International steel group, Ispat, prepares for its industrial revolution

IT is a long time since the steel industry created as much excitement in the stock market as now surrounds the flotation in New York and Amsterdam of Ispat International, the fast-growing, London-based group with a $3 billion (£2 billion) price ticket.

Ispat, which acquired Irish Steel in Haulbowline, Co Cork, from the Irish Government 18 months ago, is to come to the market early next month. Mr Lakshmi Mittal, the company's founder and chairman, is offering a 16 per cent stake worth about $460 million in the share sale.

Ispat, which has most of its operations in the Americas, is coming to the market with an extraordinary growth record that has seen net profits soar from negligible levels at its foundation in 1989 to $630 million last year. In 1996, the net return on sales, which totalled $1.8 billion, was 34 per cent. The profit figure includes gains from revaluing assets, but even without this contribution, net profits were $262 million - or 14.7 per cent of sales.

The figures invite three main questions from potential investors: how has Mr Mittal achieved this growth; can he maintain the momentum; and how can outside investors be sure of a fair share of the returns, when the founding shareholder will retain 97 per cent of the voting rights?

Mr Mittal (47) was born into an Indian steel-making family. He struck out on his own in the 1970s in Indonesia, successfully turning an initial $1.5 million investment in rolling mills into an international steelmaking empire.

The company's growth has been driven mainly by the acquisition of under- performing steel mills at low prices, often in privatisations. Ispat has revitalised these operations - in Mexico, Trinidad & Tobago, Canada, Germany and Ireland - by putting in new managers, cutting costs, investing in the plants and expanding output. When Ispat took over Irish Steel, the company officially changed hands for £1. But the complex deal involved the Government giving Ispat the equivalent of £38.2 million. Of this, £17 million was a write-back of debt stretching back to 1985, while the balance was a direct grant. In return Ispat said it would invest £30 million in the company over the following five years and guaranteed the majority of the 350 jobs.

The group has concentrated on producing steel in electric arc mini-mills, which can make steel effectively in flexible small units in contrast to traditional blast furnaces. Most mini-mills operate by converting scrap steel into marketable products, which is highly profitable when scrap is cheap. But the success of minimills has driven up scrap prices over the past 20 years and squeezed margins. So, steel companies have developed direct reduced iron (DRI) - a method of processing iron ore into mini-mill feedstock.

Mr Mittal was among the first to grasp the full commercial opportunities of DRI and has made Ispat the world's largest producer of DRI, with an output last year of five million tonnes.

The jewel in Ispat's crown is Mexico, where the company has increased output per employee five-fold since acquisition. Mexico last year accounted for 37 per cent of group sales and 63 per cent of operating profits. Its operating margin was 18.8 per cent. By comparison, Caribbean Ispat managed an 11 per cent margin and Sidbec-Ispat in Quebec 8.6 per cent, while Ispat Hamburger Stahlwerke in Germany made a small loss.

Ispat is trying to raise standards by further investment and encouraging plants to share information. It is also planning to improve its position in Germany through the DM150 million (£55.5 million) acquisition, announced last month, of two mills from Thyssen Stahl, with a combined turnover of DM1.2 billion.

The company is spending $600 million on expanding the plants in Mexico and Trinidad, which would take the group's annual steel capacity to 8 million tonnes.

It also intends to bid for Siderurgica del Orinoco (Sidor), the state-owned Venezuelan steel company, if the government goes ahead with privatisation. With an annual output of 2.9 million tonnes, this would bring Ispat's capacity to nearly 11 million tonnes and take the group into the world's top 10 producers.

Analysts forecast the group could see sales and net earnings growth of 20 per cent a year over the next few years and become the world's biggest steelmaker by 2010.

However, investors need to consider some potential problems. First, the headline net profit figure includes profits from a revaluation of assets, which is now virtually complete and will not bring big gains in future. As the prospectus says, US rules would not have allowed the gains to be included in net profits. USstyle figures are given separately.

Ispat is also being lumbered with a twotier share structure, so Mr Mittal can raise capital without relinquishing almost complete control. The A shares on offer will have only one tenth of the voting rights of B shares, which Mr Mittal will retain. He will keep 97.5 per cent of the voting rights, or 97.1 per cent if extra shares are put into the sale under a "greenshoe option".

Moreover, Mr Mittal is keeping an important chunk of his business out of the flotation. Neither the Indonesian mills nor the giant Karmet steelworks in Kazakhstan are included. These are in the prospectus under the heading "potential conflicts of interest".

Finally, there is the all-important question of price. The company says it plans to retain earnings for future growth and pay only "nominal" dividends - so the main return to shareholders will be through share price growth.

At the indicated price of $22 to $26 a share, the historic price/earnings multiple is about 21, based on earnings of $1.12 a share for the year to March 1997, excluding the revaluation gains. For the year to December 1998, analysts expect strong growth to take earnings to perhaps $1.80 a share, giving a prospective multiple of about 13.5.

This is a modest discount to Nucor, the fast-growing US mini-mill group to which Ispat is often compared, and which trades on a prospective multiple of about 14.5. It is a high price for Ispat, given that its main operations are located in a riskprone developing country. The entrepreneurial Mr Mittal must work hard to justify the premium rating.