Cleveland-Cliffs to acquire AK Steel

Cleveland-Cliffs Inc. (NYSE: CLF) is acquiring the common stock of AK Steel Holding Corp. (NYSE: AKS)  in a merger agreement announced Tuesday morning. Cliffs Chairman, President and CEO Lourenco Goncalves will lead the expanded organization, which will be a vertically  integrated mining/steelmaking firm.

The transaction, a $1.1 billion deal, will combine Cliffs – North America’s largest producer of iron ore pellets, with AK Steel, which produces flat-rolled carbon, stainless and electrical steel products – to create value-added iron ore and steel products. Cliffs said the combined company “will be ideally positioned to provide high-value iron ore and steel solutions to customers primarily across North America.”

The development could be bad news for Northeastern Minnesota, however. Instead of constructing a second pig iron plant, which Goncalves had considered building on the Iron Range, the merged companies will look at repurposing AK’s Ashland, Kentucky, blast furnace to produce that product, which feeds electric arc furnaces (EAF). 

Goncalves earlier had hoped to build the first hot briquetted iron (HBI) plant on the Iron Range but, citing a lack of cooperation with state elected officials, Cliffs looked elsewhere. The first plant is currently is being built in Toledo, Ohio, at a cost of approximately $700 million.

“As part of our due diligence for this transaction, we are taking a deep look at our Ashland, Kentucky, blast furnace, which has been idled since 2015. Instead of considering the construction of a second HBI plant, we now have the potential to produce pig iron in Ashland (Kentucky). We could potentially restart this blast furnace, returning the employees to work, create another outlet for our pellets and add another high-margin product to our portfolio,” Goncalves said in a Tuesday conference call. The conversion cost would be $25 million to $30 million compared with closure costs of $60 million. Timing of a possible revitalization will depend on market demand. The furnace does not need to be relined, a costly process, he said.

AK Steel already buys iron ore pellets from Cliffs. Although the taconite contract is multi-year, there’s still uncertainty when it is renegotiated. Goncalves said combining the firms will eliminate that volatility, adding financial stability and predictability for the combined firm.

“We are excited to be able to deliver real value to the shareholders of both Cliffs and AK Steel through a value enhancing and leverage-neutral transaction. By combining the best-in-class quality of AK Steel’s assets and its enviable product mix with Cliffs’ debt profile and proven management team, we are creating a premier North American company, self-sufficient in iron ore pellets and geared toward high value-added steel products,” Goncalves said.

“The pro forma Cliffs will be a vertically integrated steel company that is expected to drive improved profitability for existing Cliffs and AK Steel shareholders and is well-positioned to serve both the blast furnace and electric arc furnace segments. In addition, Cliffs’ existing strong balance sheet and self-sufficiency in pellets for the combined company provide flexibility to pursue additional growth opportunities, including the potential future utilization of the blast furnace in Ashland to produce merchant pig iron, an opportunity neither company could pursue on a standalone basis,” he added.

AK Steel previously announced plans to close the largely-shuttered Ashland blast furnace by the end of 2019. Goncalves said Cliffs might repurpose that facility. 

It continues to operate blast furnaces Dearborn, Mich., and Middletown, Ohio.

Goncalves predicted 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. 

“Our track record of providing high-grade iron ore combined with AK Steel’s recognized ability to produce the highest quality steel grades, creates a highly complementary and compelling business model. We look forward to welcoming the AK Steel team into our organization and creating a unique company focused on executing value-enhancing opportunities for all of our stakeholders,” he said.

“We believe this transaction is a compelling opportunity for AK Steel shareholders to participate in the substantial upside potential of what will be a premier vertically integrated producer of value-added iron ore and steel products with significant scale and diversification,” Roger K. Newport, CEO of AK Steel, said in the Tuesday news release. “Our shareholders will benefit from exposure to a larger, more diversified company that is better positioned to capitalize on growth opportunities. 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. With AK Steel’s 120-year heritage, which began in Ohio, and expertise in steelmaking, AK Steel and Cliffs make an excellent combination, which we expect will facilitate a smooth integration process.”

The executives said a merger:

• Brings together complementary businesses to create company with full suite of value-added products: The combination will create significant opportunities to generate additional value from market trends across the entire steel value chain and enable more consistent, predictable performance through market cycles. The integrated supply chain provides AK Steel self-sufficiency in iron ore supply. Together, Cliffs and AK Steel will have a presence across the entire manufacturing process, from mining to pelletizing to the development and production of finished high value steel products, including Next Generation Advanced High Strength Steels for automotive and other markets.

• Solidifies demand for Cliffs’ pellet offtake, with potential for growth into merchant pig iron: The combined company will ensure pellet volume commitments to AK Steel’s blast furnaces along with Cliffs’ Toledo hot briquetted iron facility, to complement its existing long-term minimum volume pellet offtake agreements with other key integrated steel producers. Further, the potential startup of pig iron manufacturing at AK Steel’s facility in Ashland, Kentucky, would create future opportunities for pellet demand and more metallics products without significant additional capital expenditures.

• Offers accretion through significant annual synergies: The transaction offers significant potential for operational synergies, which will contribute to long-term value creation for investors. The combination is expected to generate approximately $120 million of annual cost synergies to be fully realized within the first 12 months after closing, primarily from consolidating corporate functions, reducing duplicative overhead costs, and procurement and energy cost savings, as well as operational and supply chain efficiencies.

• Creates a stronger company with compelling pro forma financial metrics: The combined company is expected to benefit from a larger and more diversified base of customers, with less overall emphasis on commodity-linked contracts. 

Following completion of the transaction, Newport will retire as CEO and a director of AK Steel. Three existing members of AK Steel’s Board of Directors will join the Cliffs Board, and two existing Cliffs Board members will step down, bringing the Cliffs Board to 12 members. AK Steel will become a direct, wholly-owned subsidiary of Cliffs and will retain its branding and corporate identity. Cliffs will continue to be listed on the NYSE with its headquarters in Cleveland, while maintaining a significant presence at AK Steel’s current offices in West Chester, Ohio, along with its Research and Innovation Center in Middletown, Ohio.

The transaction is expected to close in the first half of 2020, subject to approval by the shareholders of both companies, receipt of regulatory approvals and satisfaction of other customary closing conditions. AK Steel shareholders will receive 0.40 shares of Cliffs common stock for each outstanding share of AK Steel common stock they own. Upon completion of the transaction, Cliffs shareholders will own approximately 68 percent and AK Steel shareholders will own approximately 32 percent of the combined company, respectively, on a fully diluted basis.

Cliffs has obtained an approximately $2 billion financing commitment from Credit Suisse in connection with a new asset backed loan and the refinancing of AK Steel’s 2023 senior secured notes.

The transaction has been unanimously approved by both companies’ boards, and both recommend that their respective shareholders vote in favor of the transaction.