Is TimkenSteel vulnerable to an impatient activist investor?
A slumping stock price and a rival's investment suggests the steel producer could be a takeover target.
by Ron Orol
Ellwood Group's recent move to rapidly accumulate a significant minority stake in TimkenSteel Corp. (TMST) touched off a debate over whether the steel producer could be a target and, if so, by what sort of entity.
Executives at Canton, Ohio-based TimkenSteel say they have had a "long and valued" relationship with Ellwood, which itself produces stainless steel and specialty alloys. As such, Ellwood is a customer, supplier and competitor of TimkenSteel.
Some industry watchers believe Ellwood may want to ultimately acquire or put together some sort of combination with TimkenSteel as a liquidity event for its owners. Others insist that the accumulation indicates that a bigger potential buyer may be lurking in the shadows.
In any event, interviews with analysts, bankers, proxy solicitors and activist investors suggests that TimkenSteel could be a tough but feasible play for an insurgent fund looking to shake things up and drive a value-improving deal. For example, an informal poll of analysts following the company suggest that it will likely be sold in the next two to five years and that an activist could help expedite such a move. In fact, one high-profile insurgent investor said that he has heard from a number of people that TimkenSteel could become an activist target.
The activity comes even though TimkenSteel was only formed as a publicly traded company in July, 2014. The $1.2 billion market cap company with $185 million in long-term debt was spun off from Timken Co. (TKR) under pressure from Relational Investors LLC in 2012. And Timken's extensive exposure to commodities may complicate any activist effort or acquisition -- and any insurgency is more likely to succeed once oil and gas prices stabilize. The company's products are used in the oil and gas extraction business, which has been hobbled by low commodity prices.
TimkenSteel's CEO, Tim Timken, is the fifth generation of his family overseeing the business and expectations are that his kin would object to a sale in today's environment of low commodity prices. Justin Bergner, analyst at Gabelli & Co., suggests that Timken management may not want to consider a sale until a $200 million continuous caster it is developing has been fully ramped up. The full value of the caster, which is expected to convert molten metal into steel more efficiently, won't be realized until it is fully operational, which isn't expected to occur until 2016.
Nevertheless, an activist and a banker following the company both suggested that TimkenSteel fits in the category of potential target for an insurgent fund simply because the business was recently spun off. "Spinouts in general are a good place to look because there is usually a significant chance for operational improvements when you have a management team generating value themselves itself rather than as part of a larger conglomerate," said the activist.
Gregg Feinstein, managing director and head of M&A at Houlihan Lokey, suggests that TimkenSteel, like other pure-play spinoffs, could become an acquisition target because it may fit in synergistically with a larger company. He added that the stocks of spinoffs often don't trade well initially because they have "unnatural holders" from before the divestiture who may be not interesting in such a high level of direct exposure to a particular sector, a situation that often makes the spun-off company temporarily undervalued.
And what of the Ellwood Group investment? The privately owned company on Thursday reported increasing its TimkenSteel stake to 8.55%, up from 6.47% in February and 5.34% in January.
Bergner said that one way to look at Ellwood Group is as a strategic investor that is helping to prevent further weakening of TMST's stock price in the currently challenged commodity price environment so that any bid would be sufficiently high enough to meet TimkenSteel's interests and their own as big shareholders. "If their presence helps solicit a sufficiently high bid then clearly as an 8.55% stake owner they would benefit," he said.
If propping up TimkenSteel's stock price was the goal, the Ellwood investment hasn't worked very well the shares this week traded at around $25.45 a share significantly lower than its all-time high of nearly $50 a share in September.
Alternatively, the investment and its effort to limit further price weakness could be a defensive action to discourage international steel producers from acquiring the business in the near-term, a move that could allow Ellwood to acquire it or engage in a merger of some sort down the road, Berger added.
Why would Ellwood be looking for a deal? There may be succession issues at the private company, which is controlled by roughly 25 family members. Bergner suggests that the family could be looking for a liquidity event and it may be positioning itself to merge with Timken. Bergner notes that Ellwood's CEO, David Barensfeld, is in his early 70s and hasn't publicly announced his successor. "If there was a succession plan in the Barensfeld family you might have expected that by now," he said.
Beyond Ellwood, Bergner notes that potential buyers for TimkenSteel, include big players Tenaris SA (TS); Vallourec SA (VK); U.S. Steel Corp. (X); Nucor (NUE) and Steel Dynamics Inc. (STLD).
An activist could seek to pressure for a sale of Timken to one of these larger buyers. Thomas Sandell of Sandell Asset Management Corp. recently held less than 1% of TMST shares, according to a Feb. 13 securities filing, but it is unclear whether the fund would launch any campaign.
Kim Opiatowski, an analyst at APB Financial Group, suggests that she doubts Timken's board would let an activist drive a sale in the near-term due to current low commodities prices. However, she contends that if Ellwood's intentions are to buy TimkenSteel then the environment of low prices is a good time to do it.
In addition, an investor raised concerns about whether an activist could succeed at driving a deal, adding that strategic operating businesses would be the only ones interested. Private equity firms, this person said, would be unlikely to obtain financing for a deal in light of a Jefferies LLC report citing low Ebitda expectations for the next three quarters.
Any activist attempting a proxy contest to drive a deal may also have technical difficulties: TimkenSteel has staggered director elections, which means an insurgent couldn't take over the board in one swoop. Shareholders seeking to call a special meeting, which can expedite a proxy fight, need to hold 50% of the outstanding shares, a significantly high hurdle.
Finally, Ellwood and TimkenSteel would together constitute a formidable opponent if they joined forces to block an activist campaign. In a director-election vote the combined 8.55% Ellwood stake and 10.5% Timken family stake could represent a major barrier for an activist seeking to elect dissident directors.
Ellwood did not return calls but its regulatory filings state that the firm accumulated the shares based on the belief that they were undervalued and represented an attractive investment opportunity. TimkenSteel said it was not looking to be acquired and it declined to comment on the Ellwood investment beyond acknowledging its "long and valued relationship" with the other firm.