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Guest Editorial

Will the deal really deliver?

By Nick Sowar

November 2008- During recent years, M&A deals have redefined the global steel industry. Are there more to come? Most likely because consolidation might be the best way to cure overcapacity and highly cyclical earnings.

A merger or acquisition can give a steel company the scale and leverage to compete more effectively. But neither can guarantee ongoing viability. Too often, the new company doesn't gain any significant or sustainable advantage because scale alone doesn't equate to superiority. In fact, in our experience, quality trumps quantity (that is, better is more important than bigger) and in M&A, quality comes from achieving meaningful and sustainable operating synergies after the deal is done.

In a fragmented industry, smaller companies don't have economies of scale with suppliers or the global footprint to keep in step with their customers. Moreover, single-mill companies must maximize production to achieve better asset utilization and minimize unit costs. A large company, on the other hand, can be more disciplined and stable. In reaction to excess supply, a large enterprise can afford to reduce, or even temporarily shut down, production in one or two mills. Controlled capacity and volume, for example, adjusting volume rather than price, translates to a rational industry where prices are stabilized for everyone, as supply and demand are kept in balance.

Given the forces at play--the global trend toward consolidation, the positive effects of size on rational market behavior and the small company's difficulties in competing--the odds of participating in a merger or acquisition are high for most steel companies. In response, management has to ask, "How do we make a deal work to our greatest advantage, not just at closing but for all the days thereafter?"

Synergy: When bigger is better
We believe synergies come from one or both of the companies involved in the merger or acquisition taking the time during due diligence to ask and answer important questions: Where does each company make money? How would we work together to leverage each company's strengths? Would that afford a meaningful and sustainable competitive advantage?

Here are five variables we believe M&A participants should understand when it comes to ensuring a complete due diligence approach:

True costs of each process
Without a fairly sophisticated understanding of the costs of production processes, the merging companies or the acquiring company may have difficulty devising a reasonable plan for maximizing the value of the deal.

Bottlenecks and bumps
The one-mill model (looking at all the options as if it were a single business operation) makes the best process steps from one facility to the next more visible. It can also expose bottlenecks to a smooth flow of work, materials and information.

Purchasing and supply contracts
The stability of cash flows is another factor in deciding the potential synergistic value of a deal. The way a company buys raw material can be classified as good or bad, depending on how it sells products.

Future/legacy costs of environmental and pension obligations
As part of the due diligence process on a U.S. mill, the acquiring company should understand future funding requirements because they impact value. In our experience, it pays to have an actuary on the due diligence team.

In M&A, a focused due diligence approach can make the difference between value realized or not, between synergies achieved or not, and between post-merger competitive advantage or not. Companies should approach deals with the intent of creating a better enterprise, not just a bigger one. Finding the answer to how the new company will work can make all the difference.

Nick Sowar, based in Cincinnati, is a partner with Deloitte & Touche LLP and serves as the Global Steel industry leader as well as the U.S. North Central Consumer & Industrial Products industry group leader. Nick also is a member of the Deloitte LLP Manufacturing Operating Committee and the Deloitte Touche Tohmatsu Manufacturing Operating Committee.

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