Cleveland-Cliffs (CLF -1.92%) failed to capture its long-pursued merger target, but investors seem to prefer the company's plan B. Shares of Cleveland-Cliffs gained 19% in December, according to data provided by S&P Global Market Intelligence, after the company said it was refocusing its capital toward stock buybacks instead of dealmaking.
The one that got away
You don't often associate the steel industry with high drama, but last summer Cleveland-Cliffs put rival U.S. Steel (NYSE: X) in play with an offer that was more than 40% above where the target had been trading. U.S. Steel rejected that proposal but said it would consider options, putting its fate, and the future of Cleveland-Cliffs, in doubt.
Investors got a lot more clarity in December, when U.S. Steel agreed to be acquired by Nippon Steel for $14.9 billion, or nearly double what Cleveland-Cliffs had initially offered. U.S. Steel said it entertained bids from a number of suitors, but Nippon was the clear winner of the auction.
Cleveland-Cliffs almost immediately found a new use for the cash it had set aside to buy U.S. Steel, announcing plans to ramp up share repurchases.
"We identified U.S. Steel as an extremely undervalued company with significant synergy potential when combined with Cleveland-Cliffs, creating a union-friendly American champion among the top-10 steelmakers in the world," CEO Lourenco Goncalves said in a statement. "Given that our CLF shares are still significantly undervalued, we will now refocus our capital allocation priorities toward more aggressive share buybacks under our existing share repurchase authorization."
Is Cleveland-Cliffs a buy after its U.S. Steel rejection?
Investors have good reason to breathe a sigh of relief. Although the economics of a U.S. Steel deal, especially at the original price, was attractive, dealmaking is hard to get right and legacy costs, union contracts, and political pressures would have made for a complicated integration. According to reports a number of bidders, including Cleveland-Cliffs, made sweetened offers, creating real risk that the winning suitor might have stretched itself thin to prevail in the auction.
Goncalves is correct in saying that even after the December surge, Cleveland-Cliffs shares are as inexpensive as they have been in nearly a decade relative to sales. But the U.S. steel industry today faces significant competition from foreign rivals and questions about the health of the manufacturing economy and demand for steel. It was that competition from foreign behemoths that prompted Cleveland-Cliffs to pursue U.S. Steel, with the company hoping to create a U.S. steel champion with the scale needed to take on foreign rivals.
Cleveland-Cliffs is a well-run operator, but this is a challenging business at the best of times. Investors would likely be wise to take advantage of the December rally and look elsewhere for new investments.
