Luxembourg steel maker Arcelor SA officially announced a merger with Russian steel maker OAO Severstal acting as a white knight in an attempt to fend off a €23 billion ($29.43 billion) bid from Mittal Steel Co. Friday.

The agreements leaves 40-year-old Russian steel tycoon Alexei Mordashov with a controlling stake in Arcelor, with 38% of the merged company, or 295 million of the roughly 640 million shares outstanding, as he yields Severstal's steel-making assets as well as iron ore mines and coal mines over to Arcelor. He is also purchasing about €1.25 billion worth of Arcelor shares at a price of €44 per share, a price the company says is higher than the most recent Mittal offer.

A source close to the deal pointed out the companies had a long history of partnerships on various projects and are both focused on making higher value, auto quality steel. Together, they would be the largest maker of steel going into the automotive industry, responsible for about 20% of that market according to the source.

"The merger is consistent with Arcelor's strategy of value before volume," said Arcelor CEO Guy Dolle, implying that his company makes higher quality steel products than Mittal Steel and he views that as one reason why the two companies would not be a good combination. In the merged company, Mr. Dolle will remain as CEO and Chairman Joseph Kinsch will maintain his position, while Mr. Mordashov will become president of the board of directors in a role said to be similar to chairman. Mr. Mordashov will be able to nominate six of the 18 board members.

The combined company would be called Arcelor, with Severstal, at least initially, listed as a subsidiary.

Yesterday, Mittal President and Chief Financial Officer Aditya Mittal ridiculed the idea of Arcelor linking up with Severstal. "No other deal compares to the industrial logic of this transaction," he said, referring to his company's offer. "Any new move would probably be defensive and in the interest of Arcelor management rather than in the interest of Arcelor shareholders."

The deal would expand Arcelor's presence in Russia, a low-cost nation for producing steel, while furthering Mr. Mordashov's ambitions to give Severstal a greater global footprint. The deal also would put a large block of Arcelor shares into friendly hands, making it more difficult for Mittal to get control, though Mittal could still adjust its terms. People close to Arcelor said such a deal, which has been in the works for some time, gives Arcelor a higher value than Mittal's bid.

The transaction requires shareholder approval, these people said.

Such a deal marks the latest chapter in a wave of consolidation in the steel industry amid higher steel prices and growing demand from nations like China. A combination of Mittal and Arcelor, the world's two top steel producers, would create an industry giant more than twice as big as its next largest competitor. But Arcelor has repeatedly rebuffed Mittal's advances since Mittal announced the bid in January.

People close to the matter said at the time Mr. Mittal sweetened the bid so quickly because he suspected Arcelor was on the verge of agreeing to a deal with a Russian partner as way to block his offer.

A deal with Severstal would be the latest in a series of moves Arcelor has taken to block the Mittal bid. In April, it transferred ownership of a recent acquisition, Dofasco Inc. of Canada, to a Dutch trust. Mittal had already agreed to sell Dofasco to ThyssenKrupp AG of Germany if it buys Arcelor, something that is more difficult with the current structure. Mr. Mittal said last week his lawyers are still looking into ways to unwind the move.

Arcelor has been scouring the globe for "white-knight" bidders to buy a big stake in the company to protect it from Mittal since January, people close to the matter have said. Many of those approaches have come up empty.

Arcelor has also been eager to find a Russian partner to expand its business further into one of the world's lowest-cost areas to produce steel. Russia and Brazil, where Arcelor already has major operations, are among the cheapest places to make steel.

Most Russian metals firms enjoy low-cost labor and have much greater control of supplies of iron ore and coking coal than their Western counterparts, insulating them from cyclical price rises of such commodities. As a result, Russian steelmakers have much higher net cash positions and operating margins than Western firms.

Severstal reported net profit of $1.29 billion for 2005, down 7.9% from a year earlier, on higher input costs. Severstal uses International Financial Reporting Standards, which differ from U.S. generally accepted accounting principles.

Severstal became one of the first companies in Russia to acquire major assets abroad. In December 2003, it bought Rouge Industries Inc. of Dearborn, Mich., out of bankruptcy, and last year it acquired Lucchini SpA of Italy. Mr. Mordashov owns one of Russia's biggest car makers, UAZ, which produces jeeps and sport-utility vehicles.

Severstal already has a longstanding relationship with Arcelor. The two have a joint venture in Severstal's home city of Cherepovets to produce galvanized steel for the rapidly growing Russian auto market.

Chicago-based steel industry consultant Michelle Applebaum expects the Mittals would likely back away, or at least wait and see how the Severstaal assets that are to be exchanged for Arcelor shares are going to be valued. She also expects the pace of consolidation will accelerate as a result of a failed bid by Mittal. "Other, smaller steelmakers are likely to seek both domestic and cross-border alliances so that they can choose their own destiny rather than be caught in the cross-fires as Arcelor and Dofasco have recently been."

The two firms advising Severstal in the transaction are Miller Mathis and ABN Amro.

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