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March 1, 2012

A European Perspective

Gisbert Ruhl on the industry's future and his vote for the North American business model.

For Gisbert Rühl, chief executive of Germany's Klöckner & Co., 2012 is the year of testing his ambition to push the metals service center industry toward a global business structure. Despite his company's deep German roots, he's betting on what he calls the North American model of metals distribution.

Last April, Klöckner, headquartered in western Germany's Duisburg, acquired Macsteel Service Centers USA, a $1.6 billion sales network composed of 30 service centers in North America, from Macsteel Global of Amsterdam. The $916 million transaction, which combined Macsteel USA, based in Newport Beach, California, with Klöckner's Atlanta-based Namasco Corp., made Klöckner USA the third-largest North American service center company.

The transaction extended an international growth strategy initiated by Rühl's predecessor, Thomas Ludwig, who turned the chief executive officer reins over in January 2010. Rühl, who joined the company in 2005, retained his role as chief financial officer.

The deal resulted in little geographic or product overlap between Namasco and Macsteel USA. It looked like a perfect step to enlarge Klöckner's North American footprint and accelerate its rebound from the global recession of 2008 and 2009. The deal also seemed to foretell further consolidation in the North American service center industry.

But a sudden downturn in U.S. economic growth, starting in early 2011, followed by an even more sudden and severe sovereign debt crisis in Europe damaged the launch of Klöckner's North American venture. The company's shares sank nearly 60% last summer.

The lanky Rühl, who stands more than 6 feet tall at 53 years of age, faced European stock analysts who were openly skeptical about the timing of the Macsteel acquisition, as well as the price Klöckner paid for the deal.

 

Independence, Service and Expansion

Having raised the global profile of the North American service center industry, Rühltakes a long-term view of the industry in an interview with Forward. He is pleased to have expanded in North America at a time when the outlook for European economic growth is more clouded. He expresses confidence in the North American “model” of independent service centers—with an emphasis on “independence” and “service.”

Like Ludwig, Rühl is convinced that the low-margin economics of metals distribution work better in the hands of distributors not conflicted by mill ownership. He tells Forward that the scale of the leading North American service centers, including Klöckner USA, likely will increase, as the industry struggles to upgrade the metals supply chain and reduce the risks of metal price volatility.

Rühl led Klöckner, founded in 1906 and run as a family business for most of its history, to its emergence as a publicly traded firm, listed on the Frankfurt Stock Exchange. Klöckner has made 24 acquisitions since the 2006 initial public offering (IPO), including Becker-Stahl-Service, a metal supplier to European automakers.

Before joining Klöckner, Rühl, who holds an engineering degree from Hamburg University, worked as a business consultant. From 1993 to 1999, he was an executive for German auto parts maker Rutgers AG, which supplies Daimler AG's Mercedes-Benz, Audi and Volkswagen Group.

Klöckner said he visits North America several times a year but has left the North American operations in the hands of William Partalis, formerly CEO of Namasco, who has consolidated North American headquarters in Atlanta.

How goes the consolidation process at the former Macsteel USA?

The integration of Macsteel runs very well and faster than expected. The opportunities are huge. It was a game-changing acquisition for us. The opportunities to reach customers with a broader product base and related services, and higher than expected scale effects, are showing the great fit of Namasco and Macsteel. [Macsteel USA's product line was focused on flat steel, whereas Namasco specialized in long products and steel plate; the acquisition doubled Klöckner's sales and service center outlets in North America.]

It was clearly a right decision for us to focus on a significant increase of investments outside Europe and especially in the United States. Revenues from these markets could provide better backup for Klöckner in the years to come. The United States contributes more than a third of all group sales. Our goal is to enlarge our footprint there.

Europe and the United States: A Difference of Efficiency

 

Much of industrial metal distribution in Europe is handled by producing mills. Klöckner is the largest European service center company not affiliated with a mill. What's the difference between the structures of service centers in North America vs. Europe?

There clearly is a big difference. The U.S. market is, in our point of view, much more efficient, especially because of the structural separation between production and distribution. U.S. mills obviously believe that the service centers could better be managed by independent owners than by the mills themselves. This is not the case in Europe. In Europe, we have a lot of mills that have a distribution arm, which is, from our point of view, inefficient.

Another difference is how the business is named. In the United States, you name it a service center business. In Europe, we are saying a steel or multi-metal distribution business. This reflects behavior. In the United States, the emphasis is on service, whereas in Europe it is on distribution. The customer orientation in the steel business is higher in the United States.

Is there going to be further consolidation in North American service centers and what would that do to independence and customer service?

The market, no doubt, will be consolidating further. This is a trend of the last 20 years, at least. The trend will go on, because in the service center business, finally, scale matters. The landscape will change further. It takes a bit longer in steel, but finally it will take the same direction as other distribution businesses. The larger companies will be the main players, and we will have some niche players going forward.

The Importance of Scale

You say that “finally, scale matters.” What has changed in recent years to make scale a more important factor in the service center business? Is the unprecedented purchase price volatility of recent years the biggest factor?

 

Scale is most important on the purchasing side. For instance, we are now, with Macsteel, one of the three largest customers of the big mills in North America. And in this position we expect to get better conditions than small and mid-size players. On the sales side, being able to serve the customer on time with a wide range of product and services also needs scale. It works on both sides.

In the United States, the emphasis is on service, whereas in Europe it is on distribution. The customer orientation in the steel business is higher in the United States.

 

Do you expect metal producers operating in North America to get more into the service center business here, replicating European mills?

This is always a big discussion—which model works and why? Will it be the European model or the U.S. model? I'm convinced that the less-integrated U.S. model clearly works better. It's more efficient, since every market participant is doing what he's best at. There is no need for change in the North American market.

You've expressed interest in acquiring more specialized service centers. Where are you looking?

Not that much in North America. In North America we are very much focused on carbon steel products. In Europe, with the mill-tied service centers, we are competing in the commodity type business for large customers directly with the mills. That makes it necessary to reduce the commodity type business and invest more in businesses, with more service or more specialized products.

Strategies for Improving Efficiency

You often talk about reducing dependence on commodity pricing by focusing more on efficiencies and value-added services. What can the industry do to improve efficiency, add value and better cope with volatile commodity prices?

 

The whole value chain from the producer to the customer is not really optimized so far in the steel industry. Maybe it's a bit better in the United States than in Europe, where typically independent steps are being optimized but not the value chain itself. Especially in Europe, this is a great effort going forward to make the [metals] value chain, like in the automotive industry, much more efficient.

In the past, I worked in the automotive supply industry and I think that industry is more than 10 years ahead in terms of efficiency, which I have not seen so far in the steel industry. The larger players have to make sure that this value chain is much more integrated and optimized.

 I'm convinced that the less-integrated U.S. model clearly works better. It's more efficient, since every market participant is doing what he's best at. There is no need for change in the North American market.

 

What are some steps that you foresee in that regard? What can be done to move in the direction of the auto supply chain efficiencies?

It starts with the mills. The mills have to be more reliable going forward. They have to meet their delivery dates. It is extremely difficult for the service center industry to provide a reliable service for their customers if steel deliveries are coming too early or too late. Then, we need an efficient warehouse structure. We have to make sure we don't pick up the steel too often. When you pick up a beam too often, efficiency is lost. An integrated value chain concentrated on the needs of customers is a big challenge for us going forward.

Are value-added services by service centers—treating the metal so that the customer doesn't have to perform those functions—part of improving the value chain?

Yes, I see more requests from customers. Why can't you do this or why can't you do that for us? This is something we will invest in going forward. This is part of our strategy to increase specialized products and services. It's a good chance to make the business less volatile.

Last year, we invested in a company in California [Angeles Welding & Manufacturing Inc.], which is a welding facility. This is an opportunity to deliver to our customers not only small beams, but a welded structure. It's requested here and there from customers.

You have noted that the steel prices globally have become more transparent to buyers and sellers. What is your view of steel futures and other derivatives to establish and hedge steel prices on an international basis? I think in the steel industry we are moving clearly in this direction. Customers are asking for the services, and we will be providing those services. We started in the United States. We consider it an interesting and unique selling proposition for us because you need a decent-sized company to provide such services. There is no doubt that futures contracts and other derivatives will play a more important role going forward. Steel futures contracts need more volume, but it is clearly moving in that direction. This is a great chance for a larger player. We can provide the hedging. We have the know-how; we have the instruments. We can bundle the requirements of several customers and hedge it against an index or a basket. This is something that is difficult for mid-sized or smaller customers to do on their own.

Do you hedge your own inventory using derivatives?

So far not, but with the growing size of our company our risk position of the inventory is growing significantly. We will therefore, going forward, use hedging for at least part of our inventories.

Lessons for the Future

If efficiency is part of the cure for price volatility, what can smaller service centers do? What can they learn from their larger competitors?

 

The problem is volatility; there's no doubt about it increasing. For smaller companies, the volatility is even more problematic, because working capital is a scarce resource. We have very diversified financing. Even if some banks were to fail, it would not be a problem for us.

Going forward, the smaller players have to concentrate more on a niche strategy and the larger players will provide the full-service centers. Concentration will be necessary for smaller players.

What are your immediate goals in North America?

There is currently no need to do another acquisition in the United States because we are still in the process of integrating Namasco and Macsteel, but I would not rule out that we would do a small or mid-sized acquisition in the United States, buying into more service-oriented structures. But this is not the No. 1 priority [compared to fully integrating the Macsteel acquisition].

The United States and Mexico recently eased regulations permitting Mexican trucks to more easily carry goods between the two countries. Does that arrangement affect your view of acquisitions or expansion in Mexico?

I don't think that a lot of volume will go from Mexican service centers into the United States, because by far the largest cost is the steel itself. Steel is not cheaper in Mexico and Canada than in the United States. The service center business is, in our point of view, always a country concentric business. That will not change going forward.

Last year, Klöcknerr acquired a majority stake in one of Brazil's major service center companies, Frerer Group and opened a facility in Changshu, China. Beyond North American, where do you see opportunities for growth?

In terms of steel demand, Brazil is one of strongest-growing markets that I'm aware of, with a promising infrastructure backlog for the world soccer games and Olympic games. China accounts for nearly half the global steel consumption. We opened a service center recently near Shanghai focusing on European customers with production facilities in China. We are providing high value-added services, especially with heavy plates. Russia and India, on the other hand, also have strong growth potential, but due to various reasons, those countries currently are not a priority with us.


Bill Barnhart, a Chicago-based financial writer, was a business editor and columnist for the Chicago Tribune for 30 years. He is the author of MSCI's 100th anniversary history, “Links in the Long Chain.”