morgan stanley report - $4.18 price target

Increasing Exposure to Mining Consumables: OST
has agreed to acquire Anglo Americas Moly-Corp and
AltaSteel businesses for a total consideration of US$932m on a debt and cash free basis. The acquisition increases OSTs grinding media production capacity (1,644ktpa) to ~55% of the global capacity, ensuring the company has a dominate position to capitalize on forecast mining growth, particularly copper and gold. We estimate that, due to new copper supply and declining head grades, global milling rates will need to increase by ~97% from 2009 levels (1,332Mt) to meet the projected demand for copper in 2025. This is bullish for grinding material demand that is required in the mining mills to crush the ore.

Acquisition EPS & DCF Accretive: OST will fund the
acquisition via debt, increasing the companys gearing
level from 18% (FY10) to 27%. On our forecasts, OST is
able to repay the debt by the end of FY13e due mainly to
the cash flow from the iron ore business. While the
higher net interest charge moderates the earnings
accretion in the initial years, we forecast earnings
accretion of 6% in FY14e. On a DCF basis we estimate
the acquisition is slightly accretive (+2%).

Acquisition Compared to Historic M&A: The OST
acquisition represents an EBITDA multiple of 9.3x. This
is below the trading value of OST ex-iron ore (11.5x).
Compared to recent M&A transactions the EBITDA
multiple paid is in line (refer Exhibit 6).

Comments from AGM: During its AGM, OST commented that 1H-FY11 performance continues to be impacted by weak construction activity and a stronger A$. The company guided earnings for the 1H-FY11 to be at a similar level as last year (A$117m). In this note, we have adjusted earnings to show the impact of todays acquisition only. We will be re-assessing our base case forecasts in the near term.

OneSteel has agreed to acquire Anglo Americas Moly-Corp
and AltaSteel businesses for a total consideration of US$932m on a debt and cash free basis. The businesses acquired are located in North and South America and are focused on grinding media for the mining industry.

The acquisition will increase OneSteels grinding media
production capacity from 460ktpa to ~1,644ktpa, approximately 55% of the global grinding media production capacity. OneSteel estimates current global grinding media production capacity to be 3,000ktpa.

This ensures that OneSteel will have a dominate position to
capitalize on forecast mining growth, particularly copper and gold. Wood Mackenzie/Brook Hunt estimate that global copper demand will increase from 14.9Mt in 2009 to 27.6kt by 2025, an increase of 85%. In addition to new supply that is required to meet the demand forecast, copper grades are expected to decline over time (refer Exhibit 2). Lower grades will require the milling of higher volumes to achieve the same copper production. We estimate that global milling rates for copper would need to increase ~97% from 2009 levels (1,332Mt) to meet the global demand forecast. We note that this is a conservative estimate as lower grades require higher retention of material in the mills, therefore increasing the amount of grinding material required.

We have highlighted the potential growth in grinding media
requirements to meet the global copper demand. Other metals
such as gold, iron ore, nickel, etc have similar concerns.

Acquisition: Positive Impact on EPS and DCF
The acquisition (US$932m) will be debt funded in US$. Our
gearing level for OneSteel increases from 18% (ND/(ND+E)) at
the end of FY10 to 27%. The higher net interest charge
reduces the earnings accretion of the acquisition in the initial years. However, driven by the forecast strong iron ore contribution, we estimate that OneSteel is able to repay the debt in ~3 years. By the end of FY2013, we estimate that the companys gearing level is ~18%. OneSteel advised that the sustaining capital expenditure for the acquired businesses is ~$10-15m. We have assumed depreciation approximately equal to the sustaining capital expense. We have not assumed any synergy benefits. OneSteel advised that any such benefits would be modest.

Comparison to Other Steel M&A

The OneSteel acquisition represents an EBITDA multiple of
9.3x. This is below the trading value that OneSteel ex iron ore is trading on (11.5x). Prior to the global financial crisis, the steel sector undertook a significant consolidation phase. Since this time, there have been few M&A transactions of size. The OneSteel acquisition compares in line with other M&A in the sector.

OneSteel AGM Highlights

Key points from OneSteels AGM held on November 15, 2011
include:

1H-FY11 performance continues to be impacted by weak
construction activity, as well as a much stronger A$, which
has negative implications for OSTs US$ earnings and its
competitive position in the domestic market;

Due to the delay in recovery of steel fundamentals and the
impact of the stronger A$, OST estimates that NPAT for
1H-FY11 will be similar to last years (A$117m);

The strength of underlying demand for iron ore and scarp
steel is expected to keep prices for these steel making
inputs high compared to historical standards, although
with volatility;

Steel margins in Manufacturing and Australian Distribution
business expected to remain under pressure due to
continued challenges expected from rapid acceleration of
A$ and competitive pressure due to low activity levels.

OneSteel faces the prospect of having to bear the cost
impact of two new taxes from the Australian government.

A new mining tax that would impact the iron ore business
(MRRT), and a new carbon tax. OneSteel advises that
there is not enough detail available to understand the
extent of the impact from these taxes.

OneSteel Acquisition Further Detail

Acquisition is subject to regulatory approval in Canada
and is expected to close end CY2010 (subject to timing of
approvals);

Acquisition of economic interest effective 1 July 2010, with OneSteel receiving the benefit of cash flows from this date;

Moly-Corp: a leading producer of forges steel grinding
balls with production facilities in

Moly-Cop, a leading producer of forged steel grinding balls with production facilities in Chile, Peru, Mexico and
Canada supplying a full range of heat-treated grinding
media, and with established customer relationships with
major mining companies

AltaSteel, a steel mini-mill in Canada supplying ballstock
for the production of forged grinding balls to Moly-Cop and
heat-treated grinding rod to the Americas mining industry