China Steel M&A
CRU Shanghai Metals Briefing
September 17, 2019
Prepared by:
Matthew Poole
Divisional Director,
Global Head, Steel and Raw Materials
CRU Consulting
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2
China Steel M&A
3
1. Introduction: setting the scene - China reborn
2. Current and planned levels of China consolidation – Will it be different this time?
3. Theory and practice of M&A – consolidation has not always delivered value creation
4. Conclusions - productivity, not just consolidation, will be the key to success
Global steel timeline – have we moved into a new steel era?
4
-5%
10%
25%
40%
55%
0
500
1000
1500
2000
2500
1997 2002 2007 2012 2017 2022 2027 2032
China World ex-China
Regional consolidation China super-cycleGlobal
oversupplyProtectionism Post China supply-side reform
Global Financial
Crisis
Eurozone
crisis
1st China
peak
steel
European consolidation
‘wave 2’
Chines supply side
reforms
China
consolidation
wave?
US industry rebirth
European consolidation
‘wave 1’
Baowu
Steel
formed
Arcelor
Mittal
formed
LHS: Global apparent steel consumption, Mt
RHS: Industry profitability (% EBITDA/Sales margin)
After success of recent supply reforms, ‘Phase 2’ reforms
5
● Reforms have so far focused on crude steel, where utilisation rates have increased in the last two years, leading
to higher industry profitability.
● China’s steel industry will this year switch from reducing overall capacity to focusing on optimising capacity
structure, including products, location and ownership.
● ‘Industry Reform Phase Two’ is beginning in pilot regions, before a full national rollout. Rules restrict existing
capacity as well as new additions, incentivising M&A to drive growth. This new phase also looks set to support the
ongoing “battle for blue sky” as facilities are relocated away from areas suffering from poor air quality.
Phase 2 is expected to focus on optimising the downstream sector
- Induction furnaces
- Closures
- Swap programme
- Additions / creep
Phase
1
Phase
2
- Products
- Location
- Ownership
- Production
efficiency
Reduce
crude steel
capacity
Optimise
capacity
structure
Actual and forecast outcomes
-244 Mt net capacity
reduced by 2023
Improved industry
EBITDA by 2017/2018
-6.7% 2016 to +23.4% 2018*
Possible Outcomes
Better EBITDA
downstream
M&A: consolidation
Assets more focused
on high value
Production efficiency
* CRU notional China steel mills EBITDA margin HRC from CRU Steel Cost Review
China market is less concentrated than developed markets
6
75%
41%
25%
81%
63%
37%
0%
20%
40%
60%
80%
100%
NorthAmerica
Europe China
Crude steel production (2018)
Top 5 Top 10
75%73%
47%
93%91%
72%
0%
20%
40%
60%
80%
100%
Europe NorthAmerica
China
HRC capacity (2018)
Top 5 Top 10
55% 55%
63%
82%
0%
20%
40%
60%
80%
100%
China ROW
Silicon steel capacity (2018)
Top 5 Top 10
Will it be different this time? Obstacles vs. enabling factors
7
Obstacles
A previous attempt at a similar policy failed in
2005, largely as a result of significant growth in
investment between 2008 and 2013 during which an
extra 500 Mt/y of capacity was added.
In the past, issues have occurred at a local and
provisional level, vested interests were unable to
cede power, profits and taxation revenues as
consolidation conflicted with targets to maintain
employment, local taxes and local autonomy.
Historically, there has also been issues around the
complexity of ownership, lack of transparency in
accounting an the inability of companies to use the
capital markets to fund a merger.
The majority of SOEs are under the jurisdiction of
regional and municipal governments (13% centrally
owned), hence there is a political challenge when
merging centrally owned SOEs with provincial SOEs
and/or private sector companies.
Enabling factors
✓The central government can now resort to “special
political instruments” to enforce its authority.
✓The government is reforming the process so it can
forge M&As between SOEs. Local and provincial
governments are now being judged and rewarded
according to different criteria and have already
conceded interests in the closure programme.
✓Industry conditions with “low to no” steel demand growth
means priorities have shifted since the previous policy
attempt in 2005. There is now a need to:
• Reduce high corporate debt levels
• Close “zombie” companies
• And improve productivity and add value across the
industry
✓The government is also encouraging mixed ownership
with private investors being invited to participate.
Debt for equity swaps are being permitted, for example.
✓Accounting standards are also improving, making it
easier for M&A to take place.
✓SASAC is also promoting partial privatisation and
stock market flotation across the board with the number
of centrally owned SOEs (all industries) falling from 117 to
96 since 2015 through mergers.
Since domestic expansions are effectively banned, M&A provides only option for expansion
What will China’s steel industry look like in the future?
8
Likely steel landscape:
● Although CRU believes that China will make significant
progress over the next few years, the government target of
60% concentration by 2020-2025 looks ambitious. In order
to achieve this target, a significant amount of M&A would need
to take place.
● The recent M&A between BaoWu and Magang Group
creating a 90M tpy company has only maintained
concentration levels at circa 37%.
● To reach the consolidation levels targeted, there would
need to be at least two x 100Mtpy companies (national
champions), and significant consolidation among mid-tier
producers with 5-6 x 30-50Mty steel companies, including
• large regional/provincial players,
• leading private steel companies,
• specialist players (speciality steels/pipes & tubes), and
• private groups potentially formed by investment funds.
● CRU expects that China will fall short of the 60% target with
40-50% a more likely level of concentration. Such a
landscape seemed unimaginable jus a few years ago, but will
also upport investment in larger BFs and EAFs.
Failure to reach this concentration level could slow the pace of forecast trends such as
the shift to EAFs and larger blast furnaces
0%
10%
20%
30%
40%
50%
60%
70%
0
100
200
300
400
500
600
700
800
900
1000
China steel industry consolidation levels, 2000-2023
Crude steel production (lhs)
Top 10 producers production (lhs)
Government
Policy target
Theory of M&A: Why conduct M&A in steel?
M&A Strategy Strategic Rationale Driver / Benefit
1 Consolidation
2
3
4
5
6
Access to new markets
Access to raw
materials and /or low
cost steelmaking
Move downstream
Acquire technology
/ capabilities
Company diversification
• Supply existing market /
customer base with fewer
/ more efficient assets
• Cost reduction
• Efficiency
• Increased market power
• Enter new geographic
markets and /or product
segments
• Revenue growth
• Diversification of market /
cyclical risk
• Outlet for existing capacity
• Security of supply of raw
materials (iron ore,
metallic, coking coal)
• Reduce costs / increased
margin
• Reduced volatility in margins
• Capture value added from
distribution/ processing
/converting steel products
• Capture value added from
distribution/ processing
/converting steel products
• Increased price / tonne
• Product differentiation
• Customer intimacy
• Improved product or process
capability
• Higher value added or lower
cost processes
• Threat of substitution in
core market positions
• Decline in ‘core’ business
• Maintain customers /
markets
• Solutions orientation to key
customers eg automotive
In practise consolidation has not always delivered value
ArcelorMittal’s global footprint spans 5 continents…
…but hasn’t delivered superior value creation.
0%
5%
10%
15%
20%
25%
0 50 100 150
5-y
ea
r E
BIT
DA
M
arg
in
5-year Average Annual Production (Mt)
ArcelorMittal
Source: Bloomberg , World Steel Association
Source: Company report, VDEh plant facts, CRU databases
● Arcelor Mittal only ‘real’ global steel
company.
● Will appetite for M&A see ‘transformational’
moves like Arcelor Mittal repeated in the
near future.
● Trade measures and protectionism tending
to promote the development of regional
champions
● Alternative option is a looser form of
strategic partnership or alliances to replicate
AM’s global footprint?
o Technology and R&D sharing
o Balancing heavy end steelmaking capacity with
downstream capacity and market access
o Better meet global customer (eg automotive)
demands for wide product range and service
globally
11
-
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
200,000
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
China ODI Manufacturing ODI
China’s
overseas
manufacturing
investments
only just
BRI supporting overseas investments, creating global giants?
$m ODI in non financial assets per annum
Source: NBS
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
0
5
10
15
20
25
30
35
Volume change % change
Ex-China steel demand growing more quickly than in China
Cumulative change in finished steel demand, 2019-2023, Mt
Current profitability may mask inefficiencies in state sector
12
0.00
0.05
0.10
0.15
0.20
0.25
0.30
2006 2010 2014 2018 2022
Labour productivity, manhours/tonne of hot metal
China Japan
United States Germany
150.0
200.0
250.0
300.0
350.0
400.0
450.0
500.0
2006 2010 2014 2018 2022
Coke consumption in BF, kg/t
China Japan
United States Germany
1400
1450
1500
1550
1600
1650
1700
2006 2010 2014 2018 2022
Fe consumption in BF, kg/t
China Japan
United States Germany
Costs wills also continue to rise in China, eroding China’s competitiveness
• China’s steel industry is moving into a second stage of development beyond supply-side
reforms (cutbacks).
• An important part of this development includes consolidation of China’s steel industry which
still operates at a much lower level than developed regions/markets.
• Hitherto, consolidation has faced numerous obstacles and targets have been unfulfilled, but
various enablers may pave the way for change in the future.
• Given the sheer size of China’s steel industry, relatively modest moves towards these targets
would create giant steel companies. BRI (and ex-China steel demand) is also encouraging
Chinese steel companies to make moves overseas.
• M&A does not necessarily deliver value creation. If China is to successfully reform its steel
industry (indeed the whole economy) it must improve productivity levels through SOE reform.
Conclusion: More M&A moves in/from China likely coming
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14
BACK UPs
15
What will China’s steel industry look like in the future?
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0
200
400
600
800
1000
2016 2018 2020 2022 2024 2026 2028 2030 2032 2034
China blast furnace size distribution, No. BF
>4000 3000-4000 2000-3000 1000-2000 <1000
2016 2018 2025 2030
> 4,000 m3 22 25 29 33
3,000-4,000 m3 20 19 29 32
2,000-3,000 m3 76 76 97 81
1,000-2,000 m3 329 320 249 146
<1,000 m3 519 442 222 85
Total No. 966 882 626 377
Total Capacity 985 937 809 604
0%
10%
20%
30%
40%
50%
60%
70%
0
100
200
300
400
500
600
700
800
900
1000
China steel industry consolidation levels, 2000-2023
Crude steel production (lhs)
Top 10 producers production (lhs)
Government
Policy target
CRU has proven process for helping clients with M&A
Establish
strategic
rationale
Preliminary
research
Set
investment
criteria
Profile
‘ideal’
target
company
Develop
key
selection
criteria
Additional
research
on
reduced
list
Develop
profiles
and score
vs criteria
Review
with client
1 2 3 4
5 6 7 8
• What is the driver
for the acquisition?
• Scale, value,
returns• The ‘perfect fit’ • 1st cut and 2nd cut
selection criteria
(see next slide)
• Desk based research
using public domain
and CRU proprietary
sources
• Primary research on
reduced list as
necessary to develop
company profiles
• Evaluate against
consistent strategic
selection criteria –
rank short list
• Initiate approach
directly or via 3rd
party
Our approach relies on an evidence based filter process
For each target country / region CRU proposes a two stage filtering process to identify a short list of target mills for further evaluation
and profiling
Filter 1* = Function of :-
• Ownership
• Location
• Scale / size
• Cost position etc.
Filter 2* = Function of :-
• Financial (P&L) performance
• Quality of management
• Product mix / market potential
• Technical capability.
• Fit with MC capabilities etc.
3 -10 mills
Preliminary search
‘Universe of
businesses’
1st cut candidates Potential targets for
collaboration/ acquisition /
strategic partnership
Target company profiles (illustrative)
0
1
2
3
4
5
0 1 2 3 4 5
Fin
an
cia
l P
erf
orm
an
ce G
ap
Potential for turnaround
Competitor A
Competitor BCompetitor C
Competitor D
Competitor E
Competitor F
The selection criteria will be developed in collaboration with client’s management through which the total universe of mills will be
‘filtered’ down to a short list of between 3 -10 potential targets depending on the size of the target market / region.
Evaluation matrix (illustrative)
Targ
et A
ttra
ctiveness
Synergies with client
*Filters / selection criteria
to be agreed with client
management team at
outset
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