Sunday, 25 January 2009

Steel Sector Undergoes Reshuffle

2008 saw an industry myriad small companies began consolidating into several giants. But the outcome of the reshuffle is still unclear.

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Steel Sector Undergoes Reshuffle

2008 saw an industry myriad small companies began consolidating into several giants. But the outcome of the reshuffle is still unclear.

Zhang Boling, Caijing
24 January 2009

After more than five years aggressive growth, China’s steel companies are facing the toughest time than ever.

According to data issued by China Iron and Steel Industry Association, 48 out of China’s 71 large- and medium-sized steel producers reported a combined loss of 12.77 billion yuan in November 2008. Moreover, experts predict that 2009 will be even more challenging for steel mills.

Steel companies have taken a series of measures to reduce losses, including halting production, reducing prices, and tightening cost controls. At the same time, smaller companies are seeking to improve risk resistance through mergers and acquisitions, leading to a new round of reshuffling in the sector.

On November 5, state-owned Shandong Iron & Steel Group Co. signed an agreement to merge with the privately owned Rizhao Steel Holding Group. The deal is set to be the largest merger between a state-owned steel company and a private one.

In north China’s Hebei Province, China’s major steel producing region, private steel mills are counting on consolidations to help them overcome the weakening market.

In December, 39 local steel mills, mines and logistics companies in the city of Tangshan merged into Tangshan Bohai Iron and Steel Group, and Tangshan Great Wall Iron and Steel Group. The establishment of these two steel groups is seen as the largest reshuffle of private steel companies in China. The two groups now have a combined production capacity of 28 million tons, accounting for 51.7 percent of the overall capacity in Tangshan.

The Chinese government has encouraged its large number of steel companies to consolidate. Minister of Industry and Information Technology Li Yizhong told the press December 12 that China will adopt a new strategy to concentrate the country’s steel industry by encouraging mergers and acquisitions until only a handful of steel giants are left.

However, questions remain about the actual effects of such a massive overhaul.

Challenge and Opportunity

Last March, the merger between Shandong Jigang Group and Laigang Group, which spawned the Shandong Iron and Steel Group, inaugurated a round of merger and acquisition activities.

A number of major steel producers have since joined them. In June 2008, under the guidance of the provincial government, Hebei’s Tangshang Iron and Steel Group and Handan Iron and Steel Group formed Hebei Iron and Steel Group, creating China’s largest steel producer by capacity.

Meanwhile, Shanghai Baoshan Iron and Steel Group (Baosteel) joined hands with Guangzhgou Iron and Steel Group and Shaoshan Iron and Steel Group to set up a venture – Guangdong Iron and Steel Group.

And in September, Wuhan Iron and Steel Group acquired Guangxi Liuzhou Iron and Steel Group to form Guangxi Iron and Steel Group.

Most of these deals were carried through by local governments and conducted when the market was still flourishing in early 2008. However, since the second half of the year, the steel sector dove into a slump. According to the Citic Securities, the average price-to-earnings ratio of listed steel companies is currently less than six times, touching historically low levels.

With the property market and manufacturing sector down, the steel industry remains pessimistic about 2009. Analysts say that both the supply and demand of steel will drop, while companies will see lower steel prices as well as profits.

Zhou Tao, a senior analyst from Guojin Securities, forecasted that China’s average steel price in 2009 will drop 20 to 35 percent from its 2008 figure. And steel companies’ profit may decease 11 percent to 32 percent year on year.

But the distressed market also creates an opportunity for an industry shakeup. Compared with the previous government-led reshuffles, the recent reshuffles have been spurred by market forces. Smaller steel makers squeezed by weaker demand and financial shortages have turned to mergers with stronger companies in order to survive.

“We have been seeking bigger partners since November 2008,” a senior manager from a private steel mill in Tangshan told Caijing. The company has halted production of seven of its eight smelters since September due to expanding losses.

According to Shagang Group, China’s largest private-owned steel producer, it has received a number of acquisition invitations from smaller companies since the industry entered a downturn in the second half of 2008. Some of the offers were quite cheap, said company source.

Hurdles Remain

Although the current sluggish market has lowered the costs of merger deals, industry insiders warn that companies are still facing the massive challenge of once consolidation occurs.

In the past few years, many Chinese steel makers have confronted failures in integration after a merger. For instance, years after the combination of Anshan Iron and Steel Group and Benxi Iron and Steel Group, the two companies’ operations still haven’t been successfully fused. Another example is Shangdong Iron and Steel Group, which has largely kept intact two parallel operations for two years since the merger of Jigang Group and Laigang Group led to its creation.

Property rights and personnel management, as well as other issues, complicate the integration process. Moreover, most steel producers only pay attention to a capacity rise after a merger, rather than the substantial integration of management and operation.

Most of the merger and acquisition activities in 2008 were conducted among steel makers based in the same region, as cross-region mergers always run into problems from the local government. Mergers of state-owned firms and private steel makers also face more challenges, since the distribution of interests among the parties can become a task. The same goes for partnerships between firms owned by the central government and firms owned by local governments.

According to a source from Baosteel, the company earlier failed in an attempt to merge with several local steel companies including Handan Steel, Baotou Steel and Jinan Steel, due to the pressure from the government.