Mining and natural resources company Cleveland-Cliffs Inc (NYSE: CLF) is acquiring steel products manufacturer AK Steel Holding Corp in an all-stock deal valued at roughly $1.10 billion. The merger deal has been announced a day after President Donald Trump provided the much-needed momentum to the shares of steel producers by stating that he is exploring the option of imposing steel tariffs on imports from Argentina and Brazil, as a response to currency devaluations.
Following the acquisition news, the stock of Cleveland-Cliffs, formerly Cliffs Natural Resources Inc, closed Tuesday’s trading at $7.51, down $1.04 or 10.70% from the prior close. The shares of AK Steel ended Tuesday’s trading at $3.01, up $0.12 or 4.15% from the previous day’s close.
The reason for the sharp decline in the shares of Cleveland-Cliffs – the largest iron ore pellet manufacturer in North America – is that the company has to issue fresh shares to finance the acquisition, implying a dilution of shareholder value. It does not necessarily mean that the market has a bearish view of the acquisition deal.
Under the merger agreement, AK Steel shareholders will be given 0.40 shares of Cliffs shares for each AK Steel share they possess. Following the merger, Cliff’s shareholders will have a 68% stake, while AK Steel shareholders will have a 32% stake. The merged entity will be headed by current Cleveland-Cliffs Chairman and CEO Lourenco Goncalves, while AK Steel’s CEO Roger Newport will retire. The deal is expected to be completed, subject to regulatory approval, in the first half of 2020.
During the process of completion of the deal, Cleveland-Cliff’s board will see an infusion of three directors from the current AK Steel’s board. Two of the Cleveland-Cliff’s board members will resign. The merged entity will have its headquarters in Cleveland, but a considerable ‘presence’ of Cliff’s will remain at the current headquarters of AK Steel at West Chester, Ohio. AK Steel will also continue to run its research and innovation center in Middletown, Ohio.
Cleveland-Cliffs, Chairman and CEO Lourenco Goncalves, explained how the acquisition would enable the company to realize a diverse client base. Goncalves said: “For Cliffs, we expect to realize immediate growth and a long-desired objective of a more diverse customer base, as well as more predictable cash flow generation due to the contracted nature of AK Steel’s sales of high-end automotive steel.”
Both companies intend to create a vertically integrated enterprise, following the merger, which implies Cleveland-Cliff’s iron ore pellet manufacturing will complement AK Steel’s flat-rolled carbon, stainless, and electrical steel production. The merger is anticipated to result in cost synergies of roughly $120 million in the first year of closing, mainly due to consolidation of corporate activities, removal of duplicate overhead expenses, logistics efficiencies, and power savings.
AK Steel Chief Executive Roger Newport explained the reason for the merger agreement. Roger Newport said, “The combination of Cliffs’ iron ore pellet capabilities and our innovative, high-quality steel product development and production is strategically compelling. Together, we expect to be able to take advantage of growth opportunities faster and more fully than either company could on its own.”
The US steel producers are facing a tough time after a brief period of relief from the price increases caused by the 25% hike in import duty last year. The fall in domestic demand due to the postponement of projects by oil and gas drillers has pushed many of the US steel producers in red. The industry has already seen several layoffs. The sector employs 10,000 fewer people compared to five years back.
The price of hot-rolled steel has dropped by 30% in 2019, causing a ripple effect on the share price of steel producers. In 3Q 2019, AK Steel posted a 96% y-o-y decline in net income.
In an effort to reverse the trend, Trump stated that he is looking at the possibility of slapping another round of tariffs on steel and aluminum imports from Argentina and Brazil.
The deal has offered new hope to AK Steel, which had announced a plan to shut down its mill in Ashland (Kentucky) by the end of 2019, resulting in 230 job losses. The deal could result in the reopening of the mill to produce pig iron. Additionally, the merger will also boost AK Steel’s profitability as it would be easy to refinance its high-cost debt, while reducing operational expenses. Therefore, the merger is expected to turn the stock of Cleveland-Cliffs bullish soon.
The historical price chart indicates that the stock of Cleveland-Cliffs has found support at 7. The next resistance is anticipated near 10.50. Additionally, the stochastic oscillator is rising towards the bullish region. Therefore, the stock is expected to appreciate in the days to come.
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