Ore and More

Shagang seeks to buy stake in CSN’s iron ore unit

Benjamin S. is always willing to sell his good assets to protect his not-so-good ones. CSN controlled Vale, and when the split came, Benjamin S. went the steel route. The fact is, he probably did not have a choice at the time, but had he instead even taken a minority stake in Vale, he would have been better off.

Now he has put a mine up for sale. The reason for this is simple. Greenfield steel mills cost $2,000 per tonne of annual capacity to build, and he wants to double his steelmaking capacity. The only way to do this is to get a balance sheet that can spend the cash, and the asset to sell to get that balance sheet is the mine. As a 10 million tonnes per year steel producer, he is going to need 16 mt/y of iron ore. The rest of the ore is going to go to the seaborne market, and he is betting that he can get more in a lump sum now in this bull market than he could get over the life of the mine in earnings.

So he has a two-thirds interest in a 45 mt/y mine to sell, and the questions are, what is the value of that and who are the buyers?

Let’s start with the potential buyers, both miners and steel companies.

First, the miners: Xstrata, Anglo American, BHP, Rio Tinto, Teck Cominco, and Vedanta. Now, who on this list has the guts to make this kind of purchase? I think Xstrata will make a real bid. They need the asset, and they will pay dearly for it. It would really help Anglo’s iron ore strategy, so they will make a real bid. It is a good project to sit alongside the MMX project. It would, on top of what they own, put them in shooting distance of 100 mt/y of production. BHP and Rio Tinto will both make a real bid as it will further their Atlantic basin relationships, and they both need that. They also have the strongest balance sheets in the business. I think this project is going to be too rich in price for Teck or Vedanta.

The steel company buyers are going to be a different list: Baosteel, Sinosteel, Minmetals, and the rest of the Chinese will put in bids. Arcelor Mittal will put in a bid. He, however, likes to buy distressed assets, and not ones that can command full market price. I expect 2-3 Russian groups will put in bids—Severstal, for example. I do not see Tata putting in a bid as this would stretch their balance sheet, but then again, those that take the risks get the reward.

How the deal is going to be priced is very simple.

We can assume that the expansion is going to cost $80-120 per tonne of annual capacity. I am going to work with a 40 mt/y mine, but you could probably goose the project up to a 45 mt/y mine. There is currently a 14 mt/y mine. I am going to assume that CSN wants to keep 16 mt of production. So they are selling a 24 mt/y mine.

The operating costs of this mine will be under $20 per tonne, but we are going to say $20 to be safe. The product is an excellent concentrate, and will fetch full fines price. It is a really attractive product to China as they can use it to blend with domestic ores so that they can produce decent pellets. Current fines price is $1.22 per MTU of iron ore, and assuming a grade of 66%, the value of the ore is roughly $80 per tonne. So we have $60 in margin. I am going to assume a 10% discount rate, no growth in the price of iron ore, and a 30% tax rate. With these variables, I get a simple enterprise valuation of $420 per tonne of annual production (60*.7)/.1. Now, we are going to have to subtract the $120 per tonne of capital expenditure because we still have to pay for that, and I end up with a valuation of $300 per tonne of annual production. With 24 mt of production to be sold, he should get US$7.2 billion.

I think that is the floor of the valuation, I would not be surprised if he got up to US$10 billion for the mine, as I think there is some growth in capacity beyond my numbers. In any case, this is a significant amount of capital, and it should let him double the size of his steel works debt-free.

On the whole, if I were in Benjamin S.’s shoes, I would sell the mine under those terms as the thought of taking $10 billion of leverage and keeping the mine is very scary. If I were Mittal, I would not sell the mine, but rather use the supply of cheap ore as a method to buy other steel companies. Benjamin S. has proven, however, that he does not have the nerve to buy when the assets are cheap, so he is right to sell when he can get a decent price.