Steel Growth's a Tricky Zero-Sum Game
By Dan Markham, Senior Editor
North America’s steel companies, in all their forms, are continually pitted against one another in a never-ending battle for a larger slice of a fixed pie. Which makes long-term profitability for competitors a particularly difficult proposition.
Domestic steel consumption does not move much, and hasn’t for a long time. The U.S. economy consumes roughly 100 million tons per year, with some movement up or down depending on economic conditions. But it generally sits comfortably in a narrow band, with no significant change in sight. Such a condition is problematic for members of the steel supply chain, whether mills, service centers, scrap companies or end users. The absence of overall market growth tests the opportunity to enjoy sustainable, long-term gains.
“In investment theory, participants make money with a diversified portfolio. Economies grow, new markets are developed and the pie gets bigger,” said Peter J. Scott, founder and managing partner of Headwall Partners at the recent Platts Steel Markets North America Conference in Chicago. “But the steel market pie isn’t getting any bigger.”
The data supports that contention. The returns of the 22 publicly traded steel companies show almost flat performance over the past decade, compared with a portfolio of the S&P 500 companies that has more than doubled in value in the same time frame. “Due to that lack of long-term growth, the steel industry has all the attributes of a zero-sum game. One person’s gain is another’s loss. Any gains by one company tend to come out of the hides of a different company,” Scott said.
Of course, there is variance within the sector, he added. Some well-run companies have turned in results that almost match the performance of the S&P 500, while lesser performers have seen their market value decrease considerably.
Static demand limits companies’ options, Scott continued. Strategies available in some growing industries, such as market expansion, new-market development, geographic outreach and others, all involve taking market share from other players when applied to the steel industry. “And when you simply take market share from existing producers, typically you do it with price concessions,” he noted.
One technique that helps differentiate the equity value of winners and losers is through mergers and acquisitions. Growth through acquisitions can lead to greater returns by focusing on transaction synergies, rather than grabbing market share from competitors. Scott looked at the transaction strategies of the 22 publicly traded market participants, separating them into four classifications by the number and types of transactions they made. Companies that engaged in few deals were labeled cautious buyers. Transformational players tended to make few deals, but when they did they engaged in large acquisitions. Tuck-in players were steady buyers of smaller companies they folded into the operation. Finally, systematic companies made many transactions of all types.
Over time, the systematic acquirers did better on a variety of performance metrics, including revenue, EBIDTA, margins and, most notably, equity value. The cautious players had the worst results. “I don’t want to overstate the conclusion. There are other factors involved. What’s more important is the overall direction and the relative values of different approaches,” he said.
He favors the systematic approach, where all senior executives are invested in M&A as a key pillar of growth, where there’s a clear process of identifying the best acquisition targets, conducting due diligence, quantifying expected synergies and expediting integration. Moreover, a strong feedback loop allows these companies to “take what they’ve learned on past deals and apply it to subsequent deals,” Scott said.
Businesses interested in becoming acquirers should ask three questions: can the company’s balance sheet handle it; are there viable acquisition targets; and do they have the manpower to integrate the acquired company?
As for companies that answer negatively to those questions, Scott added, if they can’t more aggressively pursue acquisitions, they should consider becoming the acquired.