By Paul Glader
2506 words
6 January 2005
The Wall Street Journal

(Copyright (c) 2005, Dow Jones & Company, Inc.)

In little more than a year, a once-obscure billionaire has put together the world’s biggest steelmaker. One of the United Kingdom’s richest men, Lakshmi Mittal became a staple of tabloid gossip after buying a $128 million mansion in London last spring. Shortly after, he spent $55 million on his daughter’s wedding, which featured a performance by pop star Kylie Minogue.

But rather than having reached his goal, Mr. Mittal is at a crossroads that is in many ways emblematic of the steel business itself. Although the industry has experienced a renaissance in recent years, in part as a result of consolidation and heady demand, there are concerns about a slowdown, especially in the crucial market of China.

Now the very strategy that brought Mr. Mittal and his family success — snapping up inexpensive businesses in neglected parts of the world — threatens to hurt it if the market turns. Although to date they have successfully wrung profits from government-owned plants, the Mittals also inherited Communist-era labor pacts, European Union production caps and some outdated operations. The company wants to upgrade its low-quality production to lure auto makers and appliance manufacturers as customers, but that effort will be costly.

Moreover, having reached the industry’s pinnacle, the Mittal empire now finds itself more closely monitored — and criticized. In October, the Mittal family combined its publicly traded steel operations with its separate private company and agreed to acquire International Steel Group Inc. — an agglomeration of American companies assembled by financier Wilbur Ross — for $4.5 billion. Now a giant that will combine all three companies, dubbed Mittal Steel Co., is trading on the New York Stock Exchange.

Some investors complain that the Mittals made billions of dollars in acquisitions for their private steel company that could instead have benefited their publicly traded operations — violating a promise in a public filing. Its move to let benefits lapse for American steelworkers’ widows drew such a storm of protest that the company quickly restored them.

The labor pacts and production limits that came with the Mittals’ acquisitions have “a lot of baggage,” says Peter Fish, managing director of U.K.-based MEPS International, an independent consultant to the steel industry. “They are carrying that now with them.”

In an interview, Mr. Mittal says a downturn will test the industry. But he dismisses concerns about his company’s future, noting its record of integrating acquisitions and confounding skeptics. “When you create something like this, you always have critics and challenges,” Mr. Mittal says.

Mr. Mittal, 54 years old, was named after the Hindu deity of fortune and prosperity. He was born in a small village in the desert region of Rajasthan, India. Soon after, Mr. Mittal’s father moved the family to Calcutta and began building a steel company. In 1975, Mr. Mittal’s father asked his son to finalize the sale of some land in Indonesia. Instead, Mr. Mittal won his father’s support to build a new steel business there.

In the early 1990s, against his father’s advice, Mr. Mittal bought steel operations in Mexico for $2 billion. That sparked a split in the family business, with Mr. Mittal taking its fledgling international operations and his brothers and father maintaining control in India, although they remain on friendly terms.

In 1995, free from family limitations, he gathered his executives in Hamburg, Germany. Taking a line from former General Electric Co. Chairman Jack Welch, Mr. Mittal talked about stretch goals, which he told them means trying “for huge gains while having no idea how to get there,” according to a transcript of the speech. His goal was to be the world’s biggest steelmaker. The company was then ranked 32nd.

While other steel entrepreneurs plowed their wealth into high-tech equipment, Mr. Mittal, joined in the business by his son, daughter and wife, invested in areas that others considered dead-end. Targeting places such as Kazakhstan, Romania and Algeria, he correctly gambled that less-developed countries would need huge amounts of low-grade steel to build roads and buildings destroyed by war or neglect.

His first big step in 1995 was to buy a steel mill in Kazakhstan, with an initial investment of $450 million, in part because it was close to China. Initially, the mill couldn’t get coal on time because of problems with the local rail system. Far from any port, it was hard to establish export routes. With no cash, the plant for years had been bartering steel for whatever it needed or thought it could resell. Mr. Mittal’s son Aditya recalls finding thousands of cases of Romanian red wine stored in the plant’s warehouses.

The Mittals ended the barter system and taught executives how to market and sell products. In 1997, the Mittals took their company public on the Amsterdam and New York stock exchanges under the name Ispat International NV. Ispat means steel in Sanskrit.

But in the late 1990s, the steel market tanked. A glut of steel, caused in part by state subsidies for domestic industries, sent prices through the floor. Many weaker companies sought bankruptcy protection. Ispat’s stock price languished, constraining the Mittals’ acquisition spree.

Instead, the Mittals created a holding company, 100%-owned by the family, called LNM Holdings NV, which continued buying steel plants in far flung places. It was funded by the Mittals’ own fortune and bank financing. They used the industry malaise as an opportunity to buy assets in Algeria, South Africa and in particular central and eastern Europe, where countries were desperate to sell off steel operations to gain admission to the EU.

In addition to demanding tax breaks, the Mittals insisted governments sell them iron-ore and coal mines, sharply reducing the costs of shipping these raw materials from Brazil or Australia. They outbid Mr. Mittal’s brothers, who are still running the Indian branch of the family business, for steel operations in Bosnia, and last year bought plants in Poland and Macedonia.

Using the family’s private company, “we bought 15 million tons of capacity in the worst downturn in the steel industry,” says Aditya Mittal, Mr. Mittal’s 28-year-old son and now president of Mittal Steel.

U.S. Steel Corp., which bid against the Mittals for the Polish steelmaker, thought the $1 billion price tag was too high, recalls John Goodish, the company’s vice president of operations. “We decided to walk away from that.”

Yet in many ways, the Mittals’ contrarian bets paid off. The demand for steel in developing countries has been robust compared with other parts of the world. New EU members have been given funds to invest in infrastructure projects, most of which require steel.

Ispat’s growth was topped in October last year with the acquisition of International Steel Group. Under the two-step deal, Ispat acquired the Mittals’ private company, LNM Group Inc., for about $13 billion, creating Mittal Steel Co. Mittal Steel will acquire ISG sometime in the first quarter. The new entity will be the world’s No. 1 steelmaker, leaping over Luxembourg’s Arcelor SA. Combined with Inland Steel, which Ispat acquired in 1998, the Mittals now own four of the five steel plants on the Great Lakes and, more importantly, some high-end steel-production facilities.

Mr. Mittal says he believes that by 2010 there will be three companies dominating the steel world, much as the three big car makers dominate the U.S auto industry. His next targets for growth: Turkey, a possible entrant to the EU, China and India.

But, in the ever-cyclical steel industry, there are signs of tougher times ahead. In recent years, steelmakers have increased production, helped by government subsidies, loan guarantees and consolidation. In doing so, they were trying to take advantage of rising prices caused by strong demand from China. Now, that country has become a net exporter of low-grade steel and its domestic demand is slowing, sparking concerns about oversupply.

Michael Johnston, senior partner in Seattle-based hedge fund Steelhead Partners LLC, which owns one million shares in Mittal Steel, calls Mr. Mittal “the best steel manager and best steel operator in the world.” He thinks, nonetheless, “people have to expect there are going to be hiccups. They are putting together a smorgasbord.”

Some analysts and competitors question whether the Mittals can use their diverse collection of businesses to supply car and appliance makers who demand high-quality steel. The Mittals say they want 70% of their output to be of this sort, up from 40% currently. The margins are better and emerging economies such as China aren’t in this business in a big way. They plan to invest about $400 million a year on capital improvements, mostly equipment and engineering staff, particularly in Eastern and Central Europe.

Guy Dolle, chief executive officer of Arcelor, now the world’s No. 2 steelmaker, says such an upgrade will be costly. “It is difficult to imagine in the next five years that Mittal Poland or Mittal Romania will sell significant volumes of product to the automotive industry,” says Mr. Dolle. “[Mr. Mittal] has to invest a lot to do that . . . That is the challenge for these times.”

The Mittals say they’ll be able to compete by taking advantage of the engineering and research talent they acquired along with ISG.

More than its rivals, observers say, the Mittal steel empire has inherited some ticklish problems through its acquisitions. New EU members, for example, have had to adopt EU rules limiting steel capacity to prevent oversupply.

In 2001, the Mittals shuttered a loss-making Irish plant acquired by Ispat. They say EU production limits prevented them from making a profit. The Mittals have also had to limit production on a new mill in Poland. Malay Mukherjee, chief operating officer of Mittal Steel, says the company was aware of the limits when it invested in these plants.

Many of the Mittals’ plants aren’t particularly lean. Their Kazakhstan operations employ about 53,000 — about a third of the local population — to make about five million tons of steel a year. By contrast, the company’s plant in East Chicago, Ind., makes roughly the same amount of steel with only 6,500 workers. As long as wages are low and raw materials cheap, the Kazakhstan plant is still churning out significant profits.

Even ISG, the Mittals’ big U.S. acquisition, isn’t problem-free. In a July filing with the Securities and Exchange Commission, made before the acquisition, ISG said its rapid growth “has placed a significant strain on our internal controls over financial reporting.” ISG said its outside accountants believed that the “deficiencies represent material weaknesses in internal control over financial reporting,” the filing said.

Mr. Mittal says “there may be some improvement needed in systems and processes,” but that the problem won’t affect the company’s financial results.

The Mittals’ biggest challenge will be adjusting to public scrutiny. In 2001, Mr. Mittal donated the equivalent of $235,000 to the U.K.’s ruling Labour Party, at current exchange rates. One month later, British Prime Minister Tony Blair wrote a letter to the Romanian prime minister supporting the Mittals’ bid for Romania’s steel operations. The letter said the bid could help Romania’s quest for EU membership, Mr. Blair’s office confirms.

The resulting political scandal, referred to as “steelgate” by one tabloid, dragged the company into the public spotlight. Mr. Mittal says he didn’t request the letter of the prime minister, but nonetheless has quit making donations to the party. “We have learned that people will try to make noise about this,” he says. A spokeswoman for Mr. Blair says the letter was written on the suggestion of the British ambassador to Bucharest, who she says was unaware of the Mittals’ donation.

The family’s lavish spending on houses and weddings has brought scorn from the British tabloids and complicated the Mittals’ labor relations. In July, London’s Daily Mirror wrote about the wedding of Mr. Mittal’s daughter, held at a 17th-century chateau and the Palace of Versailles. It quoted workers laid off from the family’s Irish plant. The story’s one-word headline: “OBSCENE.”

In August, the Mittals stopped paying benefits to about 2,000 widows of deceased U.S. steel workers. Union employees at Ispat Inland in East Chicago picketed the plant with placards highlighting the Mittals’ lavish spending. One woman in a wheelchair held a sign that said, “Mittal starves widows.”

At the time, a company spokeswoman, Nicola Davidson, said, “Mr. Mittal’s personal life is separate to the business . . . We don’t think these issues should play a material role in business discussions.” One month after the picket, the company reinstated the benefit.

Some investors are now making noise about other aspects of the Mittals’ business, notably the relationship between the Mittals’ private and public companies. After the Mittals sold shares of Ispat to investors in 1998, they said in an SEC filing that Mr. Mittal would only make acquisitions through the public company.

In October, when the Mittals combined their holdings to consummate the ISG acquisition, investors saw for the first time that the private holdings, however risky, were valued at about $13 billion. Mr. Mittal, who was paid a salary of $1.6 million by Ispat in 2004, received a $2 billion dividend from his private company as part of the ISG deal.

Some investors feel Ispat shareholders were denied the benefit of the private company’s acquisitions and worry that the family will go down this road again.

“One reason for investing with the Mittals is that [Mr. Mittal] is very good with acquisitions,” says Tim Hurckes, a New York-based stocks and bonds analyst, who used to own Ispat stock as a private shareholder. “But when [Mr. Mittal] didn’t have the money, he proceeded on his own and contrary to what he filed with the SEC.” Mr. Hurckes says he sold his “modest” stake because he was frustrated by the separate public and private businesses.

The family says it used the private company to make acquisitions to shield Ispat from high-risk acquisitions in places such as Poland and Kazakhstan. Mr. Mittal’s son Aditya says the promise contained in the initial SEC filing wasn’t binding. He says the family recently signed a more stringent noncompete contract, which mandates that all acquisitions will happen through Mittal Steel Co.

Mr. Mittal says an eight-member board will be created for the new company. Along with three family members, it will consist of five independent board members and maybe a nonexecutive lead director. “We have been diligent to adhere to high standards of corporate governance,” Aditya Mittal says.