Should Arrium steel for a takeover tussle?

The relatively rapid return of the ‘'Steelmakers Australia'' consortium to its tilt at Arrium with a slightly re-worked version of their original proposal has been instantly rebuffed, again. The Arrium response was so predictable that it raises the question of why the consortium adopted the approach that it did.

With the consortium, which includes the Hong Kong based commodities trader Noble Group, South Korea's POSCO and some Korean pension funds, now saying that it has determined it will cease seeking engagement with the Arrium board we'll probably never know, although it is presumably an option for Steelmakers to adopt a more hostile approach that seeks to circumvent the Peter Smedley-chaired board.

Ceasing engagement doesn't necessarily mean surrendering ambition, although the nature of the Arrium register and the likelihood that the ‘'revised'' indicative price was so far short of the level at which Smedley and his board might consider engaging or be forced by the market to engage may mean that the consortium doesn't really have any realistic tactical options.

Even if Smedley weren't Arrium's chairman the original, unfinanced, highly-conditional and less than informative approach at 75 cents a share seeking due diligence, conversations with Arrium's bankers and the backing of Arrium's board for a scheme of arrangement was always going to be dismissed out-of-hand.

The fact that Smedley, with a known track record of responding dismissively to similar proposals, is chairman absolutely guaranteed that outcome, particularly as it was so opportunistically timed to take advantage of the abrupt and steep fall in iron ore prices to less than $US87 a tonne.

Adding another 13 cents a share to 88 cents a share when the iron ore price has bounced back up to around $US120 a tonne, and after Arrium has just shipped its first tonnes of ore from a new mine that will double its iron ore production, was a waste of effort while the offer remained highly conditional and without any funding in place.

It is interesting that Steelmakers' response to its latest rejection cited, as one of the factors it took into account in framing its approach, a belief that iron ore prices would continue to trend down towards $US85 a tonne and remain extremely volatile.

POSCO said recently that its interest in Arrium was sparked by a desire to increase its iron ore self-sufficiency but if it did believe the iron ore price would fall back to $US85 a tonne it probably wouldn't need to acquire a physical hedge against its exposure to the price.

The broader view in the market is that the current iron ore price reflects the costs of marginal production within the industry and therefore provides something of a floor price.

The market consensus also says that the increased indicative price was only four times Arrium's forecast earnings in 2014, the first full year where it will gain the full benefit of that near doubling of iron ore production, so Steelmakers' view of the iron ore outlook seems at odds with the broader market's.

That doesn't mean that the consortium will be proven wrong, but it does mean that it would take a very significant lift in the price to get any traction in the market, let alone with Arrium's board.

POSCO has also said it would only hold a small (but unspecified) interest in the consortium, which makes it difficult to understand the strategic agenda Steelmakers Australia was pursuing and therefore come to any conclusion about the likelihood, if any, of its return.

It could have been purely opportunistic, given the sharp fall in Arrium's share price as the iron ore price cracked.

POSCO's recent ratings down grading (it lost its single-A rating) after a 25 per cent slump in earnings and its proposed sales of assets probably explain why it planned to have only a small initial exposure to Arrium if the offer had succeeded. (While the identity of the consortium members is known the proposed distribution of its equity wasn't disclosed.)

It is, however, the natural strategic player within the consortium given Arrium's portfolio of steel-making and distribution, grinding materials and, increasingly, iron ore, (where it is in the process of doubling its production). Korean pension funds don't appear natural long-term owners of an Arrium.

The other curious aspects of the approach is that it was conditional on being able to talk to Arrium's existing lenders about the refinancing of their existing debts and that the only comfort Arrium was given that the consortium, despite its apparent credentials, actually had access to funding was a very conditional letter of comfort from Bank of America Merrill Lynch which didn't even specify the amount of funding it might be prepared to provide or arrange.

What happens next, if anything, is anyone's guess but it is hard to believe a group as substantial as POSCO would become engaged in a takeover approach that was purely opportunistic.

It would, however, be difficult to mount any kind of offer for Arrium, with its widely dispersed and – because of its origins within the old BHP Steel business – retail-flavoured register, without the support of the board.

The board's support might also be needed to have a realistic chance of gaining Foreign Investment Review Board approval, given the significance of Arrium – and the dependence of its former BHP Steel sibling, BlueScope Steel on it, as its biggest customer – in terms of a domestic steelmaking capability.

From Arrium's perspective, if the consortium does fade away never to return, the curious episode could have a useful side-effect.

Arrium changed its name from OneSteel to try to change market perceptions of it as predominantly a steel maker. As the world's biggest grinding materials business and with iron ore production of about six million tonnes now climbing towards 12 million tonnes a year the group is rapidly evolving into far more of a materials group than a steel company, with its steel and grinding materials businesses (which is tilted towards copper and gold mines) providing something of a natural hedge against a fall in iron ore prices.

If the approach has helped sell that message to the market, it has done Arrium a favour.

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