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January 1, 2008

SURVIVOR

Germany's Klöckner & Co. has endured two world wars, huge losses from oil speculation, large-scale looting and multiple changes of ownership, not to mention 100 years of roller-coaster business cycles. Can Thomas Ludwig keep this company in good health?

 
photos by Rüdiger Nehmzow

Klöckner & Co. AG, the largest independent metals distributor in two continents, is a little like the archetypal battered boxer of lore. Bleeding, often badly injured, the lad nonetheless is game. He’s sprawled out for the count, yet somehow, he struggles off the mat, lifts those aching and weary arms, throws more punches and wins the fight.

Klöckner, founded in 1906 by German metals trader and entrepreneur Peter Klöckner, perhaps should have disappeared during the privations of the First World War, or certainly during the devastation of the Second, when the Ruhr industrial area of Germany was pulverized by bombing.

Searching for a winning formula, the company has at times made and/or traded steel, raw materials, textiles, transportation services, building materials, fuels, chemicals, equipment, personal computers and parts, and industrial plants. It has been owned by three generations of its founding family, but also by unhappy lenders and banks, private-equity companies, a utility and, at one time, Iranian crooks who looted the place for €120 million (nearly $176 million at today’s exchange rates) before they were caught after just one month in control of the company.

No wonder that for the current CEO of this outfit, a favorite phrase is, “Such is life.” No wonder that today’s cares of business seem small when discussed by Dr. Thomas Ludwig, who, at age 59, has seen his share of adversity yet, when asked about it, simply shrugs it off.

“OK, there are risks. Sure, it’s clear, we will see bad years,” says Ludwig, who became Klöckner’s CEO in 2003 after the bank that financed the Balli Group and Iranian owners the Alaghband brothers gained final control of Klöckner stock. “But I’ve seen so many difficult years that I’m not worried about it. It’s part of life. And today, the sun is shining. When the sun is shining, we shouldn’t worry about when it might start raining again.”

Klöckner survived for several reasons. Peter Klöckner was an entrepreneur who built his company and family into the fabric of the German industrial heartland. Every time Germany rebuilt, the Klöckner family rebuilt, too.

But in the last decade, Klöckner steadily shed all of its other businesses and focused on “stockholding distribution,” what North Americans would call metals service centers. Klöckner also operates “service centers,” but in its lexicon, service centers are larger facilities usually dedicated to processing flat rolled product in larger quantities for more substantial customers. The typical Klöckner facility sells about a third of its material with value-added processing services, while 100% of its service center output includes some processing.

Distribution alone hasn’t been enough to keep Klöckner going. Also essential was the company’s way of doing business—familiar to North Americans, but less usual in Europe. About 50% of European metals distribution is controlled by the mills themselves, but Klöckner has always been independent, multinational and acquisitive. It has always believed in regional responsibility to meet local customer needs. It has favored warehouses that stock multiple types of metal, not just steel.

“The profitability of the distributor is different from that of a producer,” Ludwig says. “I see no clear business advantage for a producer to own a distribution company.” But in Europe, the Klöckner approach to business is unique. “There is no other player like Klöckner,” he says. “We have no other big independent with sales of €1 billion or more that does business in many countries.”

So Klöckner offers its suppliers what no other European distributor can: access to markets throughout the continent and in North America via its Namasco subsidiary. It is diversified by market, by product lines and by its multiplicity of customers.

“Despite all the trouble, we have had a very strong base,” Ludwig says. “We have an excellent management team and a very strong position in individual markets. It’s remarkable that during this crisis [of 2002-2003] nobody left the company out of our top 40 or 50 people. Normally, competitors would try to get the good people, but everybody stayed. We have strong loyalty to the company.”

Based in Duisburg, Germany, near Düsseldorf in the historically industrial Ruhr Valley, Klöckner has been a publicly owned company since late June 2006. It operates about 250 metals warehouses in 15 countries, including the United States and Canada, although it announced in December plans to sell its Canadian business, struggling because of a reliance on the auto industry where the healthier segments have moved south. In the United States, Klöckner operates mostly under the Namasco and Primary Steel names. Altogether, Namasco North America operates from 34 locations with a broad range of ferrous and non-ferrous metals and processing capabilities.

“Klöckner has done a good job of establishing a large, independent service center capability in Europe and has been increasingly focused on transferring its success there into the North American market,” says Mark Parr, a managing director of KeyBanc Capital Markets. “I would look at them from a long-term perspective as having ongoing interests in consolidation of the North American service center industry.”

Sales now exceed about €5.5 billion ($8.1 billion) a year and were up about 16% in the first nine months of 2007. When Ludwig became CEO in 2003, sales were about €3.8 billion ($5.6 billion). Volume for the first nine months rose 4.7% to 4.9 million tons, while nine-month earnings fell 11.5%, to €287.9 million ($423.3 million). Earnings fell because lower stainless steel prices forced an inventory write-down, and margins were squeezed as discounts were offered to move product.

About 90% of Klöckner’s sales are spot (vs. contract), and only 6% of sales relate to the automotive industry, compared with about 40% channeled to nonresidential construction.

Ludwig, the son of two doctors, was born in the small town of Vechta and raised in Paderborn in North Rhine-Westphalia, not far from the Düsseldorf area where he works today. He studied mathematics as an undergraduate, later earning a doctorate in business administration, and entered the metals industry through a German Steel Federation recruiting program that placed candidates in a range of jobs at various steel companies.

Ludwig was assigned to Klöckner-Werke, the Klöckner family’s steel manufacturing company, in 1977. During the next eight years, he held a variety of jobs, ending his stint at the steel company as director of the purchasing department for raw materials, energy and equipment. Promoted to the Klöckner & Co. Group—the steel company’s parent trading and service company—he traded aluminum and ran aluminum recycling programs. He subsequently traded iron ore and alloys, and oversaw scrap recycling and environmental protection services.

In 1991, Ludwig was named to the Management Board responsible for raw materials and environmental engineering. He left Klöckner in 1995 when its scrap business merged with the larger scrap business operated by Thyssen; Ludwig became chairman of the Management Board of the new Thyssen Klöckner Recycling GmbH. He was named to the Management Board of Thyssen Handelsunion AG a year later, and became chairman of the same board for ThyssenKrupp Serv AG in 2001.

Ludwig rejoined Klöckner in 2003, recruited to be CEO by WestLB AG, a bank that had helped finance the disastrous acquisition of the company by the Balli Group.

FORWARD: Why did you return to Klöckner? You had a big job with Thyssen—why take the risk?
I had certain advantages. From my time at Klöckner, I was one of the few people who had a certain feel for the position of the company. I still knew a lot of people there. That meant right from the first day, there was a lot of trust and confidence from the people in me and, from my side, in the key people in the company. That was the base for what we did then, and it was very important.

And what was the alternative? I was 53 or 54. I could stay with ThyssenKrupp another five or 10 years. Or I could take this opportunity. I always saw that there was a risk, but I was 100% convinced that this was a good company with good people and that we could turn the business. For me, it was a big challenge, an exciting challenge. It was a fantastic opportunity.

FORWARD: You strongly believe that it makes very little sense for mills to own their own distribution channels. Why do you say that?
Distribution is a low-margin business, and when you see the numbers, it’s clear that for a producer, owning distribution downgrades margins. Capital employed is high; return on capital employed is lower in distribution than it is for a producer. The average cash flows are different. Financially speaking, this makes no sense. When I was with ThyssenKrupp, it was my position that they should divest the distribution business.

FORWARD: So why do producers continue to own distribution companies?
There are a lot of historical reasons. There is also the idea that they want to control the supply chain, so they believe they must be close to all of their customers. I always compare this with the automotive industry. Would it be wise for GM or Ford to buy their car dealers? You would say it’s a stupid idea.

Strategy is always difficult, though. You can argue for hours and hours about strategy. Yet it is my personal view that we will see the day when [producers] will divest these businesses.

FORWARD: You set a goal for 2007 of acquiring at least a dozen distribution companies. Why?
We believe we have to consolidate this industry. If producers are consolidating into bigger and bigger groups, then if we want to keep our margins and profitability, we must consolidate the distribution and services industry. If you look in other products and distribution markets, such as food or pharmaceuticals, electrical products or whatever you want, you will find that only the top three companies really make profits.

The reason is that distribution is a low-margin business, and only when you have a certain purchasing power can you get the best conditions and a competitive advantage. This gives you a much better profitability than the smaller companies. At the end of the day, you win the race.

This is the logic behind a consolidation strategy. It’s a very simple business model. If you are No. 1, then normally your profitability is much better. You receive better conditions from suppliers. You have economies of scale, a better network, better logistics, better IT knowledge and better purchasing power.

FORWARD: How does this work out for the benefit of the customer?
We serve mid-size and small customers. Normally we have low customer synergies, which means our customers are present in one or two markets. We have very few customers who are in multiple markets.

The advantage of our network for small customers is that you can share all the costs behind the scenes, for IT, logistics, how you organize your stock, stock turns. On the other hand, I can tell a company like ArcelorMittal that I can sell your product and I will cover the entire marketplace. You can’t reach those customers directly, but if you supply me, you can be sure that you will get a certain part of the market because I’m present, have the ability and have the financial strength. This is the competitive advantage that we create from our network.

FORWARD: So without your network, you wouldn’t get the same terms from an ArcelorMittal?
No, I would not. We know this because of our acquisition program. We can compare the programs we have with producers with what was offered to the acquired companies. In all cases, our conditions are better.

We buy roughly 6 million tons of metal products a year. If I can get one additional euro per ton because I’m bigger, I increase my profits by 6 million euro. Multiply that out over the price of hot rolled coil and we talk about some extremely interesting numbers, big numbers. This is a huge potential. In Europe, 70% of metal moves through distribution; in the United States, it’s 50/50.

FORWARD: Where are your most promising growth markets?
We are moving slowly, step-by-step, but we will build up a comparable market position in Eastern Europe as we have in Western Europe. Our next step after that will be to go into the BRIC [Brazil, Russia, India, China] states. We have an office in China now, but it sources material from Chinese mills; we do no distribution there. The same in Russia. There is a lot of opportunity, and as long as the number of opportunities is much higher than what we can do, I’m happy.

FORWARD: What are the main differences that you’ve seen between the U.S. and European markets?
We want to establish leading market positions in the regions where we choose to do business. But we don’t feel like we have to cover every region in the United States. We simply need better coverage of the country in five years.

We have bigger customers in the United States, and the logistics are different. You can serve customers who are 300 or 400 miles away from a warehouse. In Europe, we can go a maximum of 200 kilometers. U.S. warehouses are more specialized.

Costs are lower in the United States. Europe is much more crowded, and traffic is more complicated. We do business in 12 different countries, and every country has its own headquarters. Everyone has a different legal system, different tax system, different labor costs and regulations, blah blah blah. It costs much more money.

So in the United States, a best-inclass company in good years can expect a 10% to 12% everyday margin. In Europe, best in class is 7% to 8%. The difference means a lot of money.

FORWARD: There is considerable talk in Europe now about Chinese trade practices, just as there has been concern in recent years about the well-being of the North American manufacturing base. Are you worried about low-cost competition from Asia and elsewhere?
We had the same talk in Europe when Eastern Europe opened in the 1990s and we saw a lot of movement of manufacturing there. We lost a lot of jobs and customers, and we had the same concern as our friends here in the United States.

What we’ve seen is that a lot of that movement was based on the short-term calculation on lower wages. But this is changing now, very fast in countries like Poland and [the] Czech [Republic]. Wages are increasing, and they must realize productivity gains or they will lose their competitiveness.

At the end of the day, you find out that with our higher productivity and our manufacturing processes, we are also competitive from a German or French base. There is still a tendency to be concerned that manufacturing is moving, but to me, this is simply part of globalization. The advantage of globalization is global growth. Take, for instance, the machinery sector. It has strong growth because we deliver a lot of equipment now to China, India and Brazil. This gives us in Germany growth rates of 11% or 12%.

So you have to make the calculation on all sides, and not just on one part. Growing demand worldwide is good, and it does not hurt us.

There is a lot of short-term arguing in this area, and people tend not to see the positive developments.

FORWARD: What about the very rapid growth of steel production capacity globally? Is that a concern?
That is a concern. The other risk is that we now have new players in the game that are state-owned and that have a different agenda, not a profit-making agenda, with no financial investors who are looking for profitability. The whole anti-dumping issue with China is part of this discussion. It is necessary that the world’s steel trade is fair trade, without subsidies, and that it is not hurt by government-owned companies.

Our clear interest is in a stable market environment, but also an open market environment. My personal view is that China will manage this. I don’t believe that China will destroy the market. They have done a great job for the last 20 years. They have double-digit growth every year. OK, they have a lot of social problems and environmental problems. But we shouldn’t forget that, overall, this growth is a positive development for China and the world.

We shouldn’t place too much blame on China. We have sold a lot of steel from Europe to China in the last 10 years. Why is it not allowed that the Chinese do this too? The whole discussion has been too much black and white. I think the truth is, in all cases, somewhere in the middle. The Chinese position is not totally unreasonable, and I think the Chinese know very well what they have to do and will manage it.

FORWARD: What will be the impact of environmental questions such as global warming on the metals industry? Have the concerns been overstated?
No. I think we accept that we have a problem. It makes no sense to discuss now whether it really is true, or what might be causing climate change. We don’t have the choice to gamble with this.

What can happen if we go for more environmental protection? Maybe it will prove to be unnecessary, but it doesn’t hurt us. But if it is necessary and we miss it, then this can kill us, kill society and kill the world for our children and grandchildren.

I think it is a bad example to blame the steel industry. It has done a lot of work on pollution. If you remember how a mill looked in the ’60s and see a modern mill today, you can see that it is not a problem. It is very important, though, that China close down its highly polluting mills, and the Russians, too.

We are working now in Germany on power plants that have nearly no carbon dioxide emissions, even when they use coal to produce energy. There are a lot of possibilities in new technologies. I am sure that in 10 or 15 years, we will have solved this problem.