Russian Businesses Buying American

COUNTRY BRIEFING - FROM THE ECONOMIST INTELLIGENCE UNIT

Russia’s leading steel producer, Evraz, and nickel giant Norilsk Nickel have announced major US acquisitions. With further domestic consolidation not on the cards, and much of the work to secure raw materials already done, Russia’s leading metals firms are now focused increasingly on acquisitions in developed markets. Yet for the foreseeable future, their growth is likely to be hindered by Russia’s murky reputation.

Evraz, Russia’s leading producer of steel, announced on November 20th that it had agreed to buy Oregon Steel Mills—the fifth-largest steel producer in the US—for US$2.3bn. The Oregon board unanimously recommended the bid, which will enable Evraz’s to produce 16.8m tonnes of crude steel per year and 17.4m tonnes of products. Also on November 20th, Norilsk Nickel—the world’s largest producer of nickel—announced a US$408m deal to buy the nickel assets of OM Group (US); this will increase Norilsk’s annual output by around 15% or 35,000-45,000 tonnes, through the addition of refining and mining operations in Finland and Australia.

Russian steel firms have been active in the US market before. In 2004 Severstal, Russia’s second-largest steel company, bought eighth-largest US producer Rouge Steel for US$286m. In 2006 Evraz bought the Strategic Minerals Corporation for US$110m. Evraz has also been active in other developed markets, buying Italian counterpart Palini e Bartoli for US$678m in 2006. Severstal too has made an acquisition in Italy, while Norilsk Nickel in 2006 bought a 20% stake in Goldfields of South Africa for US$1.2bn.

Targeting America

Until recently, the expansion of Russia’s leading metals players has been directed mainly towards one or two objectives: securing raw materials or expanding production capacity. Aluminium giant Rusal, for instance, has cut deals in Guinea, Nigeria, Guyana and Australia in a bid to become more self-sufficient in bauxite. Evraz bought the US-based Strategic Metals Corporation partly to secure more vandium, which is used to fortify steel, and to gain the ability to process it.

Norilsk Nickel’s deal with OM fits into the other headline objective—the expansion of production capacity. So also does Evraz’s acquisition of Oregon Steel Mills. However, these deals also point to a third strategic objective: the growth of market share in developed economies. Via Oregon Steel Mills, Evraz will find a market for its semi-finished products in the US market: the Russian company will supply slabs to the North American plant, which will roll them into steel plate. In addition, Oregon will give Evraz exposure to the steel pipe market in the US. Poor access to the US market is a key factor behind acquisitions of the kind that Evraz has just agreed. Because Russia remains outside the WTO, it is particularly vulnerable to anti-dumping actions that are difficult to challenge successfully. Until Russia enter the WTO, therefore, the best way around the hurdles is via US acquisitions. A similar logic informed Severstal’s purchase of Rouge Steel in 2004, as this was the Russian company’s best chance of supplying the US auto industry with high-quality steel.

Coming on strong

In pursuing expansion through acquisitions, Russian metals companies have relied on four core strengths. First, they have been able to act swiftly and decisively, because of their concentrated ownership. Most big Russian steel firms are majority owned (and often run) by one or a very few owners who built the business from scratch. Second, they are cash-rich as a result of several years of high world commodity prices and strong growth in Russia and other emerging markets where they operate. Third, they have access to low-cost raw materials. And fourth, as Russian companies, they are well suited to operating in emerging markets in eastern Europe, Asia and Africa—and these have been the prime growth area for many metals firms in recent years. Now, as Mittal Steel’s takeover of Arcelor has demonstrated, some emerging-market multinationals feel able to take on Western giants in their home markets.

The aggressive approach to foreign acquisitions taken by Russia’s metal giants is a result of historical factors and contemporary trends towards global consolidation in their sectors. Russia’s steel complex was built up during the Soviet Union as an integral part of an economic area embracing the entire Soviet bloc, including east-central Europe. As a result, it was endowed with production capacity far in excess of domestic demand in post-Soviet Russia. The transition disrupted supply chains as well as trading relations with markets. So as the consolidation of metallurgy enterprises within Russia gathered pace, it was natural for these firms to look abroad—in the first instance, to other former Soviet states—to secure raw materials, and soon after to find new markets.

The consolidation process also contributed to the proactive stance of Russia’s steel giants today. The owners of Russia’s atomised metallurgy businesses during the 1990s faced a stark choice—acquire or be acquired. Those who now lead the big metallurgy firms have an inclination for acquisitions and plenty of experience. Today, the bias towards takeovers is enforced by a global wave of consolidation, particularly in the steel industry, exemplified by the merger between Mittal Steel and Arcelor, and more recently the battle to acquire Anglo-Dutch Corus.

Maligned metallurgists

Because of their bargaining strengths and outlook, Russian companies are likely to seek further acquisitions in developed markets. Few other avenues are open. Further consolidation within Russia is not in prospect for the foreseeable future, and growth possibilities in the domestic market have been exhausted.

In some quarters, the expansion drive is a cause for concern. Russia’s state-controlled oil firms have become increasingly assertive in Russia in the last two years, to the detriment of foreign investors. Gas monopoly Gazprom, meanwhile, has used its strength as a supplier to enter downstream markets in Western Europe—and has threatened, on occasion, to redirect gas supplies if its expansion plans are thwarted. Elsewhere, the state-run arms export agency is busy consolidating large parts of the military industrial complex and has very recently taken a majority stake in the company that controls a third of the world’s supply of titanium.

However, to group Russia’s steel firms together with these state-run corporations is a mistake. Metallurgy is an area of government interest, to be sure, but steel and aluminium, and even nickel and platinum-group metals, are not as politically sensitive in Russia as oil and gas. These companies are privately run and commercially driven, even though the owners need to keep President Vladimir Putin happy. Unlike Gazprom, no major steel company has acted as a government proxy to buy media outlets, nor has one bankrolled a government vanity project such as the construction of an Olympic village near Sochi. Nevertheless, one of the major hurdles for these companies in expanding abroad is the perception that they are too closely linked to the Russian government.

A further concern, and one that is more valid, centres on the lack of transparency with regard to finances and ownership of these companies, as well as concerns over corporate governance and environmental responsibility. These shortcomings counted against Severstal when it sought to compete with Mittal Steel for Arcelor. However, Severstal’s subsequent London IPO was a clear sign of the Russian metallurgy firms’ willingness to address these concerns head on. Although all need to do more on this front, the perception of outsiders often lags reality. While it continues to do so, Russian firms—regardless of their ownership, management and commercial credentials—will be at a disadvantage in competing for assets in developed markets.

Whilst every effort has been taken to verify the accuracy of this information, The Economist Intelligence Unit Ltd. (http://www.eiu.com/) cannot accept any responsibility of liability for reliance by any person on this information

To subscribe or visit go to:  http://www.riskcenter.com