china steel m&a - .net framework

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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directly or indirectly or in any other format without the prior written permission of CRU

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Legal notice

2

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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


1400

1450

1500

1550

1600

1650

1700

2006 2010 2014 2018 2022

Fe consumption in BF, kg/t

China Japan


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

13

BACK UPs

15

What will China’s steel industry look like in the future?

16

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

china steel m&a - .net framework

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