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(PHOTO: DORTMUND2008 / WIKIMEDIA.ORG)

ThyssenKrupp AG, the German multinational conglomerate with focus on industrial engineering and steel production, and Tata Steel Limited, the Indian multinational steel-making company, signed a final agreement on June 29 to establish a long-expected joint venture – the European steel industry’s biggest shake-up in more than a decade.

The merger would create Europe’s second-largest steelmaker, second only to ArcelorMittal and represent a major consolidation move in a sector plagued by overcapacity. It has been in disarray following a collapse in steel prices under a supply glut driven by a torrent of cheap imports flowing in from China. The new joint venture would employ 48,000 people at 34 locations, ship 21.3m tons of steel per year, generate proforma sales of €16bn and an operating profit of €1.57m.

The German group would transfer pension obligations worth €4bn into the joint venture, while Tata would put in €2.5bn of debt. Both partners would hold a 50 per cent equity stake, but ThyssenKrupp would get 55 per cent of the proceeds of a future initial public offering.

The underlying strategy is simple. On the one hand ThyssenKrupp would separate the volatile steel producing business from its more lucrative capital goods business, which includes making elevators, submarines and car parts, and on the other Tata Steel would dispose non-core units and redirect its efforts from normal commodities to higher-quality products as it is not strategically wise to compete with the Chinese steelmakers with the same products.

The non-cash merger to pool the European steel assets of ThyssenKrupp and Tata Steel into a new company based in the Netherlands did not need shareholder approval, having been agreed by ThyssenKrupp’s supervisory board, but this may not be sufficient for a conglomerate whose shares are owned by 69% by international institutional investors including whose shares are owned by activist funds of the caliber of Cevian Capital, Elliott Management or Union Investment.

The German group has been restructuring since 2011 to leave the steel business and focus on diversified industrial goods, and since then it has been under shareholder pressure. The Swedish Cevian has been calling for a change in strategy because the restructuring has been limited in scope and taken too long, while the American Elliott has been criticizing management for failing to improve margins in its core business and delivering poor shareholder return.

ThyssenKrupp’s board managed to keep the ranks until it became clear that its steel business was improving, creating a perceived value gap between it and Tata Steel. Shareholders were vocal in saying ThyssenKrupp was giving up too much to sign a 50/50 deal as the German group’s earnings from steel had swelled while Tata Steel Europe’s have disappointed since the memorandum of understanding for the joint venture was signed last year.

Some investors deemed that the difference in valuations between the two sides had widened so much, up to €1.9bn, that shareholders would be getting a raw deal unless the terms were substantially revised, that is the German group must take some assets out of it or add more debt to rebalance the terms or that ThyssenKrupp would take a fair stake in the new company at about 80% based on the higher profitability of its European steel operations.

Shareholders’ frustration mounted quickly, and a few days after the deal the banks were already broken as the chief executive Heinrich Hiesinger resigned, followed a few days later by the chairman Ulrich Lehner. Thyssenkrupp’s supervisory board unanimously appointed finance head Guido Kerkhoff to serve as interim chief executive.

With annual output of 11.4 million tons of steel ThyssenKrupp’s Duisburg site has scale, while Tata’s IJmuiden plant in the Netherlands is considered to be among Europe’s most efficient, and both are situated close to customers in mainland’s Europe’s automotive manufacturing heartlands, which means that the other plant such as Port Talbot could specialize in grades used in packaging, engineering and general manufacturing.

Most of the synergies would be realized within the first three years of the joint venture, Guido Kerkhoff said during an investor call, but the deal comes as European steel makers face tariffs of 25 percent on their exports to the United States, their biggest market, which might force local markets to absorb more of the steel production.

The industrial logic is indeed faultless and the new business may be based on strong fundamentals, but it is difficult to say whether the merger really is a big strategic leap ahead as sheer size is not necessarily a success factor and taken into account all the job guarantees given to workers in Germany, the Netherlands and Great Britain, it seems unlikely that a lot restructuring will happen until 2022 or later.

References: Financial Times, 2018; Reuters, 2018; Tata Steel Europe, 2018; The Guardian, 2018; ThyssenKrupp, 2018