Energy & Resources, Talking Point

Hebei’s M&A king

A wave of consolidation is sweeping China’s steel sector – led by Wang Yifang

Hebei’s M&A king

Consolidated results: Wang has made Hebei Steel nation’s number one

In 1957 China’s steel industry produced a mere 5.3 million tonnes a year. This bothered Mao Zedong, who viewed steel output as a proxy for national virility. Sitting by his swimming pool in Zhongnanhai, he decreed that output should be doubled by the following year. Then he set a target of 30 million tonnes for 1959. It was all to be achieved, he told Nikita Khrushchev sagely, through the efforts of 90 million Chinese, all producing steel from homemade furnaces.

It was, of course, a policy disaster and one of the great failures of the Great Leap Forward campaigns. But times have changed: Reuters is forecasting that China will produce 600 million tonnes of steel this year (which is six times more than that of Japan, and well over 100 times China’s output at the time of Mao’s swimming pool calculations).

Ironically enough, the current Chinese government has concluded that this is far too much; especially when much of it is low quality, and produced in small, energy-inefficient mills. So the goal is to move steelmakers up the value-curve, and promote higher tech mills. Fewer and bigger are the buzzwords; with less overcapacity.

The poster child for this programme is Hebei Iron and Steel Group, which in short order has become China’s biggest steelmaker.

Enter Wang Yifang…

“Steelmakers across China are busy merging and consolidating operations, driving for more efficiency and better resource allocation,” reports the New Century Weekly. “But Hebei Steel has been there, done that.” The man who has driven the process is Wang Yifang.

Back in 2005, Hebei province was home to an untidy portfolio of state-owned mills. In those days Wang ran state-owned Tangshan Steel – a small player that gained greater scale after it absorbed two other Hebei-owned mills. “The restructuring went so well,” writes New Century Weekly, “that the government decided to replicate the merger on a province-wide scale.”

Thus, in June 2008, Wang oversaw a merger with Handan Steel. The resulting entity was renamed Hebei Steel and Wang was made chairman and general manager.

During his tenure as Hebei’s top steel executive Wang has taken over seven mills – the most recent being Shijiazhuang Steel, bought in March for Rmb1.9 billion. The rapid consolidation has seen Hebei Steel leap – in volume terms – to the top of the industry, surpassing Baosteel with an output of 40.2 million tonnes per year. According to Wang, the integration has led to annual savings of Rmb3 billion ($441.7 million) on the pre-merger cost structure.

It can’t have been straightforward?

No, Wang faced serious challenges. The greatest was to combine the merged entities sales and procurement departments.

In a market with fluctuating iron ore costs and often volatile prices for finished steel products, the individual mills traditionally fought over procurement and undercut each other on sales and pricing.

The staff in these buying-and-selling departments also enjoyed great power and resisted change.

So when the financial crisis hit in 2008 they argued the process should be delayed. Wang took the opposite view: that the increased volatility of the market made reform all the more essential.

“The crisis hastened our pace of integration,” he recalls. “Without it, we may not have executed it so forcefully.”

In early 2009 the sales and procurement functions underwent their final integration, unifying purchasing and pricing. An international trade department was also established to consolidate import-export operations across a series of the smaller mills.

The result?

In an industry where losses are common in China, Hebei Steel made Rmb6.9 billion in pre-tax profit in 2009 (albeit about half of what Baosteel made). “Hebei is at the forefront of the industry,” says a confident Wang. “At present, even if the whole steel industry is in dire straits, Hebei Steel would definitely be among the last to fall.”

Little wonder that New Century Weekly says Hebei’s example is “now favoured by mills nationwide”. (For more on recent steel industry mergers see WiC70, Steely Determination).

As to further growth, Wang has already consolidated the province’s state-owned firms, which means further acquisitions would need to involve private sector firms. His reservation is that many of the private mills are sub-scale. “We cannot waste our resources on junk,” he observes.

Then again, he doesn’t seem keen on buying state-controlled steelmakers in other provinces (perhaps because his political ties in Hebei will have less leverage elsewhere). So that may mean Hebei Steel’s position as China’s biggest steel firm could prove short-lived.

Who might surpass it?

As reported in WiC63, Anshan Steel has also proved an active consolidator. It recently merged with Pangang Group. An ongoing merger with Benxi Steel – if completed – will see the firm renamed Anben and expand the group’s total output to 56 million tonnes – putting it in the top spot.

This fits with government ambitions. There are currently just under 1,000 steel smelting enterprises in China, with the top five steelmakers making less than 30% of the nation’s steel. That’s abnormal in the global context, suggesting a fragmented and inefficient industry structure.

Beijing wants the industry to be dominated by three large companies with annual output of 50 million tonnes, followed by a number of smaller companies producing around 30 million tonnes a year, reports the Wall Street Journal.

To encourage M&A it has prohibited new steel projects until 2012, so if a mill wants to expand before then it will most likely have to absorb one of its rivals. There is also continued pressure on the industry’s minor players. New rules were announced last month that will force the closure of steel firms producing less than a million tonnes annually.

Why the hurry to merge?

As indicated earlier, consolidation is intended to make the sector more profitable and more eco-friendly (the bigger players have more modern mills that use less power and will have the balance sheets to invest in cleaner technologies).

The government is also keen to create industry champions that can then negotiate in a more muscular fashion with BHP Billiton, Rio Tinto and Vale over iron ore imports.

As WiC has reported extensively, the Chinese have taken a bloody nose in their dealings with the large iron ore suppliers (most recently, see WiC56). While the Chinese have tried to present a united front in negotiations, the sheer number of mills clamouring for iron ore supply has often undermined the efforts of the industry body – CISA – to drive a better bargain. The government believes post-consolidation it will have a stronger hand.

A problem-ridden industry…

There’s also little choice but to consolidate. A possible double-dip in the US, a slowdown in the local property market (and hence in construction) and a new tax on low-grade steel exports have all sent shivers through industry boardrooms. According to the website Metal Miner, profits at the major steel mills fell 37.8% in June (on the year before) and were expected to drop further in July.

Further market turbulence is expected. Oversupply and excess competition is hurting margins, and iron ore prices are climbing again. Little wonder that Hebei’s Wang believes the industry’s current difficulties may be “more grave than the global financial crisis in 2008.”

And not all the restructuring is going to plan…

Hebei Steel’s example is generally taken as a positive one. But consider the plight of Sinosteel, which is going through much more troubled times. The steel trading firm owned by Sasac (see WiC45) is in a bad way after it tried to restructure privately-held Shanxi Zhongyu Iron and Steel. Unfortunately, Zhongyu turned out to be a tough takeover proposition. Its mill has severe technical problems (the furnaces were discovered to be in such poor shape that they were threatening to explode) and the company has failed to deliver the steel orders that Sinosteel has prepaid for.

That’s left the trading firm with a Rmb4.2 billion bad debt which has reportedly made Sasac boss Li Rongrong livid.

Sinosteel’s experience offers something of a cautionary tale and evidence that the consolidation process may not be easy.

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