If the takeover drama around United States Steel (X 0.67%) has caught your attention, you might want to step back and hit the pause button. Acquisition battles are always uncertain and, sometimes, nothing comes of the news and rumors. Given that U.S. Steel's stock rocketed more than 20% higher because of the takeover talk, there's material downside risk if it all comes to naught. Meanwhile, a lot of potential good news may already be priced in.
The U.S. Steel backstory
United States Steel is an iconic name in U.S. history, let alone in the steel industry. It very literally helped to build the country that you know today. However, it was created at a time when the steel industry used blast furnaces to make primary steel. Blast furnaces are large and expensive to operate. When steel prices and demand are high, they can be very profitable, but when demand and prices are weak, the cost of keeping a blast furnace running generally leads to red ink. In other words, the core of U.S. Steel's business is highly cyclical.
Although U.S. Steel has been working to incorporate more modern electric arc mini-mills into its business, blast furnaces remain a driving force. Younger steel companies, like Nucor and Steel Dynamics, focus on electric arc mini-mills, which are easier to ramp up and down with demand. That makes these businesses more resilient to the steel industry's cyclical ups and downs.
That's a problem for U.S. Steel, which has been something of an industry laggard. But being an industry laggard often attracts the attention of suitors that believe there's value to be had in buying -- and, with any hope, improving the performance of -- a company like U.S. Steel.
When news broke about U.S. Steel fielding acquisition offers, the stock rocketed higher. That makes sense since most takeovers come with a premium price tag. Now, the story is that U.S. Steel is in talks with multiple suitors. But what happens from here is still highly uncertain.
Buy U.S. Steel
If you buy U.S. Steel today, you are very clearly betting that a takeover will happen. And, more notably, you are expecting the price of the takeover to be higher than the current price of U.S. Steel -- likely substantially higher. But there are material risks to consider.
For example, one of the main companies in the mix is Cleveland-Cliffs (CLF -1.92%), a company that has rolled up two other large U.S. Steel mills in the very recent past. Adding a third might draw the attention of regulators because it would reduce competition in the North American primary steel market.
Another company rumored to be in the mix is ArcelorMittal (MT 0.59%), but that company sold its U.S. operations to Cleveland-Cliffs not too long ago. Why sell a U.S. business to just buy a new one? A third company supposedly involved in talks is a relatively small Canadian steel maker that may have a hard time mustering the financial resources to pull off a transaction.
There is a real risk that nothing will happen, which would likely result in a swift stock price decline for U.S. Steel (probably mirroring the dramatic increase). Or, if a deal does take shape, the takeover price may not be that much higher than U.S. Steel's current price. Most investors will probably be better off watching from the sidelines.
Sell U.S. Steel
If you owned U.S. Steel prior to the takeover story, you have benefited from a swift price increase. Given the uncertainty here, you might want to consider selling to lock in that gain. If nothing comes of the current discussions, the stock will most likely fall back to pre-discussion prices.
In other words, there's material downside risk since a lot of potential good news has been priced into the stock in a very short period of time. The worst that would happen is that you'd miss out on some gains if a takeover comes to pass and it is at a higher price than where U.S. Steel trades today. Unless you think the potential higher price is going to be materially higher, sticking around may not be worth the risk.
Hold U.S. Steel
If you own U.S. Steel, the other option is to simply do nothing. That would make complete sense if you bought it because of its plan to diversify its business into the electric arc mini-mill space. In that case, you are probably thinking about the stock as a long-term investment, and the takeover talk could end up being nothing more than near-term noise. If it is sold, you get a quick win. If it isn't, your investment thesis hasn't really changed.
Being "in play" complicates the story
Takeover talk can be exciting, but talk is just that until there's a signed deal. And even after a deal is agreed to, there's still a chance that an acquisition will fall apart. If you didn't own U.S. Steel before the takeover story started to swirl, it probably isn't worth the risk of jumping in now. If you owned it prior to the big stock gain, you have to ask yourself if you want to lock in the swift price increase or stick it out thinking you'll -- maybe -- get more. Or, perhaps, you like the business strategy and all of this chatter just doesn't matter that much to you.
Whatever you do or don't do, however, it is important to recognize that uncertainty is going to be high over the near term.
