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USX - Conglomerate Discount


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USX - Conglomerate Discount

  1. 1. Investor PresentationMichael GiampaMichael HazinskiIlya ZyskindSrinivasan RaghavanSrisunder Subramaniam
  2. 2. USX Diversification StrategyUSX: Steel and Energy – Successful IntegrationBenefits of being a ConglomerateRisks of splitting up USXUSX Plan to increase shareholder value
  3. 3.  1982: Marathon Price : $6.2B 1986: Texas Oil & Gas : $3B Reasons  Steel is usually up when energy is down, and vice versa (CFO Robert Hernandez). Steel and Oil commodities offset each other  USX conglomerate could borrow on better terms than it had when in just steel business  Use cash generated by Steel business to drive the growth of the Oil business which needs cash  Increased asset base , market capitalization lead to bigger size and reduce the earnings variance
  4. 4.  Successful smoothing of Earnings Steel performed better than Energy in 1986  Marathon 1990 Net Income increased by $110MM, while Steel fell by $217MM  Steel: $501M, Energy: $475M Efficient Operations in Steel Business  Man hours per ton of steel 3.8 in 1986 from 10.8 in 1982  Workforce reduced to 20,000 from 75,000 in 7 years  Salaried employees slashed to 5,000 from 30,000  Operating in only high margin business  Focused on exports which give higher margins  Lowest labor costs and long term negotiated contracts with labor Experienced Management and Board of Directors  The USX executive team and board of directors are regarded as some of the most talented in the industry and are uniquely qualified to manage both cyclical businesses
  5. 5. • Option Value: Potential to grow earnings and sell to a more strategic buyer in the future based on favorable market conditions. • Declining market for steel, a five-year low in industry profits, and potential buyers within the industry that are heavily burdened by debt they issued to modernize operations. • Ride out the current business cycle for Steel by taking advantage of the Energy business Ability to sell selected non-performing assets as market conditions improve and still maintain the debt covenants (Eg: Selected Steel plants) Use the NOL (Net Operating Liabilities) from energy business and steel business to gain tax benefits  Estimated Deferred Tax assets as of 1990: $454M  Estimated NOL as of 1990: $900M• Increase shareholder value by using cash flow from steel business to fund growth in the energy business• As a diversified company, USX shareholders enjoy a lower cost of debt capital that neither company could achieve on its own.
  6. 6.  Financing Issues  US-Steel will no longer have access to the cash flow, assets and operations of Marathon, which may adversely affect its ability to finance its Research and Development activities, Capital expenditures, Working capital and Dividends  Energy business’ cost of borrowing will go up and thus reducing the EPS  Agency costs  Information asymmetries • Cost of Borrowing goes up • Interest coverage ratio Tax Issues  Unclear that a spin-off would qualify as tax free event under Section 355. In addition, a spin-off would likely nullify tax credits from the steel operation’s earlier losses. • The company will lose the benefits of NOL’s (Net Operating Losses) • Tax implications of stepping up the assets after the split off • Loss of federal subsidies• Shareholder Value • Firms with bigger size have commanded a bigger price premium in stock market and USX shareholders will lose this • Steel shares would go down a lot because of lower growth rate • Exposure to pure play commodity prices on each stock (Oil and Gas, Steel)• Operational Issues • Negotiations with unions • Higher administrative costs
  7. 7.  Higher multiple for pure play Energy and Steel companies is because of the higher risk associated with each sector USX offers a conglomerate discount which reduces the overall risk for investor and provides a higher risk-adjusted Transparency to the market by increased segment reporting Disclosure of Energy and Steel business’ KPI’s