accounts for 31 percent of iron and steel manufacturing in the U.S. with the largest share of that region in Ohio (11 percent) with 27.4 percent of all scrap recyclers located within the Great Lakes region.
“On the upstream side, there will likely be consolidation amongst recyclers,” Grant said. “Industry players should pay attention to the larger competitive dynamics within their markets to assess what level of consolidation is likely and where they fit into that process.”
“In recent years, China has scaled back real estate and infrastructure investments, reducing their demand for steel. Falling demand coupled with falling prices, partially due to oversupply in the market, has the country’s steel industry poised for further consolidation,” Zappone said. “Globally, the metals industry has experienced a decline of 17 percent while the average deal value has seen a 143 percent increase over the same period.”
As Zappone explained, financial investors are entering into the industry as prices remain at their lowest levels in a decade and domestic demand is expected to grow approximately 13 percent to 102.9B tons by 2021.
“While U.S. M&A activity has slowed down compared to the considerable activity earlier in the past decade, the total number of operators has declined at an annualized rate of 4.5 percent to 365 companies over the last 5 years,” Zappone said. “Through 2021 the number of steel companies in the U.S. is expected to decline at an annualized rate of 1.1 percent to 353 facilities due to consolidation and closures.”
“Asia will account for 71.3 percent of the 2017 100.3 million tpy capacity increase,” Zappone said. “North American capacity is expected to remain the same with a 3.2 million tpy increase expected in electric arc furnace capacity offset by closures of 2.2 million tpy capacity in blast furnace operations. There are no capacity additions underway in the EU, LA, Israel or Australia.”
“Financial sponsors also have the potential to boost global transactions and deal values, with U.S. private equity firms sitting on a record $1.31 trillion in unvested capital according to Prequin,” Zappone said. “However, private equity dry powder hit a record number of $1.1 trillion in 2013 – the prior record was 2008 – and has only grown in the last 2 years. These companies have been patiently waiting for the right time to invest. However, volatile but generally rebounding steel prices, stronger downstream demand and increased product differentiation are all possible to revitalize industry revenue in the coming years.”