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Quarterly Financial Report
Thursday | 19 November, 2009 | 4:43 am

Second quarter 2009 in review

By Houlihan Lokey

November 2009 - The second quarter concluded with positive news for domestic steelmakers, despite continued weakness across most end markets. With inventory levels largely depleted throughout the industrial supply chain and imports at historically low levels, limited restocking began to occur in June, allowing domestic steelmakers to announce two price increases and to begin bringing selected production facilities back on line. Nonferrous metal prices increased as a result of continued strong Chinese demand and limited scrap availability. M&A activity remained largely muted throughout the quarter, as strategic buyers remained on the sidelines in an effort to conserve cash while financial buyers continued to face limited availability of credit.

The domestic economy began to show signs of stabilization throughout the second quarter, but continued to face weak demand and an increasing unemployment rate. China remained the bright spot in the global economy, as its $585 billion stimulus package helped to support both ferrous and nonferrous prices globally. Chinese steel demand, supported by increased confidence among property developers, increased substantially throughout the quarter and China became a net importer of steel for the first time since December 2005. In addition to increased steel consumption, China continued to use and stockpile nonferrous metals, driving substantial price increases.

Domestic steelmakers were able to announce two price increases in June as a result of low service center inventories and low import levels. Service center inventories have declined for ten consecutive months and have reached 26-year lows. Similarly, imports have declined to 16-year lows due to the lack of a U.S.-to-world price premium throughout the first half of 2009. Limited restocking and low inventory/import levels have increased mill lead times to a minimum of six weeks for hot-rolled coil (HRC), with limited availability through August. Industry sources are reporting that HRC pricing for September delivery increased to approximately $500/ton. Analysts expect both ferrous prices and mill utilization rates to increase throughout the third quarter, but cautiously suggest that price increases will be limited as steelmakers bring additional facilities back on line.

Because announced price increases didn't fully take effect during the second quarter, ferrous prices were generally flat or down quarter-over-quarter. HRC pricing decreased by $40 per ton, or 8.3 percent, from the previous quarter's levels, declining from $480 per ton at the end of the first quarter to $440 per ton at the end of the second quarter. Hot-dipped galvanized also decreased, falling to $615 per ton, a decrease of 0.8 percent from the prior quarter. Facing declining rig counts, OCTG prices decreased 21.4 percent to $1,551 per ton from $1,974 per ton at the end of the first quarter. Analysts expect ferrous prices to increase throughout the second half of 2009.

As a result of weak demand for steel, scrap prices remained flat quarter-over-quarter, as No. 1 HMS scrap declined in May and increased in April, beginning and ending the quarter at $115 per ton. Analysts expect scrap prices to increase throughout the second half of 2009 due to minimills coming back on line. In May, Rio Tinto settled its benchmark iron ore contract prices with several Japanese steel mills. The contract calls for a 44.5 percent and 33.0 percent year-over-year decline in the price of iron ore lumps and fines, respectively, during the 2009/2010 contract year. As of the end of the quarter, Chinese mills continued to hold out for larger year-over-year price reductions. Due to current price volatility and disagreement with the Chinese over potential contract prices, analysts suspect that lower volumes will be exchanged on a contract basis and significant tonnages will continue to be transacted on a spot market basis

Nonferrous metal prices, with the exception of titanium, increased during the quarter. Aluminum pricing increased 18.4 percent from $0.62 per pound at the end of the first quarter to $0.73 per pound ($1,615.50 per metric ton) at the end of the second quarter, despite growing inventories. Due to traders taking advantage of attractive warehouse financing deals, analysts suspect that substantial volumes of aluminum were locked in financial deals and not available for immediate withdrawal, creating tightness in the physical market and increased spot prices. Copper prices increased 26.7 percent from $1.83 per pound at the end of the first quarter to $2.32 per pound at the end of the second quarter. Copper prices were driven higher by a number of factors including increased Chinese demand and tightness in the copper scrap market. Nickel prices increased 70.2 percent to $7.26 per pound at the end of the second quarter from $4.26 per pound at the end of the first quarter. Increased prices were mainly due to short covering and opportunistic stock building, as opposed to a substantial increase in immediate physical demand. Zinc prices increased 19.5 percent from the first quarter, increasing from $0.59 per pound to $0.70 per pound at the end of the second quarter. Zinc prices were supported by short covering, recent production cuts and stockpiling of metal in China.

During the second quarter, aluminum prices remained approximately in line with or below the marginal costs of production, and analysts estimate that aluminum producers above the 60th percentile of the cash cost curve had negative cash margins. In response to price levels, aluminum producers continued to announce production cutbacks and delayed expansion projects. Titanium faced pricing weakness during the quarter, as Airbus lowered its production target for the single-aisle A320 family from 36 units per month to 34 and Boeing announced its decision to reduce production rates on its 777 airliner and additional delays to its 787 Dreamliner program, the world largest consumer of titanium on a per-plane basis.

Although merger and acquisition activity remained subdued during the second quarter, several notable transactions occurred in the metals and mining sectors. The second quarter witnessed six domestic transactions with total announced values of $2.1 billion, a decrease compared to the 30 transactions announced during the same period last year. Internationally, 53 transactions were also announced with an aggregate value of $5.7 billion compared to 75 transactions announced during the same period last year.

The most noteworthy development of the quarter was Rio Tinto's reversal of a $19.5 billion deal with the Chinese state-owned Chinalco. Rio Tinto cited a number of factors for scrapping the deal, including its improved share price since February, rising commodity prices and improving credit markets. As part of the same announcement, Rio Tinto unveiled a plan to raise $15.2 billion from shareholders in a deeply discounted rights issue and another $5.8 billion from BHP as part of a joint venture agreement. The joint venture--which must gain clearance from anti-trust regulators in Europe--will bring together Rio Tinto's and BHP's Pilbara iron ore mines, railways and ports.

In June, Xstrata proposed a merger of equals with Anglo American to create a global mining giant worth around $68 billion. Anglo American quickly rejected the offer due to the its lack of premium to Anglo American's existing shareholders. Through the end of the quarter, Xstrata continued to reiterate the merits of a merger of equals to create a rival capable of competing with bigger miners such as BHP Billiton, Rio Tinto and Vale, but declined to offer a takeover premium due to its view that shareholders of each firm would equally share in the resulting synergies. It is not clear how Xstrata intends to proceed given Anglo AmericanÕs refusal to consider a proposal that does not offer a premium to the current share price.

Other notable activity included Sapa's acquisition of bankrupt aluminum extruder Indalex, Inc. and the merger of Alpha Natural Resources and Foundation Coal Holdings. Sapa, a subsidiary of Oslo, Norway-based Orkla ASA, acquired Indalex's ten active plants in the U.S. and Canada, with 29 presses and a total capacity of about 346,500 tons per year. The final purchase price represented an enterprise value of approximately $95 million. Alpha Natural Resources and Foundation Coal Holdings announced a deal under which the two companies will merge in an all-stock transaction, creating the third-largest coal producer in the U.S., with 2008 pro-forma revenues of $4.2 billion.

Throughout the quarter, three bidders for Asarco, LLC (Asarco) continued to submit plans of reorganization, increasing their bids thoughtout the process. Although a federal bankruptcy judge approved the proposed sale agreement of Sterlite for $1.1 billion in cash and approximately $600 million in debt, Grupo Mexico and Harbinger, a private equity fund and key Asarco bondholder, also submitted plans. Subsequent to the end of the quarter, the federal bankruptcy judge ruled that Asarco's three suitors could solicit support from creditors who will help decide which path Asarco will take out of bankruptcy.

The second quarter continued to experience weakness in the credit markets, as both strategic and financial market participants encountered difficulty tapping lenders. Steelmakers and service centers largely refrained from participating in the M&A market during the second quarter and continued to focus on their own balance sheets and liquidity needs. Going forward, strategic buyers with strong balance sheets will continue to bid on strategic growth opportunities as well as distressed assets, in an attempt to gain market share. Analysts believe that current market conditions will cause further industry consolidation and will result in reduced capacity and pricing strength going forward.

2Q 2009 M&A MARKET REVIEW

The second quarter witnessed six domestic transactions with total announced values of $2.1 billion, a decrease compared to the 30 transactions announced during the same period last year. Internationally, 53 transactions were also announced with an aggregate value of $5.7 billion compared to 75 transactions announced during the same period last year.

Alcoa Inc.
In May, Alcoa Inc. (Alcoa) announced the sale of its Cast Auto Wheels business without revealing details of the buyer or the terms of the deal. Alcoa announced in January 2009 that its Cast Auto Wheel unit, based in Beloit, WI, was one of four downstream businesses that it was divesting in order to reduce costs. The Beloit facility was not included in the sale, but was reportedly in the process of being sold. The sale of Alcoa's Cast Auto Wheels business will not affect it profitable forged wheels business.

Alpha Natural Resources, Inc.
In May, Alpha Natural Resources, Inc. (Alpha) announced the acquisition of Foundation Coal Holdings Inc (Foundation), a Linthicum Heights-based coal mining company, in a stock swap transaction valued at $1.4 billion. Upon completion, Alpha Natural shareholders and Foundation Coal shareholders will own 59 percent and 41 percent of the combined entity, respectively. The combined entity will be the third-largest coal producer in the U.S., with 2008 pro forma revenues of $4.2 billion. Alpha and Foundation together will operate 59 coal mines and 14 preparation plants and will have one of the most expansive geographic footprints in the industry, including reserves of more than 2.3 billion tons of coal. The transaction is expected to close in the third quarter of 2009.

ArcelorMittal
In April, ArcelorMittal South Africa announced that it purchased a 16.3 percent stake in mining company Coal of Africa Ltd (CoAL) for $44.1 million in cash. The deal is expected to secure part of its future coal needs, mitigating one of ArcelorMittal 's key variable input costs. As part of the transaction, ArcelorMittal South Africa has an option to enter into an off-take agreement with CoAL for the supply of 2.8 million tons of metallurgical coal on an annual basis.

Asarco, LLC
In April, a federal bankruptcy judge approved the proposed sale agreement between Asarco, LLC (Asarco) and Sterlite USA, Inc. (Sterlite), a subsidiary of Sterlite Industries (India) Ltd. and Vedanta Resources plc, for $1.1 billion in cash and approximately $600.0 million in debt. The approval came over the bid of Grupo Mexico SA de CV (Grupo Mexico), which entailed $1.3 billion of cash. In April, Grupo Mexico announced that it reached an agreement with a key group of creditors to support its bid and increased its offer to $1.55 billion, including a $250 loan to Asarco. In May, Harbinger, a private equity fund and key Asarco bondholder submitted its own reorganization plan, including $500 million in cash and the assumption of certain liabilities. In June, Grupo Mexico reportedly raised its bid to $2.9 billion and Sterlite reportedly increased its bid to between $2.0 billion and $3.0 billion. Subsequent to the end of the quarter, a federal bankruptcy judge ruled that Asarco's three suitors could solicit support from creditors who will help decide which path Asarco will take out of bankruptcy.

Matcor Metal Fabrication
In June, Matcor Metal Fabrication, Inc. (Matcor) announced the acquisition of Morton Industrial Group Inc., a manufacturer of engineered metal components, from Brazos Private Equity Partners, LLC. The acquisition expands and diversifies Matcor's share of OEM supply programs and expands its capacity to ten locations in throughout the U.S. and Canada.

North American Trading Co
North American Trading Co., LLC (NATCO) announced the acquisition of the Allenport facility (Allenport) of Severstal North America Inc., a unit of OAO Severstal (Severstal). The facility has been idled since May 2008 because Severstal owned duplicative facilities elsewhere, particularly its Yorkville, OH plant. The plant includes a pickle line, tandem mill, box anneal facility and temper mill, all critical to the final forming and conditioning of light flat rolled steel products. The transaction will include Allenport's equipment and 400-acre land property and is expected to close in the third quarter of 2009.

Sapa AB
In June, Sapa AB (Sapa) announced the acquisition of U.S. aluminum extruder Indalex, Inc. (Indalex) for the purchase of substantially all of Indalex's assets in the U.S. and Canada. The transaction represents an enterprise value of approximately $95.0 million. Sapa will acquire Indalex's ten active plants in the U.S. and Canada, with 29 presses and a total capacity of about 347,228 tons per year. The transaction will allow Sapa to improve its geographical presence in North America and be better positioned to service customers through improved painting, anodizing and fabrication capabilities. The combination has a significant potential of realizing cost synergies through plant restructuring and cost improvements.

Worthington Industries, Inc.
In June, Worthington Industries, Inc. (Worthington) announced the acquisition of the assets of Piper Metal Forming Corporation, U.S. Respiratory, Inc. and Pacific Cylinders, Inc. (together, Piper). Piper is a manufacturer of aluminum cylinders and extruded metal parts, serving the medical, automotive, defense, oil services and other commercial markets. Piper's revenues were approximately $30 million during the 2008 calendar year. Piper will be included in Worthington's Pressure Cylinders business segment and is expected to complement Worthington's existing presence in the cylinder market.

Metals Equity Market Information
Market Review

 

  • The Houlihan Lokey Metals Index increased by 41.2 percent during the second quarter. All segments experienced positive returns for the quarter. The largest increase, attributable to the Integrated Steel Producers segment, was 93.5 percent. Most metals related equities experienced outsized gains when compared to broader gains by the overall equity market.
  • The Dow Jones Industrial Average increased 11.0 percent and the S&P 500 increased 15.2 percent during the quarter, while the Russell 2000 increased 20.2 percent. The Houlihan Lokey International Producer Index also jumped 60.8 percent during the quarter.
  • At the end of the quarter, the Scrap Processors segment posted a median multiple of 7.3x LTM EBITDA, the highest of the segments. The Integrated Steel Producers segment had a median multiple of 3.0x, the lowest of all segments.
  • Quarterly sector NFY EBITDA multiples for all segments increased over prior quarter expectations. The Specialty/Nonferrous Producers segment posted the highest NFY EBITDA multiple of 12.5x and the Tube & Pipe Producers segment posted the lowest at 7.2x.
  • About Houlihan Lokey
    Houlihan Lokey, an international investment bank, provides a wide range of services, including mergers and acquisitions, financing, financial opinions and advisory services, valuations and financial restructuring. In 2008, the firm was ranked the No. 1 M&A adviser for U.S. transactions less than $2 billion by Thomson Reuters. In addition, the firm advised in eight of the 10 largest corporate bankruptcies and on more than 500 restructuring transactions valued in excess of $1.25 trillion in the past 10 years. The firm has more than 800 employees in 14 offices in the United States, Europe and Asia. Each year it serves more than 1,000 clients, ranging from closely held companies to Global 500 corporations.

    For more information, visit Houlihan Lokey's Web site at www.hl.com

    . Houlihan Lokey's Basic Industrial Group was the No. 1 M&A adviser on all industrial sector deals in 2008, with 39 announced transactions. The Metals Group provides metals industry clients with strategic and creative advice to help maximize shareholder value by offering investment banking, corporate finance and financial restructuring services to every segment of the industry.

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