Lakshmi Mittal's big dream, when he set out to acquire Arcelor, was to rid the steel industry of price cyclicality. Two years after the mega deal which transformed the steel business, is he any closer to his dream? By Vivek Sharma

In 2006 when Lakshmi Mittal detailed the bid to acquire Arcelor, his most compelling argument for the deal was that it would make steel price-cycles history. Though many dismissed this as an implausible dream, there was merit in his argument. Steel was probably the most fragmented among basic or core industries, until recently.

While the major steel producers had the technology and marketing expertise, they lacked access to sufficient iron ore reserves. Those steel producers which had enough and more iron ore reserves, especially the state-owned companies in Eastern Europe, were mostly inefficient and lacked market access.

As steel producers abound and competition intensified, consumers gained more bargaining power. Producers, saddled with excess capacity, were too eager to undercut each other and played into the hands of big consumers like auto and white goods manufacturers. The industry soon learned to live with steel price cycles, inextricably linked to the fortunes of the large consuming industries. They made money when prices were good and prepared themselves for the winter when the cycle turned.

Then the big miners started consolidating. This development squeezed the steel producers even further, as the iron ore suppliers could demand higher prices as their numbers were reduced to a handful and they could behave like oligopolies. Besides, geographical and logistical constraints forced many steel producers to depend on select iron ore suppliers.

Mittal is now seen as the visionary who foresaw this difficult future and started building a large, geographically diversified steel empire. He bought his steel assets when the price-cycle was down and was perfectly positioned to reap windfall gains when the upswing came. Before prices started moving up, Mittal fortified his empire with tenacious - and sometimes ruthless - drives to improve efficiency. It is better to have a few large producers, he argued, which will smoothen out the price fluctuations - if not completely eliminate price-cycles. The Arcelor deal was to be the culmination of his grand plan for consolidating a highly fragmented industry.

After the deal
Post-merger financial performance of Arcelor Mittal has been exemplary. For 2007, the first full year of combined operations, total revenues increased nearly 18 per cent to over $110 billion even though total shipments were marginally lower than previous year. Net income was up 30 per cent at $10.4 billion and free cash flows were over $14 billion. Synergies from the deal until the end of 2007 were estimated at over $1.4 billion. The company's market value has jumped more than 60 per cent over the last year and now stands at close to $140 billion.

The company is investing heavily in adding capacity and acquiring iron ore reserves. It invested nearly $5.5 billion in capacity expansion at existing plants last year. Though the plans to set up mega steel plants in India are crawling at an agonising pace, Arcelor Mittal has recently announced an investment of up to $10 billion in Indonesia.

For most companies, the appetite for acquisition will be more than satiated after a mega deal as it goes about integrating the acquired business. Not so for Arcelor Mittal. In 2007 alone, the company spent over $12 billion in buying up smaller firms and iron ore reserves across the globe. At the end of last year, deals worth nearly $4 billion were under negotiation - to be completed this year. The company has a stated aim of raising its own iron ore output to 75 per cent of consumption in a few years, to lessen the reliance on big iron ore suppliers and improve margins. 

Arcelor Mittal's new corporate slogan, 'Boldness Changes Everything', is a reflection of Mittal's way of doing things. And the company will need to be even bolder as it sets out to plant its foot in the biggest steel market of all - China. Last year, Arcelor Mittal spent $650 million to acquire a minority stake in a Chinese steel manufacturer. A tiny foothold in anticipation of bigger deals to come!

Why the merger succeeded
Most mergers, especially the high profile ones, don't live up to the high expectations they generate at the time of the deal. It is also true that, bigger the deal, higher is the chance of failure. AOL-Time Warner, HP-Compaq and Daimler Chrysler are just a few of the mega deals that went sour and took a heavy toll on the men and women behind those deals. Over-ambition, lack of clear vision, cultural differences and difficulties in integrating the merged businesses are often the main reasons for the failures.

Given the very hostile initial response from the Arcelor management to Mittal's offer and the eagerness shown by the French and Luxembourg governments to stymie the acquisition of a European owned company by an Indian firm, the merged Arcelor Mittal was more likely to disappoint.

Instead, the merger has worked and is probably the most successful mega deal of recent times. The former Arcelor managers who were hostile are nowhere in the picture and Mittal is firmly in the saddle. The French and Luxembourg governments no longer have any misgivings about the 'foreigner' who controls one of their brightest jewels and wields such enormous power. In fact, Mittal is now a widely respected business figure in Europe.

The merger worked well because the merging companies - Mittal Steel and Arcelor - themselves were created by stitching together many smaller firms in multiple geographies. Arcelor was cobbled together from former state-owned steel producers in France, Spain and Luxembourg. Mittal Steel, as is widely known, was a result of a decade-long acquisition campaign by Lakshmi Mittal in obscure corners of the steel world before reaching the US.

Being born from many smaller entities, both Arcelor and Mittal Steel were very familiar with and adept at combining businesses. It was almost as if mergers were in their DNA. Because of the constant additions, managers of both companies were well equipped to handle diversities and, more importantly, change. That made Arcelor Mittal the success it is today.

Are price cycles history yet?
Nearly two years have passed since the Arcelor Mittal behemoth came into being. By any measure - be it aggregate capacity, shipments, geographical spread or financial might - the firm lords over the global steel industry by a wide margin. Even its biggest competitors are nowhere close; its nearest rival is less than half the size of ArcelorMittal. The Mittal - Arcelor deal also triggered a wave of consolidation moves in the steel industry, the biggest being Tata Steel's takeover of Corus, and the big players are scouting for more. These deals have validated Mittal's argument for industry consolidation. But, has the pricing power swung back to steel producers?

We all are now familiar with airline fuel surcharges, the additional costs passed on to air travellers when fuel costs rise - without changing the base ticket price. It was unthinkable that something similar can be attempted in the steel industry, where long term fixed price contracts are the norm. Until recently that is, because Arcelor Mittal is moving in that direction.

Stung by the nearly 50 per cent increase in input costs this year, Arcelor Mittal has started adding a surcharge to its prices, even when the company has long term contracts with the buyers. Of course, the company is emboldened by the sharp rise in spot steel prices and knows that buyers don't have many options. But at the same time, it is also a reflection of the newfound pricing power of producers in the post-consolidation scenario.

It is premature to say steel price-cycles are history. In fact, it will be wishful thinking to presume that prices will remain firm. The downturn will come, maybe later than sooner as the short to medium term outlook remains quite positive. But, when it happens, the downturn will be less severe and easier on producers as the large players will have the capability to sacrifice volumes to protect prices. And the credit for that should go to Lakshmi Mittal.