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January 1, 2007

How Big is Big Enough?

Gerdau Group’s Jorge Gerdau Johannpeter readies Brazil’s largest steelmaker for its next acquisitions and continued industry consolidation.

Photos by Fernando Bergamaschi
Jorge Gerdau

In 1901, German immigrant Jorge Gerdau bought the struggling Pontas de Paris nail factory in Rio Grande do Sul, Brazil’s southernmost state. As the region’s towns grew to accommodate a wave of European settlers, nails seemed a good match for Gerdau’s other business, a furniture factory.

The temperate climate of the region—750 miles south of tropical Rio de Janeiro—already was attracting German and Italian settlers to tracts of ranching pasture and farming land that looked like areas they had left in the Old World.

Few, however, could have guessed the remote region would become the center of a steel empire.

More than 105 years later, the state’s capital, Porto Alegre, is a city of 1.5 million and home to the $10.9 billion Gerdau Group—Brazil’s largest steelmaker, the hemisphere’s largest producer of long products and a growing acquirer of steelmaking assets. By 1948, the Gerdau Group was already a publicly listed company on the local stock exchange when it made its first investment in steel, building the Riograndense mill in Porto Alegre. This would emerge as Gerdau’s signature mini-mill, a small steel-making facility relying on scrap metal as raw material, and focused on local marketing and sales to keep costs low. The same mini-mill strategy still is employed in many of the company’s global operations.

RIDING A WAVE

 

Jorge Gerdau Johannpeter, 70, the outgoing CEO who remains chairman and has led the company since 1983, speaks Portuguese, German, English and Spanish. He was brought up largely among second- and third-generation immigrant communities of Germans and Italians in Porto Alegre, where even a German newspaper was published.

But while Old World work ethic and frugality ran strong in the family, young Gerdau Johannpeter didn’t spend all of his time in steel. In the 1950s, with home-fashioned wooden planks, Gerdau Johannpeter and his brother Federico pioneered surfing, considered the ultimate “extreme sport” among his contemporaries in the South Atlantic waters of Brazil.

The experience taught Gerdau Johannpeter the timing required to catch a wave. In late 1999, with the U.S. steel industry in crisis due to over-production and plummeting prices, Gerdau Johannpeter accelerated his company’s international expansion by snapping up large U.S. steel assets, adding to those plants it already held outside Brazil, in Canada and South America.

More than 60% of Gerdau’s revenue now comes from sales outside of Brazil. The value of Gerdau’s U.S.-traded American Depositary Receipt (ADR) shares has grown more than six-fold in the past five years to more than $15 per share and has shot up by more than 50% over the last 12 months. Earnings of $1.4 billion in 2005 matched the record set a year earlier, while revenues rose 23.5% to $10.9 billion. For the first nine months of 2006, net profit rose 7% to $1.3 billion, while revenues grew 5.3% to $12.6 billion.

Gerdau and its subsidiaries worldwide employ more than 27,000 employees. Steel production capacity is more than 20.5 million metric tons a year, and the company in 2005 was ranked No. 14 among world steel producers by the International Iron and Steel Institute.

BRAZIL STEELS ITSELF FOR FAST GROWTH

Brazil’s steel industry, the world’s ninth largest, has what observers consider a golden triad of attributes: access to mammoth iron ore reserves, cheap labor and ample energy resources, especially hydropower.

Add into the mix the country’s rapidly growing automobile, construction and farming industries, and it is little wonder Brazil’s steel industry is among the world’s fastest growing.

Government bank BNDES, the National Bank for Economic and Social Development, the largest financier of Brazilian industrial projects, and which tracks steel industry growth, sees Brazil’s steel output capacity doubling to 72 million metric tons per year by 2012, from around 36 metric tons per year in 2006, says BNDES President Demian Fiocca.

Brazil has been producing nearly 3% of the world’s steel.

That growth will require investments in new facilities and plant expansions worth more than $21 billion over the 2007–2011 period, BNDES data shows. That’s more than double the $9 billion companies spent boosting Brazilian steel output over the previous four years. Brazilian steelmakers aim to supply a domestic economy that is expected to grow at 4% to 5% per year, government estimates show.

While Brazil’s GDP grew 2.3% in 2005, and was on track for a modestly higher growth rate in 2006, Brazilian sales of long steel—Gerdau’s main product—are growing at nearly 12% a year, data compiled by the country’s steel industry group IBS, or Brazilian Siderurgical Institute, shows. The boost in long steel demand in Brazil illustrates how even modest economic growth can prompt a significant boon in civil construction.

In the first three quarters of 2006, Brazil produced nearly 23 million metric tons of raw steel, of which 8.5 million metric tons were exported, IBS data shows.

The steel expansion is led by Gerdau Group in long steel; Arcelor Brasil in flat, carbon and long steel; and Companhia Siderurgica Nacional SA (CSN) in flat steel, which late last year launched a bid for U.K.’s Corus Group in competition with India’s Tata Steel Ltd.


IN THE FIRST THREE QUARTERS OF 2006, BRAZIL PRODUCED NEARLY 23 MILLION METRIC TONS OF RAW STEEL, OF WHICH 8.5 MILLION METRIC TONS WERE EXPORTED, IBS DATA SHOWS.


However, Brazil also has attracted new arrivals with big projects under study or already underway. In late September, German steel giant ThyssenKrupp AG began construction of a steel complex in Southeastern Brazil. The $3.6 billion complex to produce steel slabs for export is the first major new steel export complex to be built in Brazil since the 1980s.

Facing resistance from local politicians, companies recently have tempered earlier talk of building a gargantuan steel export complex in Maranhão State, which is estimated could someday churn out 20 million metric tons per year for export to Asia. China’s Baosteel and Rio-based Cia. Vale do Rio Doce remain in talks on a potential 5 million metric-ton-per-year joint venture steel complex in Maranhão.

 

PATIENCE AND BARGAIN-HUNTING

The group’s growing international holdings include Gerdau Ameristeel, the second-largest U.S. long steel producer, as well as plants in eight countries of North and South America and Europe.

Acquired by Gerdau in 1999, Tampa-based Ameristeel, now Gerdau Ameristeel, traces its origins to Florida Steel Products, which made steel for the construction industry. By consolidating new mills, Ameristeel has grown into the No. 2 mini-mill steel producer in North America, with 17 mini-mills, 17 scrap-recycling facilities and more than 50 downstream operations. Since 1999, the U.S. unit of Gerdau has acquired North Star Steel from Cargill Inc. and Sheffield Steel Corp. of Oklahoma. In October, Ameristeel bought a controlling stake in California’s Pacific Coast Steel, which supplies the construction industry in California and Nevada, for $104 million in cash, adding another 200,000 metric tons a year to Gerdau’s capacity.

The Gerdau family has built a steel dynasty based on patience, bargain-hunting and piecemeal expansion that so far has shied far from any of the steel industry’s mega-buyouts, whether as predator or prey.

Low-waste steel fabrication technology has helped Gerdau compete on costs. Mini-mill steel often sells locally at low profit margins, but as Gerdau buys more mills, it has been able to go lean to squeeze less-efficient producers, later raising steel prices across the board.

While exporting a portion of its production, Gerdau often builds mills close to big customers and to sources of scrap metal.

“Gerdau is the essential Brazilian multinational and has been shrewd enough to turn profits where others have failed,” says Pedro Roberto Galdi, a steel analyst for ABN Amro in São Paulo. “Gerdau has expanded in long and specialty steel so far, but once it reaches its potential in those areas, the company may start acquiring flat steel assets.”

Gerdau Johannpeter prefers not to speculate. There is much more global consolidation to be carried out first in the long steel and specialty steel areas, he says.

The company’s chief financial officer, Osvaldo Schirmer, told investors and analysts in November that Gerdau wasn’t in takeover talks, although the company is interested in buying more steelworks, especially in Argentina and Mexico, if they come up for sale.

Schirmer said the Gerdau Group plans to spend at least $3 billion through 2009 to modernize and expand its steelmaking, with around $2 billion of that investment directed to its Brazilian steelworks. However, those investment forecasts don’t include possible acquisitions, which could drive spending higher.

Meanwhile, there will be a fresh mind plotting the company’s future, as the CEO role is handed down to a fifth generation. Gerdau Johannpeter’s son Andre becomes CEO in January while his father remains chairman.

An executive vice president, Andre Gerdau Johannpeter, 43, worked his way up from plant worker apprentice at age 16 to a top executive of Gerdau Ameristeel between 2002 and 2006. He returned to company headquarters in early 2006.

Andre Gerdau Johannpeter’s accomplishments go beyond steel. He was a two-time bronze medalist in equestrian events at the Atlanta and Sydney Olympic games, where he rode Gerdau family-bred prize horses.

Gerdau Johannpeter’s nephew, Claudio Gerdau Johannpeter, 43, and a chairman of the board for Gerdau’s Spanish unit Sidenor, was set to take over as chief operating officer, a new position.

At a press conference in Porto Alegre in late November, the two new leaders said the group’s plans could include expansion in Latin America, Europe and Asia, particularly China. Andre Gerdau Johannpeter said the company wants to own more speciality steel plants and flat steel assets.

Before the succession plans were announced, Gerdau Johannpeter and the Gerdau Executive Board also canvassed non-family candidates. But Gerdau Johannpeter said throughout the search that he was determined that the business not lose the feel of a family-run enterprise. Almost half of Gerdau’s outstanding shares are publicly traded, including on the New York Stock Exchange as ADR shares, while most of the rest are owned by investors in Brazil and abroad, including the Gerdau family.

So renowned is Jorge Gerdau Johannpeter for his cost-efficient management that Brazilian President Luiz Inacio Lula da Silva considered offering him a post as finance minister or trade secretary once he retires from his current post, several Brazilian newspapers have reported. In a statement, the company said Gerdau Johannpeter has no plans to join the government.

In an interview, Gerdau Johannpeter explained why continued steel industry consolidation is important and why he rejects the notion that only “mega-producers” can survive.

Some observers say the steel industry will consolidate into about five giant producers, each with output of 100 million tons or more. Do you share this view, and would it be a good thing?

It’s too early to say there will only be five megaproducers. The industry consolidation seems bound to continue at a quick pace, but predicting the dimensions is still guesswork. I’m not so sure about the 100 million tons a year. There are still major differences among steel products, steel buyers and regional markets. Steel companies, apart from simply expanding production, will probably want to keep certain specialties.

In any case, expansion and consolidation are clearly important, but so is conserving a business model with a track record for success that doesn’t depend just on size. I won’t guess just how far the industry consolidation will go, but I don’t know that the successful model involves just a few mega-producers.

In that case, what’s so positive about more consolidation?

More industry consolidation is bound to take place because the steel industry is in a period of structural transformation in which mergers and acquisitions play a central role. Steelmakers have remained fragmented if you compare them to the industry’s upstream suppliers of iron ore, coal or equipment, or its downstream clients like automakers, which are already quite consolidated. We’ve already seen a tremendous consolidation of suppliers. [Brazil’s Cia. Vale do Rio Doce this fall became the No. 2 mining company following its $17.6 billion purchase of Canada’s Inco Ltd. It was No. 4 previously. It lags only Australia’s BHP Billiton.]

In this context, the creation of big global players like Arcelor Mittal helps to keep the industry healthy, creating more equilibrium between supply and demand. The steel industry is becoming less vulnerable. Geographic diversification reduces exposure to volatility in any one market, while production increases take advantage of economies of scale.

Is Gerdau Group racing to expand production? What is steel production capacity, and how much do plans call for producing in the next few years?

Present capacity is more than 19 million metric tons per year, of which we have 9 million in Brazil and more than 10 million abroad. By 2008, the goal is to reach 22 million tons. However, that is a goal reflecting the projects that we are committed to already. It doesn’t include growth through potential acquisitions.

During 2005, Gerdau’s purchases included steelmakers in the United States, Spain and Peru. Where will Gerdau seek to expand?

One of our great advantages is a solid financial position. It’s one reason that Gerdau has room to grow, including with new acquisitions. Brazil is a very competitive producer of steel, so it would stand to reason that the Gerdau Group wants to expand in Brazil, and [a majority of] new planned investments [through 2009] will occur in Brazil.

However, the Brazilian steel market already is divided among big players, leaving few [acquisition] opportunities. In order to expand, the company is studying new business throughout North and South America in long steel. We’ve already done a lot of expanding in the Americas, and we want to do even more. We also are looking to enter specialty steel ventures all around the globe. In China, for instance, we could make specialty steel auto parts.

Gerdau bought U.S. steelworks in the late 1990s at a time when the U.S. steel market was facing a slump. But now Gerdau Group’s U.S. plants are generally profitable and contribute about half of the company’s revenue. What is your turnaround formula, and how important is the U.S. steel sector and Ameristeel for Gerdau in global terms?

Buying Ameristeel [in 1999] with its four large steel plants marked Gerdau’s entrance into the U.S. market, after earlier North American acquisitions in Canada. Whenever we buy new plants, we try to quickly apply our tried-and-tested operational and management standards. This could mean implementing a new steel-making technology in cases where the mill isn’t efficient. It could mean using our expertise throughout the region to cut logistics costs, the price of materials or other costs.

Some of the strategies have evolved over generations and started at home in Brazil. However, we don’t neglect aspects of the local corporate culture that are working well. You have to incorporate what you learn along the way.

The North American market is extremely important for us. Gerdau Ameristeel is the second-largest long steel producer in North America, and the region contributed 47% of Gerdau’s net profit during 2005.

Steelmakers have been enjoying unprecedented demand for their products. How long can the boom go on?

This positive cycle already has lasted three years. We expect the positive environment of high demand and prices to continue for at least the next three years.

The solid performance of the steel sector is clearly linked to China, which has become both the largest producer and consumer of steel. However, we don’t expect China to be the world’s major net exporter of steel. There are other regions, such as Brazil, that can produce steel at a lower cost. The tendency is for output to expand where the costs, such as for materials used to make steel, are going to be cheapest. In the long run, China’s steel industry isn’t cost-competitive enough.

One perennial worry in the steel industry is that China will be this powerhouse exporter of steel, depressing prices globally, cutting into industry profits and leading to mass layoffs elsewhere. It’s true that certain segments of the U.S. steel market have been negatively affected by China’s growth, such as machine wire plants. Many U.S. industries are importing this product directly from China, prompting U.S. plants to close.

The emergence of China as a major player has not yet had a negative effect on the steel industry in Brazil or Latin America because this region is very cost-competitive. The influx of Chinese imports has taken a toll on some other industries in Brazil, like shoe and textile manufacturing.

You will be leaving as chief executive officer but plan to stay on as chairman of Gerdau’s shareholder board. Please explain the company’s succession plans.

The process began in 2001. The goal is simply to ensure the long-term sustainability of our business. It’s important to point out that the company has already been led by four generations [of Gerdaus], and now the leadership will change hands once again. It’s a natural process. It’s important to keep the values, which have their roots in several generations. Just as important, however, is ensuring professionalism.

In the process of choosing a successor, we have counted on guidance from overseas—human resource consultants—as well as carrying out internal consultations. All parties with an interest in the process have had a say. Board members choose a new president by consensus and by virtue of who possesses the qualifications needed to run the company globally.

Do you consider family-run businesses more successful?

I’ve seen studies that show family-run businesses tend to be 15% more profitable than other businesses. But I wouldn’t say that family-run businesses have an outright advantage over others. The success of the Gerdau Group depends on shared values, and family relations are one of the best ways to develop those. This family has a long tradition in its field, including a deep knowledge of the dynamics of the steel industry.