Nippon Steel Is Not A Threat

Once the largest company on the planet, U.S. Steel (X) was established in 1901 when the steel companies of J.P. Morgan and Andrew Carnegie merged. The company played a vital role during the 20th century, enduring the Great Depression and contributing to manufacturing efforts during World War I and II.

However, the oil and trade crises of the 1970’s and the Asian currency crisis and trade agreements of the 90’s diminished the company's influence and forced it to restructure.

“That company peaked out in 1916,” longtime steel industry analyst Charles Bradford told CNN in August when the bidding started for U.S. Steel. “It’s been downhill ever since. Peak output was in the 1970s. It’s done nothing for decades.”

The company’s peak employment of 340,000 came in 1943, during World War II, when it played a critical role in the Allied forces’ war efforts.

Steel output peaked in 1953, when the company produced 35.8 million tons of steel while steelmakers in Europe and Japan were still struggling to recover from the war. Last year, U.S. Steel shipped only 11.2 million tons of steel from its US operations and had just under 15,000 US employees.

In 1959, U.S. Steel was challenged when half a million steelworkers began one of the longest and most damaging strikes in U.S. history. President Dwight D. Eisenhower intervened using the Taft-Hartley Act to compel workers back to their jobs, citing concerns for national security. 

The strike marked a turning point for U.S. Steel and the steel industry. Its aftermath saw the company's slow decline and eventual removal from the S&P 500 index in 2014. Valued at $3.8 billion, a 30% drop from 1959, U.S. Steel's fall reflected broader shifts away from heavy manufacturing in the U.S. economy. 

Later trade protections under the Reagan, Clinton, and Bush administrations tried unsuccessfully to protect domestic steel production and keep U.S. Steel afloat. The failure to adapt to newer technologies and changing customer preferences, which favored competitors like Nucor, contributed to U.S. Steel's decline. 

Cleveland-Cliffs Rejected

Price increases and trade protections did little to protect the broader domestic steel industry from consolidation and foreign competition, and in 2023, U.S. Steel quietly began considering bids for the entire company. 

By August, the company had rebuffed a takeover bid from rival Cleveland-Cliffs Inc. (CLF), which sought to create one of the world's largest steelmakers. The proposed cash and share deal, valued at approximately $7.25 billion, reflected a 43% premium at the time.

Cleveland-Cliffs produced 16.8 million tons of steel in 2022, while U.S. Steel produced 11.2 million tons at its US operations and another 3.7 million tons in Europe. The deal fell apart after Cleveland Cliffs executives refused to sign a company-wide non disclosure agreement. 

Shortly after, Esmark Inc entered the contest, with an all-cash public offer of $7.8 billion, or $35 per share. Esmark, which has a number of steel interests in its portfolio, noted in its statement that the deal would be “subject to regulatory and antitrust clearances.”

Esmark majority owner and chief executive James Bouchard said in an interview that his steelmaker, which does not publicly report its earnings, has cash for its $7.8 billion bid for U.S. Steel Corp (X.N) sitting in his bank account. "I got $10 billion in cash in my bank account," Bouchard said. He did not provide more details to verify he has access to the cash.

Nippon Outbids

After a few more months of silence, Japan’s largest steelmaker Nippon Steel extended an offer of $14.1 billion or $55 per share, which U.S. Steel proudly accepted. The deal places an enterprise value of $14.9 billion for U.S. Steel. 

The proposed deal would make U.S. Steel a wholly owned subsidiary of Nippon’s North American division, and its finalization is expected in the second or third quarter of 2024, pending regulatory approval. 

“We are confident that … this combination is truly best for all,” said U.S. Steel CEO David Burritt. “Today’s announcement also benefits the United States — ensuring a competitive, domestic steel industry, while strengthening our presence globally.”

“U.S. Steel’s best days are ahead, together,” Burritt told investors at the conclusion of a conference call Monday.

According to estimates by the World Steel Association industry group, the total production capacity of the combined entity would be nearly 59 million metric tonnes, pushing it up to third place among global steel producers. 

Politicians on both sides of the aisle including Sen. John Fetterman and Sen. J.D. Vance reacted negatively to the proposal, citing national security concerns and fearing for the health of the dwindling manufacturing industry. 

But Harvard educated Nippon Steel President, Eiji Hashimoto, framed the acquisition in geopolitical terms, envisioning a dominant force in the global steel sector to compete with China.

Hashimoto emphasized the "sufficient economic rationality" of the deal and his desire to establish a comprehensive global network for the steel industry's evolving global landscape. According to a joint press release, the transaction “combines cutting-edge technologies…to advance innovation and deliver high-grade steel products…to customers around the world.”

Hashimoto has overseen Nippon Steel with an iron fist, forcing customers to pay more on their low margin orders, including its biggest customer, Toyota. 

Hashimoto would later sue Toyota, alleging that Toyota had used stolen technology for a steel material in electric motors, seeking damages equivalent to $176 million from Toyota and Toyota supplier Baoshan Iron & Steel, a subsidiary of China Baowu Steel.

Last year, Toyota said it would refrain from pushing suppliers for lower prices as the industry grappled with skyrocketing energy and materials costs. Despite initial losses when Hashimoto began his tenure in 2019, the company rebounded to generate a profit of $5.1 billion last year under his leadership.

The deal's political complexity will intensify as it faces approval from the Committee on Foreign Investment in the United States (CFIUS). 

National Security and The “Steel Crisis”

When Cleveland Cliffs made its offer in August, the United Steelworkers union vowed only to support an offer from another unionized American steel company. The union, which has 11,000 members at U.S. Steel, attacked the Nippon Steel deal.

“To say we’re disappointed in the announced deal between U.S. Steel and Nippon is an understatement, as it demonstrates the same greedy, shortsighted attitude that has guided U.S. Steel for far too long,” said USW President David McCall. 

“We remained open throughout this process to working with U.S. Steel to keep this iconic American company domestically owned and operated, but instead it chose to push aside the concerns of its dedicated workforce and sell to a foreign-owned company.”

In a letter to Treasury Secretary Janet Yellen, Republican senators urged the Committee on Foreign Investment in the United States (CFIUS) to block the sale, alleging that Nippon Steel’s allegiances lie with a foreign state. 

“[CFIUS] can and should block the acquisition of U.S. Steel by NSC, a company whose allegiances clearly lie with a foreign state and whose record in the United States is deeply flawed,” Sens. JD Vance (R-Ohio), Marco Rubio (R-Fla.) and Josh Hawley (R-Mo.) wrote.

Democrats are also critical of the acquisition, with concerns about its impact on the American steel industry and national security. 

“Today, a critical piece of America’s defense industrial base was auctioned off to foreigners for cash,” said Ohio’s Republican Senator JD Vance, in a statement. “I warned of this outcome months ago and will oppose it in the months ahead.”

The statement is ironic for Senator Vance, who wrote about the earlier acquisition of Armco by Kawasaki in his 2016 memoir “Hillbilly Elegy.” It was as though “General Tojo himself had decided to set up shop in southwest Ohio,” Mr. Vance recalled. Then the locals realized new owners could invest in their decaying community.

“The Kawasaki merger represented an inconvenient truth: Manufacturing in America was a tough business in the post-globalization world,” Mr. Vance wrote in his book. “If companies like Armco were going to survive, they would have to retool. Kawasaki gave Armco a chance, and Middletown’s flagship company probably would not have survived without it.”

Pennsylvania Democrat Sen. John Fetterman – who lives in and was previously mayor of Braddock, PA, where one of U.S. Steel’s first steel plants still operates – slammed the deal and promised to work to block the transaction.

“It’s absolutely outrageous that U.S. Steel has agreed to sell themselves to a foreign company,” Fetterman said in a statement. “Steel is always about security – both our national security and the economic security of our steel communities. I am committed to…block this foreign sale.”

Rep. Ro Khanna (D-Calif.) told The Hill in an interview that part of the corporate intention behind the deal is to boost Japanese exports of high-end steel while shifting U.S. production to lower-end steel in states where companies don’t have to pay union wage rates.

“What you’re going to allow Nippon to do is eliminate union jobs in Pennsylvania, Michigan, Ohio; send those jobs down South; move to mini-mills and get rid of blast furnaces; and have the blast furnace jobs…come from Japan.” Khanna said.

Neither party has mentioned moving or closing production facilities in the United States or laying off workers. A joint statement said “[Nippon Steel] has long admired U.S. Steel with [a] deep respect for its…talented workforce…we are committed to honoring all of U.S. Steel’s existing union contracts.”

But claims of the imminent demise of America’s domestic steel industry and threats to national security at the hands of “unfair” imports and deals are not new. In fact, they sound just like claims made by politicians and the press during the 1999 “Steel Crisis.”

Significant protectionist measures were proposed, and both President Clinton and Bush put significant tariffs in place to prevent foreign dumping on the domestic steel industry. 

However, a closer examination reveals that there was no steel crisis. In 1998, domestic steel mills shipped 102 million tons, the second-highest annual total in the preceding two decades. Moreover, 11 of the 13 largest steel mills were profitable in 1998, collectively earning over $1 billion. Steel imports continued to fall in 1999 and domestic productivity improved. 

Instead, the influx of steel imports could be attributed to the Asian economic crisis, resulting in a collapse in demand for steel in the region and a realignment of currency values that made foreign steel more price competitive in the United States. 

Global Steel Production

China and Chinese companies have become dominant players in global steel production, contributing approximately 54% of the nearly 2 billion tons produced annually worldwide, as reported by the World Steel Association. State-owned Baowu Group in Shanghai, China, alone produced nearly 120 million metric tons of steel in 2021. Baowu is still being sued by Nippon Steel.

In comparison, the combined steel production of Cleveland-Cliffs and U.S. Steel in the same year amounted to almost 33 metric tons. A combined entity would have been in the top 10 global steelmakers, albeit at the lower end of the list. The United States currently holds the fourth position in global steel production, behind China, India, and Japan.

In 2023, steel prices stabilized as countries sought alternative supplies to replace losses from the Russian and Ukrainian markets. Furthermore, China, the world's largest steel producer, lifted trade limitations associated with its previous zero-COVID policy. This change enabled China to utilize its steel production more freely on the global market, although efforts to reduce production persist.

The construction sector, which played a pivotal role in driving steel demand in 2021, is expected to experience a slowdown due to the phasing out of subsidies, increased uncertainties, rising prices of essential commodities, and a projected increase in borrowing costs. This deceleration in residential construction demand is anticipated over the forecast period.

To offset the cooling construction market, the machinery demand is projected to recover. Post pandemic, machinery demand saw growth as industrial activities picked up. Automation is becoming a significant area of investment, addressing labor shortages and mitigating risks of potential future shutdowns. Additionally, the agricultural machinery sector is expected to gain momentum amid the looming food crisis caused by Russia's invasion of Ukraine, with countries aiming to enhance productivity and yields.

The steel industry is increasingly focusing on sustainability, decarbonization, and circular economy practices. Escalating emissions permit costs, societal pressure, and government regulations are compelling carbon-intensive steel manufacturers to seek solutions for reducing their carbon footprint. 

Sustainability is poised to become a pivotal trend in the industry, with companies anticipated to invest in recycling scrap metal waste to diminish the environmental impact of their production processes. 

“We are excited that this transaction brings together two companies with world-leading technologies and manufacturing capabilities, demonstrating our mission to serve customers worldwide, as well as our commitment to building a more environmentally friendly society through the decarbonization of steel,” NSC President Eiji Hashimoto said.

Financial Performance

United States Steel (U.S. Steel) holds a strong market share, contributing to robust profit margins, Return on Invested Capital (ROIC), and Net Operating Profit After Tax (NOPAT). The firm's market share provides a competitive advantage, allowing it to achieve operational efficiency and impressive financial figures. 

U.S. Steel is expected to benefit from a favorable labor environment and a potential interest rate shift. Lower wage demands may lead to increased profit margins, and a shift in interest rates could enhance U.S. Steel's borrowing capacity, enabling aggressive expansionary capital expenditure (CapEX) cycles.

The company has consistently outperformed earnings expectations, with its third-quarter results revealing a revenue beat of $170.33 million and an earnings-per-share beat of 25 cents. U.S. Steel's business segments, including flat-rolled, tubular and U.S. Steel Europe have shown positive progress. 

Mini Mill activities, especially after the full acquisition of Big River in 2021, contribute to revenue diversification. However, the tubular business remains a strong performer, delivering EBITDA margins above 32% for the past five quarters.

U.S Steel’s Mini Mill’s are smaller mills that can be built around the country for less cost than a traditional mill, and provide state of the art finishing capabilities for U.S. Steel’s raw products. 

While U.S. Steel faces challenges with idled facilities like Granite City, Lorain, and Lone Star, these may not significantly impact the stock price due to their prolonged idle status. Looking ahead to 2024, U.S. Steel anticipates $200 million in new income from investments in the Big River Steel mill and steel products suitable for electric vehicles (EVs). The management expects the baseline net income to remain around $2 billion in 2024.

A Bad Economic Impact

Fears about an overreliance on Chinese production capacity during the pandemic has led to closer coordination among U.S. economic allies, especially in the Asia-Pacific region, notably Japan, South Korea and Taiwan.

The economic fallout from the pandemic has been catalyzing some longer-term tailwinds away from uniformly globalized production and toward increased domestic capacity, which may be another reason the U.S. Steel sale isn’t sitting well with lawmakers.

“We will unapologetically pursue our industrial strategy at home,” national security adviser Jake Sullivan said in a programmatic speech earlier this year on U.S. economic strategy.

Sullivan qualified his embrace of “industrial policy” — a doctrine of more centrally planning the economy that fell out of fashion in the mid-1970s — by saying Asian allies and international partners would be a central part of this shift in strategy.

“Through our trilateral coordination with Japan and Korea, we are coordinating on our industrial strategies to complement one another, and avert a race-to-the-bottom by all competing for the same targets,” he said.

But imposing barriers against steel imports carries a significant economic cost for the United States. While the domestic steel industry may enjoy temporary benefits, millions of American workers and tens of millions of consumers will face negative consequences. 

Consumers are likely to pay more for products made with steel, such as household appliances, trucks, and cars, by artificially propping up the domestic price of steel through trade barriers. 

According to the Cato institute, If protectionist measures raise the average price of steel mill products by $50 a ton, Americans could face the equivalent of a $6 billion “tax” on the more than 120 million tons of steel consumed annually. 

Steel protection measures also pose a considerable burden on major manufacturing sectors that heavily rely on steel as a primary input. Sectors like transportation equipment, fabricated metal products, and industrial machinery and equipment, employing a total of 3.5 million production workers, could be adversely affected. 

Production workers in manufacturing industries using steel as a major input far outnumber steelworkers, with a ratio of 20 to 1. Companies like General Motors, a major consumer of steel, have warned that anti-dumping duties or harsh policies on steel imports could negatively impact their ability to compete globally.

The construction industry, accounting for approximately 35% of domestic steel consumption, is one of the largest direct consumers of steel. Tariffs on imported steel would result in higher prices for homes and commercial office space, jeopardizing the jobs of thousands of construction workers. 

When considering non-manufacturing industries, the 8 million employees in steel-using sectors significantly outnumber the fewer than 200,000 steelworkers, with a ratio exceeding 40 to 1.

Smaller companies engaged in manufacturing metal products are especially vulnerable to rising import prices. These firms, typically purchasing on the spot market rather than long-term contracts, are the first to feel the impact of higher steel prices. 

As many of them also serve as suppliers to larger corporations, they are less capable of passing on increased steel costs in the form of higher prices for their final products.

U.S. Steel closed at $48.35 per share on December 26th, indicating the market predicts a roughly 58% chance of a merger.