According to a statement made by Cleveland-Cliffs (CLF) on Sunday, the firm revealed that on July 28th it had made an offer to the Board of Directors of US Steel (X) of $17.50 in cash and 1.023 shares of CLF stock, for the company. As of Friday afternoon's closing bell, this valued US Steel ast $32.53 per share, which would be up 43% from where ($22.72) the stock closed that day.
US Steel made a statement of its own on Sunday. Though rejecting Cleveland-Cliffs' bid as being "unreasonable", CEO David Burritt of US Steel said in the press release that "The Board is taking a measured approach to considering these proposals, including seeking more information in order to evaluate proposals that are preliminary and subject to ongoing due diligence and review."
Apparently, US Steel has received multiple offers spanning from the acquisition of specific assets to proposals for the entire company. US Steel has interestingly invited Cleveland-Cliffs to participate in its newly launched review process.
It Gets Intense
US Steel is claiming that it is unable to properly evaluate the Cliffs' proposal as Cliffs has not engaged or shown a willingness to engage in a "customary" process to assess valuation unless US Steel agrees to terms in advance.
Cleveland-Cliffs claims that it is ready to engage immediately in "substantive" talks with US Steel to find a way toward reaching a mutually acceptable definitive agreement. It is believed that the two firms if merged could achieve $500M worth of synergies. In a press release of his own, Cleveland-Cliffs CEO Lourenco Goncalves said, "US Steel's Board of Directors rejected our proposal, calling it unreasonable. As such, I believe it necessary to now make our proposal public to help expedite substantive engagement between our two companies."
The union involved, the United Steelworkers, has affirmed in writing, that it would endorse this transaction with Cleveland-Cliffs and Cleveland-Cliffs alone, indicating that those other "multiple" bids would have trouble gaining traction.
Drawing The Lines
There is no deadline or specific timetable set for US Steel to complete its strategic review. The firm says that there is no assurance that the result of such a review would conclude with the consummation of a transaction or any other possible outcome. For that matter, US Steel has retained Barclays Capital (BCS) and Goldman Sachs (GS) as financial advisers, while Cleveland-Cliffs has bought aboard Wells Fargo (WFC) , Goldman Sachs, and UBS Group (UBS) . Interesting that Goldman is reportedly advising both sides.
A combination of the two companies would create a company with about 30M tons of shippable steel capacity, also with substantial iron ore and coal assets. According to the World Steel Association, this would create the largest such company in North America, putting it ahead of Nucor (NUE) . There could be regulatory hurdles. The two firms as one would effectively control 100% of the US iron ore market. Both names are huge in automotive grade steel.
Current US regulators have gone to extremes, even at the expense of looking quite foolish at times, in taking stances against mergers between US companies that have appeared to have worked out issues between themselves and with competitors on their own. Despite the fact that nine of the largest 15 steel companies in the world are Chinese and consolidation may be the best way for US steel companies to remain globally competitive, current leadership at the FTC can not be trusted to refrain from interfering, even at a potential cost to US commerce in the aggregate.
It is important to note that under Goncalves, Cleveland-Cliffs has been a buyer of growth, acquiring both AK Steel and the US operations of ArcelorMittal (MT) . This has made the firm the largest producer of flat-rolled steel in North America. Let's remember, the US is expected to launch a large infrastructure building plan that could end up providing new business to key players in this and many other industrial type firms.
Reaction
The shares of US Steel were trading with a $28 (+25%) handle in the early going, while the shares of Cleveland-Cliffs were also trading higher, up almost 3% with a $15 handle. CLF trades at nine times forward looking earnings, after reporting in late July. The firm has not paid a dividend since 2020. The firm posted a GAAP EPS of $0.67 for its second quarter on $5.98B. The bottom line print missed by a penny, while the top line number beat Wall Street despite contracting 5.7% year over year.
US Steel also reported in late July. US Steel beat Wall Street's expectations for both top and bottom line results, despite a 20% decrease in revenue generation. US Steel trades at five times forward looking earnings, and yields 0.88%.
Cash Flows & Balance Sheets
For the trailing twelve month as of the June quarter, CLF generated operating income of $1.873B. Out of this came CapEx of $794M, leaving free cash flow of $1.079B. Over that same time frame, X generated operating cash flow of $2.723B. With CapEx over that time at $2.462B, free cash flow over twelve months lands at $261M.
Turning to the balance sheets, CLF ended the quarter with a cash position of $34M and inventories of $4.727B, putting current assets at $7.165B. Current liabilities add up to $3.408B. This lands the firm's current ratio at a more than acceptable 2.10, but its quick ratio at just 0.72, which is not a problem as long as all of the firm's receivables are paid.
Total assets amount to $18.303B, including $1,337B worth of goodwill and other intangibles. Total liabilities less equity comes to $10.259B, including long-term debt of $3.963B. The firm's current position is solid on the surface, but "iffy" when digging in. The paltry cash position could be problematic.
As for letter X, the firm ended the most recent quarter with a cash position of $3.08B, inventories of $2.54B. This has put current assets at $7.835B. Current liabilities add up to $4.072B. This lands the firm's current ratio at a nice 1.92 and its quick ratio at a "robust" 1.30.
Total assets amount to $20.209B, including $1.377B worth of goodwill and other intangibles. Total liabilities less equity comes to $9.491B including long term debt of $3.843B. The firm's cash position covers more than 80% of that load. By contrast, CLF's puny cash position covers just 8.6% of that firm's long-term debt-load.
My Thoughts
Very interesting deal. Both firms create positive free cash flow, though Cleveland-Cliff's cash flow generation ability is far superior to US Steel's. That said, US Steel's balance sheet is in far better shape than Cleveland-Cliff's. I guess with an intention to pay US Steel $17.50 a share in cash and the rest in stock would mean that CLF is going to have to meaningfully add a long-term debt-load of $3.963B, basically because the firm has very little cash on hand.
X is trading at a rough $4 discount to the take-out price, which goes to show that investors do not truly trust that this particular deal gets done. I think shareholders of CLF are really in a jam here. With a balance sheet like that, the firm is in no position to be acquiring large competitors. As a matter of fact, I think Cleveland-Cliffs should pull the bid and just go to work on correcting imbalances that I would be very uncomfortable with.
I would think that CLF is probably a candidate for a short position here. Close to 7% of the firm's entire short is held in short positions, so there is already plenty of company. I don't love this price for US Steel either, but if they are being honest about having other bids, then maybe it is warranted. 8.5% of the entire float in letter X is already held short. 8% is kind of my cut-off. I do not like to short stocks that run with short positions that comprise 8% or more of their entire float.
Readers will see that CLF hit stiff resistance at the "half way back" point of the November through March rally. From there the stock has consolidated with support just under $14 and resistance up around $17.50. My thought? This stock goes to $12 either on news of a deal or even news of no deal.
Trade Idea (minimal lots)
- Sell Short 100 shares of CLF at or close to the last sale of $14.60
- Sell short one January 19th CLF $12 put for about $0.60.
Net Basis: $15.20
Target: $12
Panic: $17 (200 day SMA)
