Will Mills Buy Up Service Centers
as Industry Consolidation Continues?

Consolidation has brought added stability to the steel market and reflects the improved health of both mills and service centers, agreed panelists debating the future of the global steel industry during last month’s Metals Service Center Institute annual meeting in Las Vegas.

Steel has caught the attention of investors worldwide, they noted, which promises to fuel continued mergers and acquisitions in the years to come among both producers and distributors. Whether the market will see mixed marriages—mills purchasing service centers—remains unclear.

Today’s vibrant steel industry is not the result of consolidation, but rather consolidation is a result of a vibrant industry, observed Dan DiMicco, chairman, president and CEO of Nucor Corp. “Consolidation in general is a healthy sign for any industry, but it is not the end all. You must have an industry that is fundamentally profitable before you start to see companies consolidate.”

Consolidation does not protect the industry from the anticompetitive actions of a government-dominated steel market such as China, he added. “It must be a privately owned, profit-driven global industry for consolidation to truly realize its core benefits, and the jury is still out on that.”

Consolidation has brought more stability to the marketplace by creating bigger players with greater ability to match supply and demand, said Louis Schorsch, CEO of Flat Products, Americas, for Arcelor Mittal, who noted that his company now controls 10 blast furnaces. “We can view the marketplace more broadly and take action to modulate our output. As the market entered this year with an inventory overhang, three blast furnaces were not operating and five were operating below capacity. With 10 blast furnaces, it is a lot easier for us to adapt to that underlying demand.”

Steelmakers foresee sustainable profitability in the years to come due to the shakeout of weaker competitors and more stable steel prices. “In last year’s fourth quarter, we operated at 67 percent capacity and were still profitable. Five years before, in fourth quarter 2001, we operated at 69 percent capacity and lost $200 million,” noted John Surma, chairman and CEO of U.S. Steel Corp. “It’s a huge change in productivity and cost effectiveness, which gives us the confidence to say, in good times and bad, that we will produce what our customers need, and if they don’t need it, we won’t make it. There’s a greater degree of stability through the cycles, which is good for all of us.”

How much further will steel production consolidate? With the notable exception of Arcelor Mittal, which has bought up mills all over the globe, most mergers to date have been regional. Deals that cross continents are likely to take place more slowly due to issues of language, currency, culture and possibly state ownership, which increase the risks to investors, noted the panelists.

Future foreign ownership of North American steelmaking capacity, and production of alloys necessary for national defense, raises a potential security issue, added Michael Siegal, chairman and CEO of Olympic Steel. “If Russians and Chinese become the sole producers of our armor plate, there is a genuine concern.”

Pointing to the aluminum industry, which is dominated by just a handful of producers around the world, DiMicco suggested that the steel industry still holds the potential for many more mergers.

 James Bouchard, chairman and CEO of Esmark Inc. and Wheeling-Pittsburgh Steel Corp., credited the steelmakers for attracting investors to the industry. “As someone who started a company recently, I have been able to ride the wave of producers who led the way into the equity markets. If that job had not been done, and Wall Street hadn’t rewarded them for their consistency and rationalization, I would not have had access to the capital to grow my company. It is all interrelated.”

Noting that the steel market is still highly fragmented and full of inefficiencies, moderator John Lichtenstein, a partner at Accenture, asked the panelists if mill ownership of service centers—the model common in European countries—would improve supply chain collaboration.

Schorsch noted that Mittal owns distribution in Europe, and sells through independent service centers in North America. Both work well in their respective markets, he said. “I’m a bit agnostic on it. You end up with a pretty good outcome through either a market mechanism or a central planning mechanism. Both models have pluses and minuses.”

DiMicco was equally on the fence. “If you are asking if mills should get into the service center business, I’m not sure,” he said. “I’m not so sure steel mills could run service centers more efficiently than service centers do.”

Hoffman sees mill ownership of service centers in North America as a distinct possibility, however, especially as consolidation creates more multinational companies. “Producers in North America are sitting on large piles of cash they must put to work, and the natural progression will be to invest downstream. The fact that this takes place successfully outside of the United States will be an encouraging factor. As foreign ownership grows in North America, they will logically think that if they can do it in Europe, why can’t they do it in the U.S.? I think, yes, you will see a drive toward service center ownership by producers.”

Acquiring service centers would be relatively inexpensive compared to mill mergers, added Bouchard, noting that service centers, with inventory and receivables insured, represent a low-risk investment.

The panelists also expressed some guarded optimism about progress against unfair competition from state-subsidized mills in China. “We may well have congressional leadership with more sympathy and more willingness to listen,” said Surma. “The only thing that will affect the behavior of leadership in China is to demonstrate that they will otherwise lose access to our markets. My sense is that they are beginning to get that message.”