Tata's Pain is ThyssenKrupp's Gain

Plant closings and consolidation will benefit remaining players

As Britain's steel industry moves a step closer toward extinction, German steelmaker ThyssenKrupp looks set to profit handsomely.

German Winner?

Investors see ThyssenKrupp gaining from potential consolidation and tariffs on Chinese steel

Source: Bloomberg

Tata, which is trying to find a buyer for its struggling U.K. steel business, is in advanced talks with ThyssenKrupp about forming a joint venture of the two companies' assets in the rest of Europe, according to newspaper Rheinische Post.

The German steelmaker has made no secret of the fact that it would like to be involved in steel industry consolidation -- but it lacked a dance partner. Until now.

While the details remain hazy, the logic of a combination is hard to fault: Tata's British business is loss-making, will require huge investment to turn around, and has massive pension liabilities -- all of which have put the future of its giant plant at Port Talbot, south Wales, in jeopardy. However, its Dutch flat steel plant is viewed by analysts as a jewel.

Combining that with ThyssenKrupp's Duisburg steel plant -- which is only about 200 kilometers (124 miles) away as the crow flies -- would create cost savings in logistics and procurement. More than half of ThyssenKrupp's European steel sales are within a 500 kilometer radius of the Duisburg plant.

Commerzbank estimates a joint venture would create about 300 million euros savings annually. That equates to a net present value of 2 euros a share -- more than 10 percent of ThyssenKrupp's current share price.

The combined company would also have greater clout in price negotiations with key customers in the auto industry, as Alessandro Abate, an analyst at Berenberg, notes.

Moving on Mittal

A Tata/ThyssenKrupp joint-venture would be Europe's number two steelmaker by capacity

Source: Commerzbank estimates

The business would have about 22 million tons of capacity, making it a stronger competitor to ArcelorMittal Europe which has about twice that amount.

Cost cuts have helped ThyssenKrupp's European steel business remain profitable even as Chinese imports dramatically drove down prices in Europe.

Technology Tops Steel

ThyssenKrupp makes more money with elevators than it does selling steel

Source: Company presentation (fiscal 2014/2015)

In the long term, it makes sense for ThyssenKrupp to focus on its capital goods businesses. Those operations make things from elevators to industrial components, tend to have higher margins and account for about three-fourths of operating profit.

Of course, there are hurdles to a deal. German politicians could push ThyssenKrupp to partner instead with domestic peer Salzgitter to create a national steel champion (rather than risk leaving the smaller rival out in the cold). And it would be complicated to wring cost savings from a Salzgitter tie-up: the state of Lower Saxony holds a 27 percent stake and would presumably oppose job cuts.

ThyssenKrupp's steel business also has a massive unfunded pension liability, as Gadfly noted yesterday, so Tata and ThyssenKrupp will need to sort out how that will be funded. The German company isn't in a position to take on the British business's pension obligations.

Yet even if a deal doesn't happen immediately, ThyssenKrupp should benefit from Tata's U.K. woes.

With so many jobs at risk, pressure is growing on the EU to levy more punitive tariffs on Chinese steel imports. That should support pricing for the industry that remains.

Regardless of the outcome of the talks with Tata, the German steelmaker therefore looks set to emerge a winner.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Chris Bryant in Frankfurt at cbryant32@bloomberg.net

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    Edward Evans at eevans3@bloomberg.net

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