A Steel Arbitrage Opportunity

It takes a lot to shake a world made of metal, but the steel world shook indeed yesterday, as news of Netherlands-based Ispat International's (NYSE: IST) acquisition of International Steel Group (NYSE: ISG) began filtering down to create a realization that the Dutch company is about to become the world's second largest steelmaker (by revenues). Privately held Luxembourg steelmaker Arcelor S.A. would remain the largest with a couple more euros a year than the new company's $32 billion in revenues; Japan's Nippon Steel and JFE Holdings would become Nos. 3 & 4, with revenues of $27.7 billion and $23.4 billion, respectively. U.S. Steel (NYSE: X), with a piddling $11.6 billion in sales, will remain the biggest U.S.-based steelmaker.

The ISG/Ispat transaction goes as follows: A gentleman by the name of Mr. Lakshmi Mittal (according to the British paper The Independent, the U.K.'s richest man) owns a private firm, LNM Holdings, and a publicly listed firm, Ispat. Ispat will first buy out LNM and rename itself in honor of the architect of this plan: the Mittal Steel Company. Then Mittal will buy out ISG for $4.5 billion in cash and stock. By the time all three firms have been combined, Mr. Mittal's family will own 88% of this conglomerate.

According to the terms of the buyout, each of ISG's shares will fetch $21 in cash and $21 in Mittal stock. News of the deal initially sent ISG shares soaring 19% in price to reach $35.25 on Monday, then another 6% to $37.34 by the end of Tuesday (with shares of peer steelmakers Nucor (NYSE: NUE), AK Steel (NYSE: AKS), and Steel Dynamics (Nasdaq: STLD), among others, rising in tandem). That still leaves a difference of nearly $5 between the offer price and ISG's current price, however -- a relatively large difference in comparison to similar buyouts that apparently reflects the market's uncertainty that the deal will receive regulatory approval in all of the 14 jurisdictions in which the companies do business. The deal is expected to close in the first quarter of 2005, though, so over the next two to five months, that difference should narrow as the likelihood of its completion increases. In the meantime, it offers risk-taking investors a chance to buy a dollar for $0.90.

Worst-case scenario: the deal doesn't go through, and an investor gets "stuck" with shares of a solo ISG -- a company that just reported earnings suggesting it will make about $5.50 in profit this year, giving it a forward P/E ratio of less than 7 even after its share price jump.

Confused about "buyouts" and "arbitrage" on offer prices? Visit this classic string from the Fool's Imperial Parking discussion board and see how the Foolish arbitrageurs analyzed that situation.

Fool contributor Rich Smith has no interest in any of the companies mentioned in this article.