State policies favour mergers and acquisitions History shows that a difficult business environment is always a good time for mergers and acquisitions, and the story is expected to play out again in the mainland's fragmented steel industry. Mounting cost pressures, intensifying competition and weakening demand as the world economy continues to struggle are pressuring a consolidation, according to industry players and analysts. The difficult conditions would force out some small and medium-sized mills or see them taken over by bigger players, said China Merchants Securities analyst Zhang Shibao. 'Amid the tough operating environment and government policies promoting consolidation of the steel industry, we would expect more [mergers and acquisitions] this year, especially in the first half of the year when the industry is still at its cyclical low,' said Mr Zhang. The mainland steel industry, the world's largest, is suffering huge losses as demand for steel products at home and abroad shrank, with steel prices falling more than 40 per cent at one point from their peaks in June last year. In October last year, the steel industry registered its first monthly loss in six years with 71 large and medium-sized steel mills posting a combined deficit of 5.84 billion yuan (HK$6.6 billion). The figure more than doubled to 12.77 billion yuan in November and further increased to 29.1 billion yuan in December as steelmakers wrote down inventories. Despite the loss of about 47.7 billion yuan in the fourth quarter, the industry recorded an 85 billion yuan profit for last year - 41 per cent less than the 144.7 billion yuan profit in 2007, according to Xu Xiangchun, the chief information officer of steel data provider Beijing Ganglian Maidi e-Commerce. By the beginning of this month, at least 19 mainland-listed steelmakers had warned of losses or a substantial plunge in net profit for last year on falling steel prices and provisions made against inventory. Recent government policies could help speed up the industry's restructuring and more detailed boosters are reportedly in the pipeline. In January, the State Council announced a support package for the industry in need of technological upgrade to transform from 'big' industry competitors into 'strong' international players. Although no concrete details of the measures were announced, Xiong Bilin, deputy director of the National Development and Reform Commission's industry department, said in an interview with China Investment magazine that the government would introduce measures to help the restructuring, such as employment of excess workforce, loans for mergers and acquisitions, and tax revenue allocation between central and local governments. In early December, the China Banking Regulatory Commission said it would allow commercial banks to provide loans to domestic enterprises conducting mergers and acquisitions in an effort to meet the mounting demand for funds. Ganglian's Mr Xu said the decision would boost the war chest of large steelmakers, especially state-owned ones, considering launching mergers and acquisitions. For example, Shandong Iron & Steel Group, a government-directed merger between Laiwu Steel Group and Jinan Iron & Steel Group in the eastern province in March last year, has received a total credit line of more than 160 billion yuan from four major mainland banks, providing enough money for it to recapitalise Shandong-based private steelmaker Rizhao Steel Group. 'This year will be a good opportunity for [mergers and acquisitions] for the mainland steel industry,' said Zhu Xian, a researcher at steel information provider Mysteel. 'The history of the world steel industry showed that depressed market conditions were always the drivers of major [mergers and acquisitions]. This happened in the United States, Japan and Europe in the 20th century. China may follow suit.' New York-listed General Steel Holdings, which has four steel joint ventures on the mainland, said it was also seeking loans to facilitate its merger and acquisition strategy. 'More peers initiated talks with us for co-operation or [mergers and acquisitions] recently, especially small and medium-sized mills,' said chairman Henry Yu Zuosheng. According to Mysteel, a total of 17 mergers and acquisitions took place last year, helping lift the market share of the top 10 steelmakers to 44 per cent from 37 per cent in 2007. That is only 6 percentage points behind the NDRC's target of 50 per cent by 2010. The major mergers and acquisitions have been government-directed, and in addition to Shandong Steel, they include the formation of Hebei Iron & Steel Group through the merger of Tangshan Iron & Steel Group and Handan Iron & Steel Group in the northern province, Shanghai-based Baosteel acquiring and recapitalising Guangzhou Iron & Steel Enterprises Group and Shaoguan Steel to build a new plant in Zhanjiang in Guangdong, as well as Hubei-based Wuhan Iron & Steel Group acquiring Liuzhou Iron & Steel Group and establishing Guangxi Iron & Steel Group to build a new mill in Fangchenggang in the province. The only exceptions were the formation of Tangshan Bohai Steel Group and Tangshan Changcheng Steel Group in late December. The two groups were formed from 39 local private mills in Tangshan city in Hebei province, the country's biggest steel-producing province, marking substantial progress at local-level steel consolidation. So far, the two mergers are the biggest among private mills - Bohai Steel with an annual capacity of 15 million tonnes and Changcheng Steel with 13 million tonnes. DBS Vickers analyst Helen Wang says mergers and acquisitions will probably continue this year as she expects the industry's earnings to drop 20 to 30 per cent from last year. NDRC's Mr Xiong said in China Investment that the government wanted to build a few internationally competitive steel giants, including Baosteel in the east, Anshan Iron & Steel Group in the northeast and Wuhan Steel in the central region, each with an annual capacity of 50 million tonnes. It also wanted to establish a few more with an annual capacity of between 10 million and 30 million tonnes by 2011. By 2011, the top five players will account for 45 per cent of the country's total steelmaking capacity, according to Mr Xiong. Analysts have forecast major mergers and acquisitions this year to include the acquisition of Inner Mongolia-based Baotou Iron and Steel Group and Zhejiang-based Ningbo Iron & Steel by Baosteel, and Anshan Steel acquiring Sichuan-based Panzhihua Steel Group and Fujian-based Sangang Group. For now, prices have rebounded considerably from recent troughs, with the price of hot rolled sheet gaining 44 per cent since late November. However, a solid rebound is not likely until the second quarter as demand in key industries from vehicles to home appliances remains uncertain, industry watchers say.