Bloomberg News

U.S. Steel Lures Shorts as Options Traders Bet on Deal: Real M&A

November 15, 2011

Nov. 9 (Bloomberg) -- U.S. Steel Corp.’s options traders are growing more convinced the cheapest steelmaker in America will be acquired, emboldening short sellers to push their bearish wagers to a record high.

The ratio of calls to buy U.S. Steel, mired in the worst earnings slump in almost two decades, exceeded puts to sell by 1.34-to-1 last week, the highest in 20 months, according to data compiled by Bloomberg. Bullish buying in the options market rose as speculation of takeovers in the steelmaking industry helped to lift U.S. Steel’s stock in the past month from its lowest since March 2009, said JonesTrading Institutional Services LLC.

While U.S. Steel is the nation’s only producer of the metal trading at a discount to net assets, buyers may be deterred by a global economic slowdown that depresses steel demand, a pension plan shortfall of almost $2 billion and net debt that is approaching its equity value as it burns through cash. Traders who make money betting against companies are now more bearish on U.S. Steel than all but one stock in the Standard & Poor’s 500 Index, according to New York-based research firm Data Explorers.

“You have a classic tug-of war going on,” Michael Holland, chairman and founder of New York-based Holland & Co., said in a telephone interview. His firm oversees more than $4 billion. Still, “there’s a real question as to whether the speculators who are looking for a takeover will be rewarded. The company isn’t just a steelmaking operation. It also has a load of debt and liabilities which saddles the operation,” he said.

Relative Value

Erin DiPietro, a spokeswoman for Pittsburgh-based U.S. Steel, said it doesn’t comment on rumors and speculation.

U.S. Steel’s shares retreated 8.2 percent to $25.27 today in New York, the worst performance among 31 raw-material producers in the Standard & Poor’s 500 Index.

After falling to a more than two-year low in October as concern slumping economic growth in the U.S. and Europe will hamper sales of steel used in everything from cars to pipes for oil drilling, U.S. Steel gained 36 percent through yesterday.

The largest U.S. steelmaker by volume has climbed even after posting a wider loss in its European division on Oct. 25.

While its equity has recovered some value, U.S. Steel is still the cheapest steelmaker in America, trading at 0.95 times its assets minus liabilities yesterday, according to data compiled by Bloomberg. That’s helped entice traders speculating on further gains and a possible takeover.

“It definitely could be an attractive takeover candidate,” Rick de los Reyes, who manages $800 million at T. Rowe Price Group Inc.’s Global Metals and Mining Fund in Baltimore, said in a telephone interview. T. Rowe owned 7.5 million U.S. Steel shares as of June 30, making it the third- largest holder. “If you look at them on just a pure asset value basis, a price-to-book basis, it’s looking pretty cheap to me.”

Bullish Options

Bullish bets on the steelmaker exceeded puts by 34 percent last week, the highest level since February 2010, data compiled by Bloomberg show.

Open interest in U.S. Steel’s January $35 calls rose 70 percent in the past two weeks to 43,630 contracts, the most widely held of the steelmaker’s options. That implies a further 27 percent gain from its price of $27.54 yesterday.

“Buyers of these out-of-the-money calls are definitely bullish,” Christopher Rich, head options strategist at JonesTrading, said in a telephone interview.

The share-price gains and bullishness in the options market hasn’t prevented so-called short sellers from raising their bets against U.S. Steel to a record 24 percent of its shares, according to Data Explorers.

Short Selling

In a short sale, traders sell borrowed stock on the assumption the price will decline and enable them to profit by buying the shares back at a lower price.

More than 35 million of the 144 million outstanding shares of U.S. Steel are currently being shorted, the data show.

The proportion of bearish bets is now higher than any company in the S&P 500, the benchmark gauge for American common equity, except Grapevine, Texas-based GameStop Corp. Three years ago, less than 1 percent of U.S. Steel’s shares were sold short.

Short interest on U.S. Steel rose along with the rally in steel shares in the past month, even as bearish bets for rivals AK Steel Holding Corp. and Nucor Corp. decreased.

U.S. Steel said on its earnings call last month that its flat-rolled unit, which makes steel for cars and appliances, will post an operating loss this quarter as prices and shipments decline due to an uncertain economic outlook.

Employers added fewer workers than forecast last month, while Federal Reserve Chairman Ben S. Bernanke said last week economic improvement is likely to be “frustratingly slow.”

Steel Demand

Meanwhile, manufacturing in the U.S. was close to stagnating last month after global demand cooled and prompted factories to reduce production, according to the Institute for Supply Management’s factory index.

Since peaking at a 2 1/2-year high in March, the price for North American hot-rolled steel coil has fallen 27 percent to $640 per short ton, according to data compiled by Bloomberg.

“The stock is relatively cheap on an asset basis, but to think the stock is going to do well from here, you do have to make a case that their volumes are going to be significantly better,” Tim Beranek, a Denver-based portfolio manager at Cambiar Investors LLC, who helps oversee about $8 billion, said in a telephone interview. “That’s a tough argument to make.”

Prospects of a takeover may also be hindered by the United Steelworkers union, which has the “first right of refusal on a change of control,” Michelle Applebaum, managing partner at equity research firm Steel Market Intelligence in Chicago, said in a telephone interview.

Funding Shortfall

U.S. Steel has a $1.98 billion shortfall on pension benefit obligations that totaled $10.6 billion last year, data compiled by Bloomberg show, the most underfunded plan among American steel producers. In addition, with borrowings exceeding cash by $3.64 billion, U.S. Steel also has more net debt versus equity value than any of its competitors greater than $1 billion.

“The stock is depressed and cheap,” said Walter Todd, co- chief investment officer at Greenwood Capital in Greenwood, South Carolina, which manages $940 million. “On the flip side, you have the pension and fundamental overhang with the company. There are definitely some hurdles to be crossed before somebody comes in and acquires them.”

--With assistance from Nikolaj Gammeltoft in Dallas and Jeff Kearns in New York. Editors: Michael Tsang, Daniel Hauck.

To contact the reporters on this story: Tara Lachapelle in New York at tlachapelle@bloomberg.net; Rita Nazareth in New York at rnazareth@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Nick Baker at nbaker7@bloomberg.net.


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