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<TABLE>
<S> <C>
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</TABLE>
BIRMINGHAM STEEL CORPORATION
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(Name of Registrant as Specified In Its Charter)
THE UNITED COMPANY SHAREHOLDER GROUP
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REPORT OF ALDO J. MAZZAFERRO, JR., CFA
November 4, 1999
Pursuant to my consulting arrangement with the United Company Shareholder
Group, I have been asked to do the following:
1. Estimate a best and worst value for the SBQ assets if sold at the current
time.
2. Estimate a best and worst value for the SBQ assets if sold at a later
date after the market and the division have recovered.
3. Analyze the difference in those two scenarios and project what the impact
on the share price of Birmingham may be in the alternative scenarios.
In general, my conclusion is that the sale of the SBQ assets today, in the
currently poor environment, would have a very negative and permanent impact on
the company's share price. I estimate that if the SBQ assets were sold in
today's negative steel market and under the poor operating results, the value of
the company's stock would be reduced. This would occur even under my most
optimistic assumptions of a gross selling price of $165 million in today's
environment. Under my most pessimistic assumptions of a gross selling price of
$75 million, a sale in today's environment would reduce the shares theoretically
******************. On the contrary, if the sale of the SBQ assets were delayed,
and those assets were eventually valued or sold under better market conditions
and were operating at full potential, I estimate the price of the Birmingham
Steel stock would range between ******************. That result would allow
appreciation in the Birmingham Steel stock price compared to today's approximate
price of $7.00.
The difference between the two share price targets is primarily due to the
likelihood that the company would received a sub-par value for the assets if
they sold them today, rather than the full value it would receive by waiting for
an overall steel market recovery and improved operating results at the division.
In somewhat greater detail, I believe a sale of the assets today is ill timed
for the following reasons:
1. Markets for SBQ products are currently very weak, with pricing down to
the $400 per ton area compared with $475 or higher 12-18 months ago. This
corresponds to weak steel markets worldwide following the Asian crisis of
1997 and 1998, and a particular weak SBQ market caused by oversupply from
domestic and foreign sources.
2. The company's SBQ assets are currently losing money. Importantly, only
part of the losses is due to the weak markets, with additional penalties
due to extremely poor productivity at the plants. The plants are running
below 50% of capacity related to a continuing difficult start-up that has
been underway for over two
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Aldo Mazzaferro Page 2 11/4/99
years. The start-up has been made more difficult by several instances of
management turnover at Memphis and Cleveland.
3. There is also another large SBQ asset for sale in the form of a bankrupt
company called Qualitech. The presence of this asset on the market is
likely to significantly reduce the price that could be commanded by the
company's comparable SBQ assets.
4. The SBQ markets, although weak currently, have potential to improve over
the next 12 months due to domestic consolidation which has recently
taken place in the deal combining under Blackstone the assets of
Bartech, Republic and USS Kobe, and the anticipated shut downs of excess
capacity in those assets that have been consolidated. This adds to the
arguments that a sale of the SBQ assets would be more advisable in one
to two years. In addition, if the Qualitech sale takes place during that
time the market for SBQ assets for sale would be much less crowded.
5. A delay in the sale would also give whatever management team is in place
at Birmingham, either the current team or the dissident group, more time
to improve the productivity at the division and get over the start-up
hurdles which continue to penalize the profitability beyond the effect
of the weak market.
6. Finally, selling the SBQ assets currently, even if they are sold for the
high end of my estimated price range in the current environment, would
merely make permanent the severe monetary damage that has already been
done to shareholder values, and rob the shareholders of any of the
benefits of a turnaround in these assets.
Below are my estimates of the asset values that I believe would be received in
a sale of the SBQ assets under various scenarios: today and later, at full
potential. In addition, there is an analysis of the estimated impact of those
sales on the projected price of the company's shares.
ESTIMATES OF SELLING PRICE IN CURRENT NEGATIVE ENVIRONMENT
BEST CASE: $165 MILLION GROSS PROCEEDS, NET PROCEEDS $40.8 MILLION
WORST CASE: $75 MILLION GROSS PROCEEDS, NET PROCEEDS (NEGATIVE $49.2 MILLION)
Any approach to valuing underperforming assets typically takes into account the
current earnings of the assets, which could be negative, or other factors such
as sales levels or current levels of cash flow. In addition, sometimes when
earnings are very low or nonexistent, a value of the assets is set based on the
liquidating value or replacement cost of the assets, less whatever expenses are
necessary to upgrade them to satisfactory levels. In the case of Birmingham
Steel's SBQ assets, that liquidating value appears to be about $165 million.
The liquidating value of $165 million represents my estimate of a value of $50
million for the Memphis melt shop and $115 million for the Cleveland rolling
mill. I did not estimate any value for the DRI facility because I believe it is
unsaleable, or that it has a negative value. Importantly, these values have
been negatively influenced, in my opinion, by the company's recent statement
that it believes some $100 million in new
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Aldo Mazzaferro Page 3 11/4/99
investment would be necessary to bring these operations up to par. In addition,
the company has stated that whatever proceeds it receives for the SBQ division
will be reduced by the requirement to payoff a leveraged lease ($74 million),
transaction costs ($8 million), and other associated debts ($42.2 million).
Thus, in my optimistic scenario for selling the assets today at estimated gross
proceeds of $165 million, net proceeds would only be $40.8 million to the
Birmingham Steel shareholders ($165 million less $124.2 million). On my
pessimistic scenario for selling the assets today at gross proceeds of $75
million, the debt repayment obligations would outweigh the sale proceeds,
resulting in a negative net impact to shareholders of $49.2 million ($75 million
less $124.2 million). This would be equivalent to the company paying another
party $49.2 million to take the SBQ division.
We estimate that the Memphis melt shop would be sold in today's environment at
values as low as $50 million, or about $45 to $50 per ton of capacity. This is
about 22% of the $220 million approximate investment in the melt shop. This
valuation estimate has been penalized by the poor operating history over the
past two years and the current absence of earnings. It is also severely
penalized by recent statements by Birmingham Steel that it would require new
investments of up to $100 million to improve the productivity of the entire
SBQ division beyond its current low operating rate of about 40% of capacity. I
cannot determine from company statements how much of the $100 million in new
investment would be necessary at Memphis specifically, but I would estimate
that it could be $50 million quite easily, given other company comments that
there are problems with the continuous caster and the size of the electric arc
furnace.
Precedent transactions in the steel industry indicate that under duress, steel
assets can be sold very cheaply. Geneva Steel in Utah was sold in 1986 for $30
million, placing a value on its 2 million tons of capacity of $15 per ton.
Birmingham Steel itself was a bidding party recently in a deal for Qualitech,
another SBQ mill, where the bid, as valued by the bidder, was in the
neighborhood of $225 million. However, this bid consisted of only a small
amount of cash and included an earn-out clause that significantly reduced the
real value of the bid, in my opinion. I estimate this bid's real value equated
to about 25% of asset value for a brand new plant that was operating (including
melting and rolling), and an iron carbide plant, or about $150 per ton of bar
capacity. That bid, at $150 per ton, should be compared to the total value
potential of Birmingham Steel's entire SBQ division, rather than just the melt
shop. For example, at $150 per ton, the company's entire SBQ division would
have a value of $165 million based on its annual capacity of 1.1 million tons
(see below).
Finally, we would place a value on the Cleveland rolling mill alone of $115
million, essentially its replacement cost. This value is not discounted because
I believe the asset is of very high quality. This is a good rolling mill
designed by Sumitomo of Japan, a well-regarded mill builder in long products.
The mill is reportedly state-of-the-art, and only a few years old. However, I
believe the company statement that some $100 million in new investment will be
necessary at the SBQ division will penalize the estimates of the division's
value in potential buyer's eyes, and will contribute to a more difficult sale
and lower gross proceeds as well.
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Aldo Mazzaferro Page 4 11/4/99
The above analysis values the company on its assets, as if in liquidation.
Usually, this yields a worst case, or lower value, than one using operating
earnings and cash flow. However, in this case, because the SBQ division is
operating so much below par, using the current operating statistics such as
sales, earnings and cash flow and multiplying by normal ratios would yield even
lower values than the liquidating value estimates. For example, division sales
are running at $200 million, and non-performing assets such as this have sold in
the past at between 38% of sales and 49% of sales, allowing a value of between
$76 million to $100 million. Likewise, valuing the roughly 500,000 tons per year
of current product output at the $150 per ton values arrived at in the paragraph
above would allow values of only about $75 million. It is clear to me from this
that the company will be forced to sell the SBQ assets on the basis of
liquidating value, which is a very negative environment for a seller.
ESTIMATES OF SELLING PRICE IN MORE FAVORABLE ENVIRONMENT
BEST CASE: $690 MILLION GROSS PROCEEDS; NET PROCEEDS: $565.8 MILLION
WORST CASE: $528 MILLION GROSS PROCEEDS; NET PROCEEDS $403.8 MILLION
In a full recovery, with SBQ pricing returning to the $450-$475 per ton range,
we estimate that the company's SBQ division would be capable of earning $88
million to $115 million in operating cash flow (earnings before interest, taxes
and depreciation, or EBITDA). This would equate to a per ton EBITDA of $80 to
$100, derived by taking the selling price ($450-$475) less billet cost at good
production rates for Memphis ($300) less conversion costs at good production
rates for Cleveland ($50) and transport costs between the two mills ($20). The
resulting profit per ton ($80-$105) is multiplied by full production rates of
the division, 1.1 million tons per year, yielding a total EBITDA of $88 million
to $115 million.
A list of selected acquisition multiples in the steel sector indicates that of
19 deals done since 1992, the median multiple of Enterprise Value (EV) to
EBITDA was 7.1x. There were some as low as 3.5x, and others much higher (due to
depressed earnings, which reduces the denominator). Reflecting recent
discussions with various managements in the steel industry, we estimate a
reasonable multiple for considering a target valuation for the company's SBQ
division in a good environment and operating at its full potential would be
about 6x its level of EBITDA. This might be in a range of plus or minus one
multiple (i.e. 5x-7x).
Applying the 6x multiple to the estimate of the SBQ division's full earnings
potential yields a fair value of $528 million ($88 million x 6) to $690 million
($115 million x 6). These gross proceeds would also be reduce by the necessity
of paying off the leveraged lease ($74 million), the transaction costs ($8
million) and the associated other debts ($42.2 million). Net proceeds after
paying off debts would be $565.8 million in the best case and $403.8 million in
the worst case, assuming a better market environment and full operating
potential for the SBQ assets.
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DIFFERENCE IN VALUATION IN ALTERNATIVE SCENARIOS
Obviously, there is quite a difference in the valuations. These are driven by
two variables: the state of the SBQ market and the productivity of the SBQ
division. Both of these are negative currently, and the estimates of selling
values in a more favorable environment incorporate a normal SBQ market and full
production levels and efficiency for the SBQ division. The differences in value
that would accrue to the company's shareholders in the form of net proceeds
based on selling the SBQ assets now versus waiting are approximately $453
million to $525 million. These differences in value are based on my estimate of
the selling prices likely to be realized under the two scenarios (best and
worst) in each of the two base cases - either selling now or waiting for better
conditions. Under the best case, waiting for better conditions versus selling
now would benefit shareholders by some $525 million (the difference between
adding a positive $336 million to value and penalizing value by a negative $189
million). Under the worst case, waiting for better conditions would add some
$453 million in value (a positive $174 million compared to negative $279
million).
IMPACT OF TWO SCENARIOS ON BIRMINGHAM STEEL SHARE PRICE
The two scenarios described above represent a potential difference in share
price valuations based on the difference between (a) penalizing shareholder
value by selling today, essentially bringing the stock down from $7.00 per
share, and (b) adding to shareholder value by waiting for better conditions,
which should boost valuations. Birmingham Steel shareholders, in my view, could
see the valuation of their shares change in either direction depending on the
action of management regarding the SBQ division. Using the same mathematics as
above, Birmingham Steel shareholders stand to see their stock price, currently
$7.00 per share, appreciate if the company waits for better conditions before
selling the SBQ division. On the other hand, a sale of the SBQ assets today, in
my opinion, would cause the $7.00 stock price to fall.
Based on the current share price on BIR stock of $7, the total stock market
value of the company is $208 million ($7 x 29.7 million shares outstanding). In
addition, the company has $551 million of debt on its balance sheet, plus two
off-balance sheet leveraged leases and an off balance sheet tax lease totaling
$152 million, for total liabilities of about $703 million. This makes the total
enterprise value, or total firm value, or Birmingham Steel equal to $911
million (market value of $208 million plus total liabilities of $703 million).
In my analysis, I assume that the debt associated with the SBQ assets is repaid
from proceeds of the sale, and then the net proceeds (after transaction costs
and associated debt repayment), if any, are applied to the remaining company
debts. The remaining company
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Aldo Mazzaferro Page 6 11/4/99
debts, excluding debts associated with the SBQ assets, are $586.8 million ($703
million minus the leveraged lease of $74 million and the other associated debt
of $42.2 million).
Based on comparable industry values, I can approximate a value for Birmingham
Steel's other assets, primarily the company's other steel mills that have 2.7
million tons per year of rebar and merchant bar shipping capacity. I would use
normalized EBITDA earnings levels for rebar and merchant bar of $35 per ton and
multiples of 5x-7x to arrive at a value of those assets of between $473 million
($35 x 5 x 2.7 million tons) to $660 million ($35 x 7 x 2.7 million). The mid
point of those estimates is about $565 million, or about $209 per ton.
Incorporating this estimate of the value of the rebar/merchant bar assets into
the overall enterprise value of the company implies that the stock market is
valuing the company's other assets - the SBQ assets - at about $346 million
($911 million less $565 million equals $346 million). Under this analysis, any
sale of the SBQ assets that generates gross proceeds of less than $346 million
would reduce shareholder value, while a sale of those assets at prices above
$346 million in gross proceeds would raise shareholder value.
Based on the above analysis, we can now arrive at an estimated impact of the two
scenarios of selling the SBQ assets, either currently in a depressed environment
or later in a better environment. Birmingham Steel noted in its most recent 10K
that proceeds from the sale of the SBQ assets would be employed to reduce debt,
specifically (a) the Memphis lease - $74 million; (b) transaction expenses - $8
million; (c) industrial revenue bonds (IRBs) and other debts specifically
associated with the SBQ assets - $42.2 million, and (d) other debt. In the table
below, I have reduced estimated gross proceeds on the sale of the SBQ assets by
these items: $74 million leveraged lease, $8 million in transaction costs, and
$42.2 million in other associated debts (total $124.2 million) before applying
those net proceeds to the model that estimates the potential additional debt
reduction and the corresponding effect on the equity valuation. The table below
explains the transaction analysis.
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<CAPTION>
CURRENT CASE CURRENT CASE
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Best Worst Best Worst
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Estimated Gross Proceeds for SBQ asset sale ($MM) 165.0 75.0 690.0 528.0
- - less: leveraged lease 74.0 74.0 74.0 74.0
transaction costs 8.0 8.0 8.0 8.0
IRBs and other associated debts 42.2 42.2 42.2 42.2
Net proceeds ($MM) 40.8 (49.2) 565.8 403.8
Total other company liabilities today ($MM) 586.8 586.8 586.8 586.8
Liabilities after sale (today liabilities less net proceeds) 546.0 636.0 21.0 183.0
Est. Value of remaining rebar/merchant assets ($MM) 565.0 565.0 565.0 565.0
Implied new market value (565 less liabilities)($MM) 19.0 Nil 544.0 382.0
</TABLE>
The table indicates that the sale of the SBQ assets under the current case will
have a very negative effect on the shareholder value for Birmingham Steel
compared to the later case. I estimate that selling in this negative
environment, even under the best assumptions, would reduce the value of BIR
stock. This represents a loss of shareholder value.
Conversely, I believe waiting for a better market would result in a significant
positive for shareholders. Under this scenario, the company would sell the SBQ
assets under more favorable conditions, or alternatively continue to own and
operate the SBQ assets and earn better returns. Keeping the asset would also
have the same positive effect on shareholder values, in my opinion, because it
would allow the stock market to place a higher valuation on the company. By
waiting for better markets, even in the worst case scenario, the higher SBQ
asset value would result in an appreciation in the shares. This would add to
shareholder value. Under my best-case scenario, the stock would appreciate
compared to the $7.00 current price. This would increase shareholder value.
Aldo J. Mazzaferro, Jr., CFA
Mazzaferro Investment Group, LLC
FORWARD-LOOKING STATEMENTS
The U.S. securities laws provide a "safe harbor" for certain
forward-looking statements. This material contains forward-looking statements,
including statements concerning the business, future financial position,
results of operations, business strategy, estimated cost savings and other
benefits of the Group's proposed management of the Company. Forward-looking
statements involve risks and uncertainties that could cause actual results to
differ materially from those projected. Readers are cautioned not to put undue
reliance on forward-looking statements. The Group disclaims any intent or
obligation to update such forward-looking statements.
