The wizard of commodities
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by Jonathan Berke
TheDeal.com
Posted 11:40 EST, 14, Jan 2005
Walk into WL Ross & Co.'s midtown Manhattan offices and you'll see a cartoon from a Southern newspaper, depicting 66-year-old Wilbur Ross wearing a black cowboy hat and sitting atop a spool of thread.
The cartoonist skewers Ross for being an iconoclast within textiles, a battered industry that remains stubbornly protectionist against foreign competition. In textiles, at least, protectionism isn't Ross' way. Burlington Industries Inc., the denim maker that Ross controls, maintains operations in Mexico, and his International Textile Group has boosted its presence outside the U.S. In December, ITG forged deals to build plants in China and Canada.
It's not that Ross, a former restructuring adviser at Rothschild before striking out as a value investor, relishes his role as a villain, at least to textile interests. But his unorthodox tactics have elicited a wave of strong reactions. Indeed, Ross' forays in recent years into steel, textile and coal — often left-for-dead industries in the U.S. — have led BusinessWeek to wonder if he's crazy and others to view him as a sort of latter-day Andrew Carnegie.
But what Ross has really become is the wizard of commodity industries, who not only believes he sees a way to salvage what he can of them, but profit wildly from rolling them up. "We think it's time to reinvent the 19th century," says Ross, alternately throwing his hands up or tapping his finger on the conference room table. "That's the general thesis."
Thus far, it's paid off handsomely for WL Ross & Co., his private equity firm. After taking several years to buy five steel companies — LTV Corp., Bethlehem Steel Corp., Acme Metals Inc., Weirton Steel Corp. and Georgetown Steel Co. — out of bankruptcy, Ross bundled them under one banner, International Steel Group. In October, he agreed to sell 90% of ISG for $4.5 billion to LMN Group, reaping a greater than 11-fold profit and giving his new fund an internal rate of return of 100% (his early fund has an IRR of 35%). Now Ross is concentrating on ITG and a rollup vehicle for coal deals, International Coal Group.
The unifying theme among Ross' interests in the three commodity industries is globalization. In recent years, trade barriers have been reduced while demand for steel, textiles and coal have boomed in developing economies. Ross saw an opportunity unique to each, as long as he adhered to a few guidelines. He had to be a below-cost producer. He had to be in the highest value-added end of each industry, where technology could make a difference. And he had to have scale that made sense.
But it's not so much Ross' strategy that makes what he's done magical, but his tactical execution. More than 30 steel companies and a large number of textile companies in recent years have gone bankrupt, buried by union wages, legacy pension and healthcare costs and high expenses. The coal industry may lack union woes, but it faces crushing environmental cleanup bills and heavy regulatory scrutiny. Yet Ross has been able to negotiate with unions, cut deals and trim overheads.
For instance, he has masterfully worked the bankruptcy courts. Ross bought many assets on the cheap and via sales under Section 363 of the bankruptcy code, enabling him to offload many liabilities.
He's also had considerable luck. The acquisition of LTV was the genesis of ISG, but only after President George W. Bush instituted an 18-month tariff on foreign imports. This allowed Ross to restart LTV's blast furnaces and mills without further erosion to its business. Had Bush not imposed the tariff, Ross concedes, he would "have simply shut down the operation and liquidated the assets."
Ross had been buying Burlington debt at rock-bottom prices after the company filed for bankruptcy on Nov. 16, 2001, when Warren Buffett, who had made a stalking-horse bid for the company, asked for a $14 million termination fee. It was a big break for Ross, who led a group that convinced the bankruptcy judge in the case that the fee was too high. Buffett's bid was scotched, and in swept Ross during an auction to buy Burlington for $614 million on Aug. 1, 2003.
"Luck plays a role in everything," Ross says. "The more homework you do, the luckier you get."
For years, Ross did his homework and others benefitted. After getting a degree in literature from Yale University and an M.B.A. from Harvard Business School, he landed at investment bank Rothschild, and over the next 24 years executed workouts for the likes of Eastern Airlines, Orion Pictures, Drexel Burnham Lambert and Texaco Inc. There were times in the late 1980s when Ross was so sought after for his restructuring prowess that he would have cases running simultaneously in bankruptcy courts in different parts of the U.S., angering judges when he couldn't be present in their courtrooms.
In 1999, he started WL Ross and began investing the $450 million in private equity funds he had raised in distressed companies in Japan and South Korea, a strategy he had pursued at the Rothschild Recovery Fund in 1997 in the midst of the Asia crisis. In 1999, he was already articulating a strategy that sounds strikingly similar to his current views on steel, textile and coal. "I think of us as a phoenix fund, not a vulture fund, because we're trying to resuscitate things," he said.
Having his own firm enabled Ross to make the key decisions instead of just recommending them. "Being a principal means that you have to be able to pull the trigger and live with the consequences, but at least you can make it happen," he says. "As an adviser, you have to convince others to accept your recommendation but have no way to make sure they are implemented or how effectively."
In LTV, Ross saw his first opportunity for value investing back in the U.S. Roughly 14% of this country's steel production was idled in 2001, according to The Nation magazine. And U.S. steel companies, whose costs made them uncompetitive against foreign producers, were stumbling over each other in bankruptcy court.
Ross hired steel guru Peter Marcus and his consulting firm, World Steel Dynamics, to learn more about the industry, then made his move. He also went to Pittsburgh, where he sat down with Leo Gerard, the head of the United Steel Workers of America, at an Italian restaurant on a hilltop overlooking United States Steel Corp. They talked about hammering out a new contract between the union and LTV.
"Core principles discussed that night formed the basis for all future discussions that the USWA had with the International Steel Group and opened a very constructive relationship," USWA's Gerard says. "[Ross] came to a very quick conclusion that workers had a lot to offer and had strong knowledge on how to make steel."
Even though LTV was once the nation's third-largest steelmaker, it was an easy mark. Already known for one of the longest bankruptcy stays in U.S. history, it made a second Chapter 11 filing on Dec. 29, 2000, shutting down its mills. Many left LTV for dead. Ross, however, got a new union contract, let the quasi-governmental Pension Benefits Guaranty Corp. assume LTV's legacy costs, and offered $125 million in cash and the assumption of $200 million in debt.
Skeptics abounded. "We were concerned about [Ross's] ability to change their culture," says Paul Vastola, an analyst with Standard & Poor's.
But Bush's March 2002 decision to impose a tariff got Ross off and running. Now known as International Steel Group, Ross' steel operation rehired LTV's old staff and got the mills operating again within four months, not the 12 or so industry experts had predicted. "It was more accidental than it was planned," says Bill Peluchiwski, the head of the basic industrials group for Los Angeles investment bank Houlihan Lokey Howard & Zukin.
Even though the tariff would give U.S. steelmakers temporary pricing protection against foreign rivals, Ross knew he had to trim costs. So where there were once 130 shift foremen in one part of LTV's Cleveland operation, there are likely to be just 30 now for the entire facility, Gerard says.
Ross, meanwhile, marched on. Bankrupt Bethlehem Steel was generating $4 billion of revenue, or about $1.5 billion more than ISG. It was also carrying $6 billion of legacy costs. Ross requested a 60-day exclusive period to forge a deal.
S&P analyst Leo Larkin was floored. "I don't understand why Wilbur Ross or anyone would be interested in buying them until they do liquidate," he said at the time.
Still, Ross soldiered on and the company clearly had confidence in the deal going through. Even though two other bidders surfaced for BethSteel, neither were qualified to make an offer. With Rodney Mott, a veteran metals executive he recruited to ISG, Ross negotiated with the USWA and other unions directly and cut a deal. "Having come in with an acceptable arrangement with the union, it was difficult for other bidders to come in and try and challenge that," recalls BethSteel debtor counsel George Davis of Weil Gotshal & Manges LLP.
Why were the unions so attracted to Ross, especially since the new contracts reduced healthcare benefits? Namely because his inclusion of performance incentives allowed workers to profit off the success of the mill. He also didn't just slash rank and file. At BethSteel, Ross pruned costs by also reducing management from seven levels to three.
Before long, the revamped labor contracts gave ISG a cost advantage of about $100 a ton over other unionized steelmakers.
"The union understood that radical changes were needed," says Ross, noting that other companies had rebuffed the USWA when it had approached them about widespread change.
But Ross also knew when to offer the unions a carrot. For example, even though the PBGC picked up much of the legacy costs of the companies that ISG had acquired, Ross still stepped in with a fully funded $50 million voluntary employee benefit plan, or VEBA, to help pay for retiree healthcare costs. Under it, active workers could contribute to the plan. It was a first for the steel industry (as part of the deal with LNM Group, a percentage of the company's Ebitda will be used to continue funding the VEBA).
In addition, Ross was determined to improve relations with his existing work force by getting management to deal with worker issues on the mill floor and appearing at a steelworkers convention held in 2003 in Miami. "There were no legal obligations, but we certainly had a big moral obligation," Ross says.
Three more deals followed for ISG: $65 million for Acme on Aug. 13, 2002; for Weirton last Feb. 18; and the $18 million pickup of Georgetown on May 4. (For the last two, ISG had already been a public company, following a Dec. 12, 2003, initial public offering.)
Concurrent with the acquisitions, steel prices rose thanks mainly to China's mushrooming demand. Prices for hot-rolled coil steel increased to $640 per metric ton in April from $259 per metric ton at the beginning of 2001, while cold-rolled coil steel rose to $709 from $370 per metric ton during the same time.
Ross says he had hoped to use ISG as a global rollup vehicle, but London-based billionaire Lakshmi N. Mittal beat him to the punch. His LNM Group bought up state-owned steel mills being privatized from Romania to Kazakhstan. LNM also acquired assets from Algeria to South Africa. "So we concluded that it made more sense to become a minority participant in their activity, rather than become a majority participant in our own," Ross says. (Ross will serve on Mittal's board.)
Ross' experience in textiles has been rougher than steel, particularly over labor relations. After visiting Judge Randall Newsome of the U.S. Bankruptcy Court for the District of Delaware in Wilmington denied Buffett's request for a termination fee on his bid for Greensboro, N.C.-based Burlington, and then, ultimately, the Oracle of Omaha's acquisition offer, the company started a precipitous slide. "The company's operations had declined substantially from the time Judge [Newsome] terminated the Buffett bid to the time the company was ultimately sold," says a source familiar with the company's operations.
Even so, Burlington's management demanded that a new buyer assume the company's underfunded pension costs. Other bidders also emerged. In the end, Ross boosted his original bid by $140 million and won.
With Burlington under the International Textile Group umbrella, Ross went back to bankruptcy court in March and bought Cone Mills for $87.2 million, despite the PBGC's insistence that he pick up the $58 million tab on the company's underfunded pension liabilities. (The matter is still in court.) Having Burlington and Cone Mills has enabled Ross to consolidate denim operations, as well as dying and finishing processes.
More shocking to Ross was how the U.S. textile industry was spurning its customers and ignoring foreign demand. "The industry had these strange attitudes that it should tell its customers what's good for them," Ross says. Textile makers tended to just export to those nations covered by the North American Free Trade Agreement and to Latin America. Besides expanding its own non-U.S. operations, ITG is investing $30 million in research and development to modernize a stale product line and improve customer relations.
Such spending on R&D is "probably more than the rest of the industry," Ross quips. He hopes the nanotechnology ITG is developing will help solve problems such as perspiration stains and wrinkles in dress shirts, as well as create flame-retardant products for children's clothing. Garments have appeared in The Gap, Marks & Spencer and other retail outlets using such technology.
Expect Ross to shake up textiles even more. One industry source says he's keeping an eye on the Caribbean Basin Initiative that Congress could pass this year. Why? Because the legislation would allow Ross to invest in plants in lower-cost markets in Central America. "Higher labor contracts," he says, "will be moved offshore."
As with ISG, Ross envisions taking ITG public one day. But the U.S. has lifted quotas on foreign textile imports, so he wants to first see how things shake out. Currently, he says he's not scouting bankruptcy courts or elsewhere for add-on acquisitions for ITG.
That's not the case with International Coal Group, already the world's fourth-largest producer with between $800 million and $900 million in revenues. Ross views ICG as a rollup vehicle he can use to buy underfunded coal companies in the Appalachian mountains that lack the capital to maintain mines.
"Certain areas in the [Appalachians] are in terrible trouble," one coal investor says. "There is a significant rift between mines and regulators."
The dynamics for coal, another old-line industry, differ from steel and textiles. It costs about 50% less to produce electricity from coal than from natural gas. But coal is a hazardous business, especially when it comes to the environment. So the regulatory climate is intense.
For example, companies have so-called reclamation obligations. That is, a coal company must obtain a permit to open up a mine. It must then clean up the site, or reclaim it, once activity has ceased. Such reclamation costs are burdensome.
Still, coal offers a value player such as Ross a great opportunity. Underneath all the environmental issues are lots of hard assets, namely a key natural resource whose supply is dwindling.
Again, while his initial foray into the sector wasn't serendipitous, Ross ultimately was in the right place at the right time.
Ross originally tried to help Morgantown, W.Va.-based Anker Coal Group Inc. by attempting to convert 30% of his $126.7 million in Anker debt into a 100% stake in the company in January 2001. But Anker filed for bankruptcy the following October after it could not restructure the deal with its creditors.
Because he retained 70% of his Anker debt, Ross was eventually able to convert it into a controlling stake in a reorganized Anker.
Then came Ashland, Ky.-based Horizon Natural Resources Inc., which also ended up in Chapter 11. Ross wanted to acquire Horizon's nonunion assets, but the deal couldn't go through until the bankruptcy estate figured out how to shed $800 million worth of pension and healthcare benefits, including payments made to retirees covered by the Coal Industry Retiree Health Benefit Act of 1992.
The retirees immediately sought a stay on the sale with Judge Henry R. Wilhoit Jr. of the U.S. District Court for the Eastern District of Kentucky in Lexington. Wilhoit sided with the retirees, but lifted the stay 48 hours later on Sept. 30. Ross went to work, lining up agencies from fertile coal mining states such as Kentucky and West Virginia and the Office of Surface Mines in the U.S. Department of the Interior to agree on a unified memorandum of understanding as to how the company would handle reclamation concerns. It worked. In October 2004, ICG bought Horizon for $786 million and added it to its growing stable.
Today, black-lung litigation worries don't hinder ICG — those liabilities, thanks to Section 363, stayed with the Anker and Horizon bankruptcy estates. Meanwhile, it's virtually debt-free and sitting on top of a billion tons of coal reserves.
Still, that's not what stirs Ross these days. He has carefully steered ICG toward low-sulphur coal, and for good reason: The most hazardous part of coal is the sulphur, so the less of it there is, the more valuable it is. Low sulphur coal sells for $55 to $60 a ton, while the high content variety goes for $12 to $15. Most of Anker and Horizon's coal reserves are low sulphur. "Our coal is a good coal that is used to blend with higher sulfur coal to bring it within federal standards," Ross says. "This coal trades at a real premium."
Even personally, Ross is on a roll these days. In October, he married Hilary Geary, a society writer for Quest magazine. It was his third trip to the altar. (He has two children, Amanda and Jessica, from his first marriage to Judith Ross. His second marriage to former New York Lt. Gov. Betsy McCaughey also ended in divorce.)
Can anything ruin Ross' run? Well, Ross has looked at another hidebound American industry, though one not from the 19th century: airlines. But it doesn't inspire him much, even though many of the same fundamentals — unionized labor costs, steep legacy liabilities — that existed with steel are also present with airlines. Plus, many of the companies have landed in bankruptcy court, where Ross does some of his best work. Is it time to move?
"We've known the industry for quite some time," he says. "We just haven't found the magic formula yet, and it's frustrating because we keep looking."
These days Ross can pick his spots. After all, it's good to be the wizard. |
