FROM BUSINESS WORLD OF 18 FEBRUARY 2006
What the rumpus
is about
Lakshmi Mittal’s
bid to acquire Arcelor has raised an unholy ruckus. One possible explanation is
racism: Mittal is a brown man, and the whites of Europe do not like the idea of
his taking over ‘their’ company. This explanation will be repeated ad infinitum
in the Indian press, and will satisfy those who look to the press for an
emotional stimulus. They want no other; if offered another, they will spit it
out.
I feel rather
uninvolved in this battle. Lakshmi Mittal is an Indian only in name. He left
India decades ago, and made London his home. He has invested all over the world
–everywhere except in India. If I had held shares in Arcelor, I might have
thought of selling them to Mittal, simply because he is offering 27 per cent
above the market price that ruled before he made the bid.
On the other
hand, if I had been the management of Arcelor, I would have told shareholders
to reject it. Not because he is brown, but simply because what he proposes to
do with the purchase could leave Arcelor’s shareholders worse off for two
reasons. First, their interests will be merged with those of Mittal, who owns
97 per cent of Mittal Steel Co and will have a majority in the new company.
Second, Mittal will buy the shares he needs in Arcelor out of new loans which
will become the composite company’s debt. The company will do better if its
rate of profit exceeds the rate of interest on that debt, and worse in the
opposite case. If it does better, that will be largely because Mittal will
dismiss a large proportion of Arcelor’s labour force – something that no doubt
worries the governments of France, Spain and Luxembourg, for they will be
paying dole to those who are thrown out of work. Merging Arcelor with Mittal
Steel is risky, and there is no clear reason to think that the returns will be
so high as to compensate for the risk. I could avoid that risk by selling off
immediately to Mittal; but then, he will buy just enough for him to throw out
the present board and bring in his own people. So if I waited too long, I could
lose.
Such are the
considerations playing on Arcelor shareholders’ minds. If they were rational,
they would rush to sell off, in which case Mittal would acquire a majority. If
he does, governments can only delay his taking control. This would be true even
if they passed a law making it possible for the board of Arcelor to block
takeover. If Mittal held a majority of shares, the board would not be able to
carry on whatever the law. And European governments cannot stop Mittal from
buying shares without playing havoc with their capital markets. Hence it is
quite likely that Arcelor will pass into Mittal’s hands. The present is just a
passing phase, not worth wasting one’s time over.
What, however,
will not pass is the structural characteristics of the world steel industry,
which ensure recurrent crises. They arise from four facts. First, the industry
is capital-intensive, which means that its variable costs are a fraction of its
total costs. If a steel producer has surplus capacity, producing an additional
ton costs him a fraction of what it costs a producer producing to full
capacity. So the former will add to his profit if he undercuts the latter. Second,
the industry is highly cyclical. Reconstruction of Europe in the 1950s, the
construction boom in Arab countries during the oil boom of the 1970s, and more
recently, the scorching growth of China have caused shortages, rising prices
and high profits; in between are long periods when capacity exceeds demand,
steel plants make losses and can be bought for a song. Second, newly built
facilities embody better technology and produce steel at lower cost. Much of
continental Europe’s and Japan’s steelmaking capacity was destroyed in World
War II, and was rebuilt at its end. That gave Europe and Japan an edge over US
industry, and led the latter to complain about ‘unfair’ competition. It
repeatedly asked for and got protection from the US government, or used the
threat of protection to persuade its competitors abroad to limit exports to the
US. And finally, the ubiquitous utility of steel, capital intensity of steel
production, and the large size of steel plants, all make the industry a
favourite of governments. So when there is trouble over steel imports and
exports, governments get involved. Steel wars become international wars.
Mittal has for
the past 15 years been buying plants that were cheap because of excess capacity
and of the collapse of the Soviet Union. Now he sees another phase of surplus
capacity coming as China’s production capacity catches up with demand. If it
comes, China will start exporting and undercutting anyone. At that point,
Europe will follow its tradition and protect its industry. Mittal is trying to
buy into that bastion of the future. Arcelor occupies that bastion. No wonder
the management does not intend to cede it without a fight.
