Russia Retreats From U.S. as Sanctions Begin to Bite

And yet, as Russian steel giant Severstal leaves the U.S. market, it looks neither bruised nor battered.

Jul 21, 2014 at 12:45PM

Rouge Steel Works -- with Severstal's exit, it's back in American hands once more. Photo: Wikimedia Commons

Spooked by U.S. sanctions, is Russia ready to abandon the American market before things get worse?

Over the past several months, the United States government has announced multiple rounds of sanctions against Russia -- in punishment for, first, that country's invasion and annexation of Ukrainian Crimea and, more recently, its sponsorship of a bloody secessionist movement in Eastern Ukraine. The most recent sanctions, announced just last week, targeted several Russian defense companies, as well as energy companies Rosneft and Novatek, and banks Gazprombank and VEB.

And that was before the big news of last week.

One day later, Malaysian Airline Flight MH17 was shot down in Eastern Ukraine.

Uh oh
Uh oh is right. While details regarding the MH17 shootdown remain murky, its effects are already being felt ... in Ohio. This morning, Russian steel giant Severstal (literally, "Northern Steel") announced that it has entered into definitive agreements to divest its Severstal North America operations in a pair of unit sales.

In the larger deal, Fort Wayne, Indiana-based Steel Dynamics (NASDAQ:STLD) will buy Severstal Columbus (a nonunion shop based in Mississippi) and its 3.4 million tons of hot-rolled steel production capacity for $1.625 billion. Steel D says the acquisition will increase its annual production capacity by 40%, to 11 million tons, and put in its hands "one of the newest and most technologically advanced mini-mills in North America."

In the smaller deal, AK Steel (NYSE:AKS) will acquire Severstal Dearborn -- what used to be known as the fabled Rouge steel works. Picked up out of bankruptcy in 2004 for just $285 million, Severstal will unload its interest in Rouge for $700 million cash, a 145% profit in 10 years. In exchange, AK will gain Rouge, which just "completed a large-scale modernization campaign in 2011," plus "a cokemaking facility and interests in three joint ventures that process flat-rolled steel products." AK says the acquisitions will add 2.5 million tons of steelmaking capacity to its operations, boosting annual shipments by 50% -- to 7.5 million tons.

The numbers
None of Severstal, Steel Dynamics, or AK Steel provided full information on the revenues or profits of the steel units involved in these transactions. But here's what we do know:

According to S&P Capital IQ, Severstal did $4 billion in business in North America in 2013. This included revenue from coal and iron ore production, as well as steel sales. The company's Severstal International operations, which include the U.S. were last reported to be earning operating profit margins of only 1.3% -- and losing money on the bottom line.

Nonetheless, both Steel Dynamics and AK Steel insist they're getting good deals:

  • Steel Dynamics: "The transaction is expected to be immediately accretive to earnings and cash flow per share, and to generate approximately $30 million in pre-tax earnings synergies per annum."
  • AK Steel: Severstal Dearborn will "be immediately accretive to our earnings."

Both Steel Dynamics and AK Steel lean heavily on expected "synergies" to generate their extra profits, with Steel Dynamics expecting "to generate approximately $30 million in pre-tax earnings synergies per annum," and AK saying it will squeeze out "annual cost-based synergies of approximately $50 million."

An orderly retreat
The dismantling of its U.S. empire, once estimated to be the fourth-largest steel-making operation in the U.S. (behind U.S. Steel (NYSE:X), Nucor (NYSE:NUE), and ArcelorMittal (NYSE:MT), isn't looking like a particularly stunning defeat for Severstal, either.

As it exits the U.S. market, Severstal will collect $2.3 billion in sales proceeds on its way out the door. That's money it can invest in its more profitable domestic Russian steel operations. The company has been shedding U.S. assets for months, and had already divested steel plants in Maryland, Ohio, and West Virginia. Last week, Severstal agreed to sell its PBS Coals metallurgical coal operation to Canada's Corsa Coal for $60 million, plus the assumption of obligations that raise the total deal value to about $140 million.

In exchange for all this, Severstal will be giving up a market that used to account for 30% of its annual revenues, and getting paid about 0.58 times sales for those revenues. That's roughly the same price a share of Steel Dynamics fetches on the open market today, and twice the valuation of a share of AK Steel.

Far from a defeat for Russia, it looks to me like Severstal has decided to simply "declare victory and go home." 

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St. Basil's Cathedral in Moscow. Photo: Wikimedia Commons

Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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