Japanese steel

Steel M&A: It’s unusual for Japan to lead the way in M&A. But the tie-up of two of Japan's biggest steelmakers is a welcome move for an over-populated industry. Still, with Nippon Steel and Sumitomo Metals targeting a deal in April 2012, the pair may be allowing for plenty of Japanese complications along the way.

The surprisingly brisk economic bounce-back of the past two years has not cured the steel industry of its endemic overcapacity. Increased demand has only encouraged steelmakers to ramp up production, which rose 15 per cent to a record 1.4 billion tonnes in 2010. The world’s steel mills were running at just 75 per cent of their capacity at the end of 2010, compared to 83 per cent nine months earlier when new capacity hadn’t yet come on stream, according to the World Steel Association.

The need for consolidation is most acute in China, which accounts for much of the world’s glut. The Middle Kingdom has almost tripled its production of the metal over the past seven years and now contributes 44 per cent of global output. But Japan’s steelmakers also have good reason to combine. The strong yen is reducing regional competitiveness. Meanwhile, higher raw material costs - exacerbated by recent Australian flooding - are already hurting margins, prompting Nippon Steel to warn on profits on January 28. A merger of Nippon, Japan's largest steelmaker, with number three ranked Sumitomo will allow the two to cut significant costs, although the companies have not yet provided any estimates. The combined entity, which would be the world's second largest steel producer and worth $35 billion on current market values, will also be well placed to negotiate better terms with suppliers of raw materials. Even so, with a total output of around 48 million tonnes, it would be far behind the world leader ArcelorMittal, which produced almost twice as much in 2010.

Getting big deals done in Japan has proved difficult in the past. The failure of the mooted merger between beverage giants Kirin and Suntory in 2010, both profitable companies, showed that sensible deals don’t always make it past the finishing line.

Still, there is reason to hope things will be different here. Nippon and Sumitomo have worked together since 2002 in certain steel industry sub-sectors and sealed their alliance with cross-shareholdings. That should make reaching an agreement easier. The steel industry’s hope will then be that China's producers sit up and take note.