US Nippon Steel rebuff would be cruel and kind

Steel yourselves. So much for an M&A shortcut. It looks increasingly likely that the Biden administration is about to block Nippon Steel's $14.9 billion agreed takeover of United States Steel, Reuters reported in an exclusive on Sept. 5 citing three people with knowledge of the situation. That would be both a cruel and kind blow to the Japanese company's plans to offset challenges at home and beyond.

U.S. presidential candidates Kamala Harris and Donald Trump had already voiced their opposition to the tie-up. Now the Committee on Foreign Investment in the United States (CFIUS) has, in a letter seen by Reuters, said the deal would damage American steel production, among other things.

Arguably the issues Nippon Steel is trying to tackle should give CFIUS some comfort. Japanese production dominates the $20 billion industrial giant's output, accounting for the vast majority of its 66 million tons a year of steelmaking capacity. But that market is shrinking, pushing Nippon boss Eiji Hashimoto to look abroad. Owning U.S. Steel would give it 20 million tons a year of capacity in a market where demand for high-grade steel is strong and where tariffs of 25% imposed on imports of the metal in 2018 have bolstered profits.

That protectionism would add a partial bulwark to Nippon's earnings against developments in China. The country's property slump has reduced demand but with little change in its 1 billion tons a year of supply. The resulting overcapacity has left the vast majority of mills unprofitable, per Macquarie, and led to a 24% increase in exports in the first half of the year to 54 million tons. Fear of cheap Chinese exports has prompted Nippon and others to urge Tokyo to impose restrictions, Reuters reported last month.

Such concerns are good reasons for Hashimoto to leave the markets for U.S. Steel's output untouched. Last week Nippon publicly pledged to prioritise American-made metal for U.S. buyers, as well as to put a majority of U.S. citizens on his new subsidiary's board.

If the U.S. does forbid the deal, it'll leave Nippon more exposed to industry challenges and end Hashimoto's hope of quickly hitting his twin goals of 100 billion yen ($700 million)of annual underlying profit and 100 million tons a year of capacity. But he has other options, not least to build up to 30 million tons of annual capacity in India with joint venture partner ArcelorMittal.

Granted, such projects will take longer. But they also won't come with the whopping 140% premium he's offering for U.S. Steel that would cap the return on investment at some 5%, Breakingviews calculates, or around Nippon's cost of capital, per LSEG. On that score at least, U.S. authorities may be doing Nippon shareholders a favour.

Context News

The Biden administration told Nippon Steel in a letter on Aug. 31 that its $14.9 billion acquisition of United States Steel would pose a national security risk by harming the American steel industry, Reuters exclusively reported on Sept. 5. The three people who provided Reuters with the information added that the White House is poised to block the deal. The two companies were given until Sept. 4 to respond.