will the chinese steel industry be a winner in the new competition paradigm? · 2016-03-03 · will...

Autumn 2011�POSRI Chindia Quarterly

045

Will the Chinese steel industrybe a winner in the newcompetition paradigm?

:: M&A boom in China's steel industry

Park Chan-WookSenior Business Analyst of POSCO Research Institute

For many companies today, “global” means “of a world of open

competition and cooperation.” For so long, the steel industry

was a protected industry and has been considered a fundamental

pillar of support for the national economy. Steel was a strategic

industry that epitomized the closed economy. However, the steel industry is

no longer considered to be a closed industry.

What, then, does it mean to be “open”? “Openness” refers to interactive

relations that affect one another without being disconnected from the outside

environment. The more open an environment is, the harder it is to predict

the direction of changes. For example, if a certain company in China shows

an unusual behavior, Indian companies and North American companies will

respond differently, because they interpret the change in different ways and

think differently about the impact the change will have on them. Various

POSRI Chindia Quarterly�Autumn 2011

046

behaviors of competition and cooperation demonstrated by companies can

increase the uncertainty of the environment, shift the existing paradigm of

competition, and trigger new changes.

Let us examine some patterns found in the steel industry, and the

changes they have caused.

○● The increasing trends of consolidation and cooperative

partnerships

Recent behaviors of competition and cooperation in the steel industry

show two main patterns.

The first pattern is the increasing trends of consolidation and cooperative

partnerships in the steel industry. Consolidation takes the form of M&A’s

within the industry and across industries that transcend regional boundaries.

There are many factors

triggering consolidation. In

the case of the steel industry,

the need to ease oversupply

and entrepreneurial pursuit

of high growth are key

factors.

In Europe, the USA, and

Japan, consolidation within

the industry is common because of the reduced burden of fixed costs and the

increase in asset productivity amidst oversupply. Some cases in point are the

creation of Arcelor in 2002, the birth of JFE, established through the merger

of NKK and Kawasaki Steel in 2003, and the merger of Nippon Steel and

Sumimoto Metal, announced in February 2011. Examples of entrepreneurial

strategies of geographical expansion and of expansion of product scope

include Russian company Severstal’s acquisition of Rouge Steel of the USA

in 2004, the Tata Corus buyout in 2007, and Indian steel tycoon Lakshmi

The future competition paradigm in

the steel industry will show a pattern

of consolidation within the industry

and across industries taking place at

the same time in a complex manner.


047


Mittal’s acquisition of the European steelmaker Arcelor.

Consolidation within the industry in China combines strategies for

easing oversupply and for entrepreneurial growth. After the merger of

Anshan Steel and Benxi Steel in 2004, Bao Steel’s acquisition of Bayi Steel

in 2007, and the establishment of Shandong Steel Group in 2008 through

the merger of Jinan Iron and Steel Group and Laiwu Steel, more and various

forms of consolidation within the industry are expected in the future.

The increasing trend of cooperative partnerships among steel companies

is well-reflected in the alliance strategy of Japanese blast furnace mills in

India. Various win-win strategies have been created between Indian and

Japanese steelmakers: an auto-use steel joint venture between Tata Steel and

Nippon Steel; a deal between Japan’s JFE Steel and India’s JSW Steel to

acquire each other’s stakes; cooperation between Sumitomo and Bushan,

and between Kobe and SAIL. Such partnerships serve as opportunities that

allow new participants to join the current competition landscape naturally, as

well as provide stimuli that break the existing order.

Eased oversupply

Geographical expansion

Expansion of product scope

Cost savings

Forward/backward consolidation

Financial synergy*

Arcelor Japan Tata China Russia

Mittal

Circumstances and characteristics of M&A’s by company

Financial synergy: the benefits of internal capital markets, cost savings from external financing, increased leverage, etc.


048

○● Consolidations in the raw materials industry

and competition for raw materials

The second pattern found in the steel industry is a structural change in

the steel raw materials industry, which started in China. China’s crude steel

production was 220 million tons in 2003, but it has risen by 40 million tons

on average each year to reach 630 million tons in 2010. However, China

depends on imports for more than 60% of crude steel production because it

has low quality iron ore and high mine development costs. This has led to

tight supply and surging prices of steel raw materials around the world.

While China’s crude steel production has risen by only 2.8 times over seven

years, iron ore prices have increased by 6.5 times.

The raw materials shock started in China has brought two structural

changes. The first is the consolidation of the raw materials industry. As the

steel raw materials industry has changed from buyer-oriented to supplier-

oriented, the power of steel raw materials suppliers has become dramatically

stronger. With their operating profits surpassing 40%, big suppliers started

taking over relatively small companies with their abundant funds. The

merger between Rio Tinto and Alcan, worth almost USD 38.1 billion, was a

Note: Self-sufficiency rate includes amounts from long-term supply contracts.Source: RBC Capital, Mar. 2011

The prospects of ArcelorMittal’s iron ore production and self-sufficiency

Iron ore self-sufficiency rate

Iron oreproduction

5365

7479

100

55% 56%61% 63%

78%

(mt )120

100

80

60

40

20

0

100%

90

80

70

60

50

40

302009 2010 2011 2012 2015


049


mega M&A deal with a significantly higher price tag than that of Mittal’s

acquisition of Arcelor. The deal clearly shows the trend of consolidation and

super-sizing in the raw materials industry.

The other structural change in the steel industry is in the competition for

raw materials. The steel industry’s effort to shift from a long-term supply

contract system to a direct development and logistics system is one of the

most important signals in determining the direction of the future competition

paradigm. The Chinese government has set out to develop foreign resources

in alliance with China’s private companies. In February 2011, Luo

Bingsheng, Vice Chairman of the China Iron and Steel Association (CISA),

stated that China seeks to derive 40% of its iron ore imports from Chinese-

invested overseas mines by 2015. In July 2010, China’s state-owned

Chinalco completed a deal to jointly develop Guinea’s Simandou iron ore

Marketnetwork

expansion

Greaterleadership

Greatermarketpower

Increase insales

Increase infree cash

flow

Consolidationand

partnership

Expansion of mine

development

Increasedcompetitive-

ness

Costsavings

Reduction in rawmaterial

financing costs

Economiesof scale and

scope Increasednegotiationpower ofsuppliers

Learningcurve

Causes and effects of changesin the competition paradigm of the steel industry


050

mine with Australia’s Rio Tinto, the world’s third largest mining and

exploration company; last February, China’s WISCO and Canada’s Century

Iron signed an agreement to develop iron ore mines in Quebec.

ArcelorMittal is one step ahead. With the aim of becoming one of the

world’s five largest iron ore producers, ArcelorMittal plans to invest 58% of

its funds for the company’s growth, USD 4.5 billion, in the resource

development sector for the next five years. It is also considering operating a

independent accounting system for the mining sector and eventually turning

it into a separate company.

○● Winner of the new paradigm—perhaps a future black

swan

By all accounts, the future competition paradigm in the steel industry will

show a pattern of consolidation within the industry and across industries

taking place at the same time in a complex manner. Consolidation within the

industry through mergers and acquisitions that transcend regional borders

will give rise to global mega steel companies. Consolidation across

industries, blurring the distinction between the raw materials industry and the

steel industry, will create powerful companies that steer the global economy.

The change in the competition paradigm of the steel industry is

illustrated in the system dynamics model shown in the diagram. A company

that succeeds in competing for consolidation and cooperative partnerships

will not only enjoy the economic effects of scale and scope, but also

improve its cost competitiveness by enhancing processes through learning

and by expanding the development of its own mines. As a result, a virtuous

cycle will be created, strengthening the company’s leadership and market

power and solidifying its presence in the market, which will eventually push

up sales. If there exists a black swan in the steel industry, it is a giant

company taking swift action to lead consolidation within and across

sectors.


051

M&A’s by Chinese steel companieswith good mid-term results


Shim Sang-HyungSenior Business Analyst of POSCO Research Institute

In 2010, Shougang Group had the sixth largest steel production

output in China. However, the company had a poor report card, with

1.1% operating profit that year. In that same year, Shougang Group

shut down its remaining rebar mills in Beijing, completing the

relocation of all of its plants from Beijing. Under the government policy of

moving steelmaking capacities to the suburbs, the company has relocated its

plants to suburbs including Qinhuangdao of Hebei Province, Tian City, and

Tangshan City. Tangshan Steel and Shougang Group teamed up in a 49:51

joint venture to build Shougang Group’s 9.7 million tons per year (tpy)

greenfield steel complex in Caofeidian, the coastal area of Tangshan City.

The layout of the steel complex is modeled after that of POSCO

Gwangyang Steelworks, which is regarded as the ideal layout. If its goal of

expanding annual production capacity to 30 million tpy is achieved, high-

end products churned out from the efficient, state-of-the-art plant will pose a


052

blatant threat to the Korean market.

What stands out more is that if operation of the Caofeidian plant is

successful, a mega steelworks will likely emerge in the market through the

consolidation of Shougang Group, with an ultimate goal of 30 million tpy

production capacity, and Hebei Steel Group, to which Tangshan Steel

belongs and which has a capacity of 60 million tpy. As most of Shougang

Group’s production bases have already been relocated to Hebei Province,

the merger with Hebei Steel Group, the embodiment of consolidation in the

Chinese steel industry, is a high potential scenario in the long term.

Since the end of last year, a rumor has been circulating that Tangshan

Steel is trying to wash its hands of the Caofeidian project and is looking for

proper stock acquirers. The main cause for this rumor is the project’s

ongoing deficits. The deficits are attributed to the fact that production and

sales have not been on schedule because only the first phase was completed

and put into operation, with the second phase of construction only

approaching completion. Some people point out other reasons: the process

design had drawbacks from the beginning; Shougang Group, with no

experience in the operation of a big integrated steelworks, was poor at

management; with frequent discord between the partners in the 49:51 joint

venture, Shougang Group has demanded a bigger stake.

Chinese steel companies are busy moving forward in the great cause of

consolidation and expansion. But do they benefit from such consolidation?

○● Increased industrial concentration through

consolidation

Even under such circumstances as small companies springing up,

reckless competition in facilities expansion, and oversupply, there is still

illegal production at obsolete facilities and low cost competition.

Remedying such inefficiency by consolidating steel companies and

increasing industrial concentration are major policy goals that the Chinese


053


government has sought

for a long time.

The contribution to

production of the top 10

companies decreased

from 37% in 2005 to

35.7% in 2007. The

reason behind this

decline is the fact that small companies’ production grew faster than that of

the top 10 companies. The business environment of the steel industry

worsened from the middle of 2008 with the deterioration of the steel market,

followed shortly by the global financial crisis. Under these circumstances,

Hebei Steel Group was established by the consolidation of five major steel

companies located in Hebei Province, and Shandong Steel was established

though the consolidation of Laiwu Steel, and Jinan Iron and Steel Group.

The Chinese government has pursued policies to increase the size of

steel companies, especially state-owned companies, through M&A’s. As

such policies have borne fruit one by one, the production of the top 10

companies has grown from 40% of total production in 2008 to 48.6% in

2010. The Chinese government has promised to increase its goal to 60% by

2015. Therefore, leading companies are motivated to continue competing in

consolidation and expansion. What matters are the effects of consolidation.

○● Shanghai Bao Steel’s successful acquisition of small

companies

According to a theory on the motivation for M&A, the benefit that a

company with high management effectiveness can get from acquiring a

company with low management effectiveness is the major reason for

concluding an M&A. A case in point is the acquisition of small steel

companies located in inland China by representative leading companies,

M&A deals and consolidation led by

companies with high management

efficiency and abundant funds

seem to have high potential for

success.


054

including Shanghai Bao Steel, Anshan Steel, and Wuhan Iron and Steel. It is

generally believed that when an M&A deal occurs between companies with

disparity in management effectiveness, the greater the difference, the higher

the probability of success of the M&A.

In 2008, Shanghai Bao Steel was the largest state-owned steel company

in Xinjang Autonomous Region. It acquired Bayi Steel, with a production of

only 3.5 million tpy, renovated obsolete facilities, and built new facilities

with a capacity of 5 million tpy. In 2009, it also bought Ningbo Steel in

Zhejian Province, and continued the construction of facilities with 2 million

tpy capacity on behalf of Ningbo Steel, which had acquired approval from

the government. Through the acquisition, Shanghai Bao Steel quickly came

to own a brand new steel mill with the largest capacity in Zhejian Province.

In late 2010, it also acquired Fujian Province-based stainless maker Fujian

Dasheng Nickel Products, and streamlined Dasheng’s business structure and

production facilities. Shanghai Bao Steel is reported to be preparing for

another investment opportunity.

Shanghai Bao Steel has successfully expanded its market in a short span

of time through geographical consolidation, acquiring small and medium-

sized steel companies located in other areas.

Shougang Group, which has been primarily a long product producer, is

going through trials and tribulations in its transformation into a carbon steel

maker. Except for this case, M&A deals and consolidation led by companies

with high management efficiency and abundant funds, such as Shanghai

Bao Steel, Anshan Steel, and Wuhan Iron and Steel, seem to have high

potential for success.

In 2010, when Chinese steelmakers’ average operating profit was only

2.7%, those of Shanghai Bao Steel, Anshan Steel, and Wuhan Iron and

Steel were significantly higher, at 11.3%, 10.6%, and 8.1%, respectively.

These are very good performances, given that this was before the effects

of consolidation really started to show. The competitiveness and


055


performance of these leading steelmakers are likely to continue to improve

in the future.

○● Hebei Steel Group achieves its goal of addressing

oversupply

Hebei Steel Group, comprised of medium-sized steelmakers in Hebei

Province, with Tangshan Steel and Handan Iron and Steel Group at its

center, and Shandong Steel, which is preparing to merge with Laiwu Steel

and Jinan Iron and Steel Group, each with 10 million tpy of capacity, have a

different motive in pursuing M&A’s from the companies discussed above.

These companies have chosen consolidation in response to government

pressure to rein in oversupply within the steel industry and restrain

expansion of facilities. Their purpose in consolidation was to address

oversupply, and to increase market share and management efficiency.

A relatively successful case of consolidation is Hebei Steel Group. This

company started from a consolidated corporate body comprised of five

state-owned companies in Hebei Province, and additionally acquired a

private steelmaker, Shijiazhuang Iron and Steel Company in 2010. At the

end of 2010, Hebei Steel Group concluded an agreement to take over the

procurements, sales, and exports of five private companies located in Hebei

Province, including Hebei Jingye Group and Youngyang Metal Products, in

exchange for 10% of the shares of these companies. Hebei Steel Group then

started to co-manage these companies. Since its founding, Hebei Steel

Group has dismantled obsolete facilities with a total capacity 4 million tpy,

and is making new investments by setting up production specialization

strategies for flat products, vanadium steel, and steel for construction for

each steelmaker under its control. Its plan is to increase the company’s value

by adding flat products and special steel to its product line, which has been

dominated by long products and steel for construction.

Among the effects of consolidation, enhanced operation efficiency


056

stands out the most. In 2009, Hebei Steel announced that it saved RMB 3

billion in costs: RMB 1.95 billion by joint procurement of fuel and raw

materials, RMB 680 million in the consolidation of sales and international

trade, and RMB 360 million in financial costs. By sharing technologies and

pursuing joint R&D, Hebei Steel is promoting technology innovation and

the development of new technologies, which is difficult for medium-sized

steel companies. Unlike M&A deals at the national level, led by big

steelmakers such as Shanghai Bao Steel, Hebei Steel Group concluded

M&A deals with companies in its vicinity. This is a positive case in that it

maximizes the benefits of joint procurement and joint marketing by

producing specialized products at each plant. However, it is disadvantageous

in terms of management efficiency because the Group lacks a company that

can lead the other steelmakers. This is problematic because Hebei Group

must compete with other consolidated groups that are led by major

corporations with experience in operating consolidated steelworks with 20-

30 million tpy of capacity, and with global capabilities.

○● The limitations of consolidating policies

Not all cases of consolidation have positive results: although Anshan

Steel and Bunxi Steel were consolidated through a state-led initiative in

2004, they are operating almost entirely independently; even though Laiwu

Steel and Jinan Iron and Steel Group were consolidated into Shandong Steel

in 2008, actual consolidation has been delayed due to problems with

financing and a clash of egos between these two companies of similar size.

Also, in certain cases of consolidation within provinces, which are hurried

by the central government’s steel industry policies, companies are busy

forming superficial consolidations without a shared purpose in their M&A.

Some examples are Tianjin Bohai Iron and Steel Group Corp., formed by

the consolidation of four major Tianjin-based steel mills in 2010, and

Shanxi Steel Group, the formation of which is being led by the government


057


of Shanxi Province.

M&A is undoubtedly a good means for a company to rapidly expand by

incorporating the capacities and business bases of a counterpart, but the

company must bear costs in the early stages of M&A. If an M&A deal fails,

the company loses a substantial investment. Therefore, a company must

make precise and objective assessments of its own capabilities and those of

its counterpart, and make sage judgments and highly strategic decisions.

M&A is the flower of management strategy, which combines the

functions of finance and assessment with business strategies and

entrepreneurship. However, M&A in the Chinese steel industry is

safeguarded by the Chinese government, which is also a catalyst for M&A’s.

China’s M&A market is not being operated with a good grasp of the

possibility of failure in M&A, and the subsequent responsibilities that come

with such failures.

will the chinese steel industry be a winner in the new competition paradigm? · 2016-03-03 · will...

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