What happened

Shares of Cleveland-Cliffs (NYSE:CLF) fell more than 13% on Tuesday morning after the iron ore producer announced plans to acquire AK Steel (NYSE:AKS) for $1.1 billion in stock. The buyer sees opportunities to cut costs via vertical integration, but the markets on Tuesday at least were more focused on the risks.

So what

Before markets opened on Tuesday, Cleveland-Cliffs said it has agreed to swap 0.40 shares for each share of AK Steel. Based on Monday's close, the deal values AK Steel at about $3.36 per share, a 16% premium to the target's Monday close. But much of that premium evaporated on Tuesday as Cleveland-Cliffs shares fell.

Iron ore mining operation.

Image source: Getty Images.

The deal would combine North America's largest producer of iron ore pellets with AK Steel, a specialist in modern flat-rolled carbon and electrical steel production, to create a vertically integrated producer. Cleveland-Cliffs said the combination should be able to cut about $120 million in annual costs.

Cleveland-Cliffs CEO Lourenco Goncalves issued a statement saying, "By combining the best-in-class quality of AK Steel's assets and its enviable product mix with Cliffs' debt profile and proven management team, we are creating a premier North American company, self-sufficient in iron ore pellets and geared toward high value-added steel products."

Post-deal, Goncalves would lead the combined company, with AK Steel CEO Roger K. Newport set to retire.

Now what

There's logic to the combination, and since being named CEO in 2014, Goncalves has won high marks for managing Cleveland-Cliffs' operations and strengthening its balance sheet. In September, the company signaled all of that hard work was paying off when it increased its dividend and issued a special one-time cash payout.

Wall Street's initial reaction appears to be fueled by investor disappointment that instead of sitting back and enjoying the fruits of that hard work, Goncalves is instead taking on a new challenge. AK Steel has more than $2 billion in debt on its balance sheet that will be folded into Cleveland-Cliffs, making the combination more vulnerable in the event of a global recession that eats into steel demand.

Post-deal, Cleveland-Cliffs expects total debt to be 3.5 times adjusted EBITDA, which is manageable, and Goncalves has proved he can move quickly to improve the balance sheet. The combination should have more-predictable cash flow thanks to AK Steel's contracted business with automakers.

The deal can be a winner in the long term. But investors on Tuesday appear to have little desire to hang around and see how the combination plays out.