Merger seeks to reinforce Europe's steel sector

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From the Financial Times in London, I'm Matthew Vincent, and this is FT News.

Germany's ThyssenKrupp and India's Tata Steel have agreed to merge their European operations in a bid to create savings and reduce capacity in the continent's oversupplied steel market. Their 50-50 joint venture, which will create Europe's second biggest steel producer after ArcelorMittal aims to generate savings of up to 600 million euros a year, partly through job losses. So joining me to discuss the deal are Patrick McGee, our correspondent in Frankfurt, and Jonathan Eley, our deputy head of the Lex column.

Patrick, if I can come to you first. Can you just remind us how this merger came about and what the companies are seeking to gain from it.

ThyssenKrupp and Tata have been in talks for more than a year, both saying the industry was in dire need of consolidation. I would speak to Thyysen pretty regularly over the last year and a half, and they would say even if they're not part of the consolidation, it's still something they really favour. Cheaper imports from China have really overwhelmed the market, causing profitability to suffer. So there's been this big need to restructure and save costs.

And meanwhile, for ThyssenKrupp, they have real success in their capital goods business. So the main thing they do there is they build elevators and escalators, but it's also submarines, car parts, and it's spreading out to other components for industry.

But if you look at them in the stock market, they're not really valued like a capital goods business. They're valued more like a steel giant. And that's, of course, because of the depressed steel prices. So for lots of investors and analysts, they've really been cheering this sort of deal, because they'd prefer to invest solely in the industrial goods business.

For Tata, the story is complex, but for different reasons, I think. They really got into the steel business with this massive purchase of Corus in 2007. And at the time, that was the biggest purchase of a UK company by an Indian company. The Indian media loved it. It was really seen as sort of a reversal of roles between [INAUDIBLE] and [INAUDIBLE]. But it became pretty clear within a few years that it was just spectacularly ill-timed.

It was 2007, so it was just before the financial crisis. It was just before China really started exporting an unprecedented amount of steel into Europe. But both companies really have also been in favour of consolidation as a way to cut costs, to be more efficient. They can avoid duplicate efforts.

And one thing the Tata Steel CEO told me yesterday is that they really see this as a deal to be a technological leader. So they're aware that they can't really compete with China on price, for what he called, quote, "normal commodities." But the hope is that they can do R&D and be technological leaders to really make high-quality goods that the Chinese cannot compete with.

So the context then is very much consolidation, cost cutting, restructuring. What shape then will this merged entity take? Where is it going to be based? Which plants are going to be the principal ones?

The combined group has 48,000 people and there are 34 locations, but there's really just 3 locations to be aware of. The largest is Duisburg, where ThyssenKrupp is set up. About half the size is Tata's Dutch site in IJmuiden in the west of the Netherlands. Those two are about 100 kilometres away from each other, so you can sort of see that some of the consolidation is most likely to take place there.

And the third site to be aware of is, of course, the UK zone in Wales, Port Talbot.

Now, all those who have interests in those regions are naturally going to want to know, what does this actually mean in terms of job losses? That's going to be one of the main ways that costs are reduced. Are there any estimates on how many jobs we're talking about?

The groups actually announced yesterday, they would each cut 2,000 jobs. But the only details we got is that half of those jobs would be in administration, half of those jobs will be in production. I think they're trying to be straight up and just get the bad news out immediately, but it's already clear that unions are taking this as an opening bid, something to be negotiated with. And if they're successful, maybe we'll actually see fewer job losses than that.

I think the real difficult question is, where are these losses going to be? And that's just because Tata has already made promises about keeping jobs in Port Talbot. In Germany, labour unions make up half the supervisory board. It's always going to be politically difficult to get rid of jobs in Germany.

We even saw Martin Schulz, who's running against Angela Merkel, the German chancellor in the elections being held this Sunday. He already slammed the decision to move this merged company to the Netherlands, because he thinks that they're moving out of Germany so that job cuts are easier. So any decision is going to be politically fraught.

But politics aside, I think it's easy to imagine finding redundancies in Duisburg and IJmuiden simply because they are so close together.

What about regulators? Are they likely to waive this merger through?

I think getting labour unions onboard is probably a more difficult battle than clearing this through anti-trust regulators. The merger only makes them a number 2, a strong number 2 in the sector, so it's not that some big Goliath is being formed. And there will still be more European steel players than there are in the US or Japan. So it's not as though the industry's being dwindled down to just two or three players now.

Jonathan, if I can turn to you. What's the reaction been on the part of analysts and investors? I mean, this is a deal that everyone has been anticipating. What do they think of the detail that's emerged?

By and large, I think they like it. As Patrick mentioned, there has been agitation for a long time for ThyssenKrupp to become less like an old-fashioned German conglomerate and more like a focused capital goods company.

There's a recognition that there is basically too much steelmaking capacity in Europe generally. And anything that reduces that capacity will, in theory, lead to stronger companies and better pricing, which would be to the benefit of all.

I think the problem is that this is going to be a particularly troublesome merger to implement in the political sense, precisely because you have these three giant sites.

Steelmaking, for some reason, is still enormously emotive, even though it employs a fraction of the number of people that it once did. And that various promises have been made to various people about how long plants will stay open, and how much will be invested, and how well they will be staffed.

The German and the Dutch operations will both continue to have a supervisory board structure, which is a continental construct where you have a board that oversees the management board. And that is formed equally from labour and capital representatives.

That won't exist in the UK, where the UK continued to bargain with trade unions, another sort of UK collective bargaining arrangement. To my mind, I think that puts the continental sites in a stronger position to keep jobs. Although, that said, there is a promise to carry on investing in Tata import Talbot until 2021.

Intriguingly, in the statement, the two companies say that the sort of next phase of cost savings will begin in 2020. And will involve a possible reconfiguring of the production sites. And that that will partly depend on the outcome of the Brexit talks which, of course, are another huge complicating factor.

Given the emotive nature of some of these issues, I take your point about steel jobs being treated so differently to any other financial services jobs-- media jobs, even. What does this mean, though, for investors?

Well, I think there's two stories here. There's the story of Thyssen and the creation of a more focused Thyssen. And I think that if this merger went through, it would be a first step in that direction. It wouldn't get Thyssen out of steelmaking all together, because they would still own 50% of a joint venture that makes steel. The debt of the joint venture would come off Thyysen's balance sheet. So its credit profile would improve. And it would still receive dividends, hopefully, from its joint venture. But it wouldn't be out of steel together. And it wouldn't cease to be exposed to cyclicality of that industry. And I think what a lot of investors will push for is a second step, where basically Thyssen sells down its stake in the venture and gets out of steel all together. And that will take some time.

I think the second thing is the rationalisation of European steel. If you wanted to benefit from that, arguably you wouldn't buy Thyssen shares at this juncture because this will take a long time to push through, if at all. You would possibly buy shares in ArcelorMittal, Voestalpine, or the Austrian steelmaker, Salzgitter, another Austrian steelmaker, or one of the Scandinavians, who arguably will benefit more rapidly from any consolidation in European steelmaking capacity.

Clearly then, the ThyssenKrupp-Tata deal is the beginning of a story, and we will await stage 2, as you call it, with interest. But for now, Jonathan and Patrick, thank you both very much indeed.

And for more on this story, and, indeed, all the latest industry news, remember to visit ft.com/industry.