CLF and AKS Merger: Could Goncalves Be the X Factor?



  • Earlier this week, Cleveland-Cliffs (CLF) announced that it will acquire AK Steel (AKS). CLF stock fell after the announcement but recovered.
  • Cleveland-Cliffs’ current CEO, Lourenco Goncalves, will lead the merged entity. AK Steel’s current CEO, Roger Newport, will retire. Will Goncalves be the X factor that AK Steel needs?
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CLF and AKS merger

Cleveland-Cliffs will acquire AK Steel to become an integrated steel producer. So far, the company focused on mining iron ore. AK Steel was among the company’s top customers. Now, along with being a supplier, CLF will also be a competitor to US steel companies. Under the leadership of Cleveland-Cliffs’ current CEO, the company has taken several strategic initiatives like asset sales and getting into the metallics market with its HBI plant. Overall, the transformation went well.

U.S. Steel’s transformation

For U.S. Steel (X), a transformation has been underway for a long time under different names. While U.S. Steel’s previous CEO Mario Longhi started the “Carnegie Way” plan, the company is currently investing in its plants under the “asset revitalization” plan. The current urge to invest massively in plants might be a repercussion of investing less in plants under the previous Carnegie Way plan. Incidentally, without naming U.S. Steel, Goncalves took potshots at the company during the conference call to discuss the merger.

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AK Steel

While AK Steel’s management has also been taking measures to address some of the legacy issues, they haven’t yielded perfect results. The company acquired the Dearborn plant in 2014 at the peak of the steel cycle. The company followed up with the debt-fueled purchase of Precision Partners. Although the transactions made sense from a strategic perspective, they led to higher debt levels for AK Steel. The company’s weak balance sheet doesn’t give it the flexibility to freely explore acquisition opportunities. Notably, AK Steel is among the most financially levered steel companies. The company’s profit margins would appear lower especially given its focus on higher-margin and value-added steel products.

Could Goncalves be the X factor for CLF?

Like in any other merger transaction, CLF cited synergies and the strategic potential. For the record, we don’t doubt anything. However, we are concerned about AK Steel’s high leverage. The company’s higher financial leverage is also a concern for credit rating agencies. After the announcement, Moody’s put Cleveland-Cliffs’ credit rating on a review for a downgrade. Read CLF Acquires AKS: A Match Made in Heaven? for the merger’s strategic rationale.

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Now, this is where Goncalves’ experience might come handy. AK Steel’s business model is actually enviable, which Goncalves pointed out. The company sells two-thirds of its steel to automotive companies—a lucrative proposition for any steel mill. Also, AK Steel produces electrical steel, which is a very niche and sophisticated product. Not many companies globally produce electrical steel. Given the nature of the business, AK Steel is less exposed to volatility in spot commodity-grade steel prices and imports. Automotive customers usually prefer reliability over price. Most of them buy from domestic steel mills.

AK Steel’s cost of debt and leverage ratios

After CLF acquires AK Steel, it will help bring down AK Steel’s current cost of debt. However, we might need to watch for any credit rating repercussions for Cleveland-Cliffs after the transaction. Also, CLF might explore selling some of AK Steel’s non-core assets to garner cash. Selling some non-core assets would help address AK Steel’s high debt levels. In my view, apart from all of the synergies and strategic rationales, CLF’s current management team, especially, Goncalves, might be the X factor for the transaction. Given his record with Cleveland-Cliffs, I would put my two cents on Goncalves!


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