Steel merger casts bad light on China’s economic reform
If the merger of China’s two largest steel mills is a showcase of President Xi Jinping’s economic reform, it is showing a bad face.
It is a classic case of the good boy bailing out the bad one that would do little for the reduction of excessive capacity while hurting minority shareholders and discouraging the management.
Those who talked about synergy and streamlining must realise that the marriage of Baosteel Group and Wuhan Iron & Steel Co (Wisco) is not between No 1 and No 2, but the merger of a Ferrari with a made-in-China Volkswagen.
The difference between the gross profit of 631 yuan per tonne of Baosteel’s listed arm and the 140-yuan loss of its Wuhan counterpart is a result of product mix, technology and physical location.
There may be a chance if factories can be scrapped. Yet the proposed corporate structure of the merged entity gives little hope.
Under the proposal, Wisco will not be merged into Baosteel. Instead, it will become a standalone subsidiary of the new controlling empire. The same goes for its listed arm, Wuhan Steel, which comes under listed unit Baoshan Iron & Steel.
That means the Wuhan camp would get to preserve its autonomy and establishment at all levels. The addition of two new layers pointed to more red tape, power play and inefficiency, not the closure of excess capacity.
Don’t bet on big brother making an order to cut. If that works, what is the need of merging?
The only promising achievement of the merger is to keep debt-ridden Wisco afloat with Baosteel’s top credit rating and lower financing cost.
Wuhan Steel’s numbers are telling. A decade of aggressive plant and mine acquisitions has left it with a gearing ratio of 248 per cent. With a 7.5 billion yuan loss last year and mounting account receivables, it has been relying on bank loans and bonds to pay its bills.
It has to repay 27 billion yuan in bank borrowing within a year. If that sounds small, think about its parent’s 120 billion yuan loan that is due in a year.
The merger will increase Baoshan Iron’s gearing ratio to 136 per cent, but it is a comfortable enough guarantor for the Wuhan camp’s refinancing.
All these would be more tolerable if Baoshan Iron was buying at a deep discount. But it is not.
Baoshan Iron is getting a 10 per cent discount to Wuhan Steel’s trading price, which the former’s independent directors described as fair and just.
The reality is Baosteel is selling its shares at a 33 per cent discount to its book value and buying its bleeding Wuhan peer at 1.025 times book value.
Wuhan steel shareholders will swap their holdings into Baoshan stock. The ratio translates into Baoshan buying at 10 per cent discount of Wuhan Steel’s trading price.
How can this pricing be fair for an asset that can only go cheaper in a year or two? How can it be just for a deal that would turn a company from profit to loss and increase its gearing by one-fifth while promising little chance of restructuring and redundancy?
No one except Baoshan Iron’s minority shareholders really cares. The controlling shareholders, or the state, pay nothing because all the gains and losses square off at the top. The bankers don’t have to suffer a debt restructuring. Wuhan Steel’s shareholders and management receive some relief.
The little one, however, can do little to stop it.
Theoretically, Baoshan Iron’s parent has to abstain from the approval of the merger. However, a month before the merger, it transferred a 9.75 per cent stake to three state-owned companies.
Add this to the announced holdings of seven state-owned fund houses, and government-related entities already control 47 per cent of the minority stake. It is hard to imagine them voting no.
The minority shareholders have only two “choices” – selling in the open market when trading resumes at a date no one knows; or accepting a cash offer that is 10 per cent below the last trading price.
Stay and hope for the best is a big no.
Imagine you are a department head of Baoshan Iron. Your success is to be used to bail out a competitor’s failure. Your boss at the top will get political credit. You are left to pray that those in Wuhan Steel don’t perform too badly.
All these are far from encouraging for Baoshan Iron and China’s economic reform.