China mergers shake up steel sector

Posted on September 27, 2016

CHANGZHOU, CHINA - MAY 13: A worker welds steel bars for export in the production area of the Zhong Tian (Zenith) Steel Group Corporation on May 13, 2016 in Changzhou, Jiangsu. Zhong Tian (Zenith) Steel Group Corporation is a privately-owned manufacturer that employs over 13,000 workers at its facility in China's eastern Jiangsu province. Since 2001,the company says it has adopted new technology to streamline the production of premium quality steel and to reduce environmental impact. The majority of its steel output is for the Chinese market with 20% earmarked for export, mostly to Asia. The company says it is profitable, but admits business has dropped marginally from past years. China is the world's largest steel producer, accounting for over 50% of global supply. China's government has vowed to cut production capacity at state-owned enterprises by up to 150 million tonnes over five years to ease concerns of an oversupply on global markets. However, its efforts appear to be overshadowed by a recent increase in steel prices that has revived production at some Chinese facilities that had been closed down. (Photo by Kevin Frayer/Getty Images)©Getty

It was a long road to insolvency for Dongbei Special Steel Group, a state-owned producer in China’s northeastern industrial heartlands that first defaulted in March after Yang Hua, the company’s chairman, was founded dead after a suspected suicide.

Efforts to save the company through months of negotiations between creditors and the Liaoning government, Dongbei Special’s owner, got nowhere

. On Thursday, eight defaults in, the company finally entered bankruptcy proceedings with a restructuring plan expected to be enacted next month.

    Dongbei Special’s demise was the latest shock in a seismic week for Chinese steel, where the first act of a Beijing-orchestrated plan to forge a more efficient and less indebted industry is under way.

    Similar to earlier attempts, Beijing hopes to use a strategy of closures, asset restructuring and mergers to create 10 groups responsible for 60-70 per cent of the country’s production by 2025.

    “If they can merge with others, they merge,” says Li Hongmei, an analyst at S&P Global Platts. “If not, they will ask the banks if they can change debt for equity. If that fails, then they will choose the last resort — that will be bankruptcy.”

    The sector’s problems with overcapacity have global consequences. Last year Chinese steelmakers’ failure to cut production to match falling domestic demand led to a glut of Chinese steel flooding global markets, dragging down prices and throwing the global industry into crisis.

    International steelmakers are fighting the rise of Chinese exports with a growing number of anti-dumping cases but Beijing says the continued rise in exports merely reflects Chinese steel’s competitiveness.

    To increase it further, Beijing is pushing top-down consolidation. An arranged marriage between two of China’s state-owned steel groups officially started a week ago.

    The absorption of Wisco by Baoshan Steel was the first step to come out of continuing discussions between Baosteel Group and Wuhan Iron & Steel Group aimed at creating a steel producer second in output only to ArcelorMittal.

    Aside from clearing out “zombies” and creating super groups, Beijing is encouraging local governments to carry out debt restructuring plans to deal with indebted local steel companies, either via debt-for-equity swaps or bond issuance.

    Last Sunday a restructuring plan including the issuance of corporate bonds was finalised for Bohai Steel Group, a producer owned by the Tianjin city government with debts of Rmb192bn ($29bn).

    Debt-for-equity deals in steel are part of a broader attempt to deal with corporate debt, says Tomas Gutierrez of Kallanish, a research group. “There is definitely a trend and it’s definitely political, because creditors don’t agree to these things willingly or easily,” he says.

    China outlines rescue plan for Bohai Steel

    Sparks fly from a blast furnace cast house at ThyssenKrupp AG's steel plant in Duisburg, Germany, on Wednesday, July 20, 2016. Chief Executive Officer Heinrich Hiesinger has been moving to change Thyssenkrupp, known for its focus on steelmaking, into an industrial group specializing in everything from elevators to auto parts and submarine building. Photographer: Krisztian Bocsi/Bloomberg

    Conversion of some assets into bonds sets precedent for stricken industry

    Pushing through the ambitious Chinese steel restructuring plan depends on Beijing’s ability to keep in line provincial governments who, worried about unemployment and tax income, often keep local lossmaking producers afloat using subsidies and loans.

    President Xi Jinping’s rapid centralisation of power through a sweeping anti-corruption campaign has given him greater control over the provinces and their enterprises than his immediate predecessors.

    The latest move in Mr Xi’s political house-clearing was the expulsion of 45 lawmakers from Liaoning, one of China’s most indebted provinces and home to Dongbei Special.

    Mr Xi’s clout may improve the odds of restructuring, according to analysts, but they warn that deals announced last week may have a limited effect on steel overcapacity.

    “The overall impact of recent announcements on oversupply is unlikely to be significant,” says Mr Gutierrez.

    Restructuring deals tend to save profitable capacity by creating a separate entity with a lower debt burden so it can continue producing.

    Steel: Industry feels the heat

    EMBARGOED TO 0001 MONDAY MAY 23 File photo dated 10/05/09 of red hot metal being moved across a heavy forge. Heathrow airport has pledged to use British steel if it is allowed to build a new runway, as Indian conglomerate Tata continues to assess bids for its UK assets. PRESS ASSOCIATION Photo. Issue date: Monday May 23, 2016. A shortlist of seven bidders has been drawn up, with thousands of jobs resting on a successful sale, including over 4,000 at the giant plant at Port Talbot in south Wales. See PA story AIR Runway Steel. Photo credit should read: John Giles/PA Wire

    Producers look to survive by moving into more flexible and specialised operations

    For Bohai, this means the formation of a subsidiary consisting of the company’s premium assets that will hold only Rmb50bn of a total debt pile of Rmb192bn.

    For Dongbei Special, it is likely that Fushun Special Steel, a high-end steel pipe manufacturer, will be spun off and continue producing, analysts say.

    The drive to preserve and promote high-end, coastal capacity while cutting off low-end, inland capacity is present throughout the restructuring plans, including the headline Bao-Wu merger.

    “Coastal capacity is growing, and that’s the main trend of the next two years,” says Mr Gutierrez. “Baosteel has a plant in Guangdong, Wisco has one in Guangxi, and they are ramping up to just under 10m tonnes of capacity a year each by the end of 2017. What [international steel producers] really should be asking is what’s happening with the extra 50m tonnes of capacity being commissioned on the [Chinese] coast in the next two years.”

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