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Alok Sheel: The emerging structural metal empires

Alok Sheel  |  New Delhi 

Although and have been engaged in merger talks for some time, Alcoa's dramatic cash and stock offer of $33 billion to buy out one of its biggest competitors has taken the aluminum industry by storm. Some analysts believe that this is a defensive move since both companies have lost market share to aggressive and more competitive Russian, Chinese and Indian companies recently. Alcoa, the biggest aluminum company since the dawn of the aluminum industry would, in particular, have felt threatened by the recent which created a company of comparable size. The proposed merger is also symptomatic of the consolidation at work in the structural metals sector, following close on the heels of the RUSAL-SUAL, and Tata-Corus deals. A major stimulus driving such consolidation is to leverage the current sustained boom in prices to grow in size and hedge against volatilities inherent in commodity markets.
What strikes about this deal, however, are its parallels with the high profile deal in the steel industry. Both mergers involve two of the biggest players in the structural metals industry and aim at creating humongous entities that will leave their nearest competitors far behind in both revenue and capacity. The combined revenues of will be around $72 billion, and the steel production capacity 130 million tons. However, while has 10 per cent of the global steel capacity, Alcoa-will have close to one third of both alumina and aluminum metal capacity. Their combined 2006 revenues of $54 billion would be higher than the aluminum revenues of their six biggest rivals (Hydro Aluminum, Aluminum Corporation of China, United Company RUSAL, BHP-Biliton, Rio Tinto and our own homegrown Hindalco-Novelis) taken together. This deal may, therefore, find it much more difficult to get past competition policy regulators. It is pertinent to note that the origins of lie in anti-trust action against in the past.
Secondly, both deals bring together low and high cost producers. Mittal Steel's putative efficiency deriving from cost-effective operations in developing countries is matched by Alcan's (13 per cent) higher profit/revenue ratio compared to (8 per cent). Alcoa's gross revenue at $30.4 billion is much higher than Alcan's $23.6 billion. The latter's higher profitability is based on the highly efficient state-of-the-art AP-18 smelter technology, of which it is now the proprietor following its recent acquisition of Aluminum Pechiney, and its Canadian connection (cheap hydro-electricity).
Thirdly, since alumina (along with power) cost is a key profit driver in the industry, both mergers are driven by the need to secure raw materials. Alcoa is very long on alumina, the powdery intermediate raw material used to produce primary metal. Alcan is short on alumina, exposing it to higher input costs during metal booms (since alumina prices are LME-linked) and lower price realisation during busts. The amalgamated entity would be long on alumina and could well add or buy into additional smelting capacity in future.
Finally, both structural metals behemoths would have a commanding, diversified presence in all key product segments across the globe, leading to reduced volatilities deriving from declining growth in any particular area or product segment in future. They will be fully integrated companies from the ore to the fabricated product, with maximum value addition and minimum input price volatility. It is pertinent to note that despite the current high prices of aluminum, the margins of essentially downstream players like Hydro Aluminum and Novelis are under pressure because they are short on alumina and/or metal.
The writer is a civil servant. The views are personal

First Published: Tue, May 15 2007. 00:00 IST
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