Dinosaur Rescue In China

A state steelmaker's painful makeover

It's a company struggling to compete in an industry plagued by global overcapacity. The workforce probably has 70,000 people too many. Scandals have swept away its top executives, and now, environmentalists want to shut its main factory down. Those are just a few of the issues facing China's Shougang Corp., a steelmaker with $2.7 billion in revenues that is one of the country's biggest and oldest state-owned companies.

But top managers at Shougang, while acknowledging their difficulties, say the 15th Party Congress--which in September proclaimed the need for market reforms--gave them a clear signal to tackle their problems more vigorously than ever. "With this Congress, we can now push boldly forward," says 58-year-old Zhang Yanlin, vice-president of Shougang Group Corp. and chairman of its Hong Kong affiliates. The goal is to turn this behemoth into a restructured company that can compete internationally. And if high-profile Shougang can fix itself, it will show that China is serious about overhauling its state sector.

Yet Beijing-based Shougang has tried once before to modernize, with disastrous consequences. Long headed by Zhou Guanwu, a close associate of Deng Xiaoping, Shougang was a natural choice as an economic laboratory when Deng pursued his first experiments in reform more than 15 years ago. Zhou wangled a special tax break and got the government's blessing for his wildly ambitious acquisitions, including a South American mine, a shipping fleet, and a Hong Kong insurance company.

JAILED EXEC. But two-and-a-half years ago, the party abruptly stopped when the government investigated the dealings of Zhou's high-living son, Zhou Beifang, then chief of the company's Hong Kong affiliates. Soon, the government was charging that the younger Zhou had bribed Beijing officials for special favors and misappropriated more than $120 million in corporate funds. The elder Zhou has since resigned in disgrace, and his son is serving a life sentence.

These were humiliating blows. More significant, with the cancellation of its low tax rates, Shougang finds itself back on a level playing field in China's increasingly cutthroat steel industry. The response of Bi Qun, Shougang's new chairman and a former government official, is an ambitious plan to acquire other Chinese steelmakers. A likely purchase would be one of the smaller manufacturers in Shanxi province, which has plentiful coal supplies.

Shougang plans to change its focus from low-grade steel for the construction industry to high-quality flat steel used in autos and consumer appliances and stainless steel used in petrochemical factories. Such retooling costs money--maybe as much as $3 billion. In addition, the company wants to mount an export drive to escape the growing competition at home. To finance these plans, Shougang next year will do its first share listing on domestic Chinese markets, offering up to 25% of the company. A listing in Hong Kong and perhaps one in New York are possible.

Even if Shougang amasses this badly needed capital and buys top-quality equipment, there will be further challenges: "The Chinese always go for the latest, greatest machines," says Jonathan Woetzel, a principal at McKinsey & Co. and manager of its Shanghai office. "What's more uncertain is whether they can use them properly and get world-class products made." China's low labor and energy costs give its steelmakers a clear cost advantage relative to European and American producers. But such advantages are outweighed by the tendency of Chinese companies to spend their money unwisely, says Woetzel. Even Shougang's plan to supply the fast-growing stainless steel market could go wrong if other local steelmakers rush into the same sector.

Another issue: Before it can list shares next year, Shougang may have to buy an ailing state-owned steelmaker in addition to the profitable mills it wants to buy. "The government is encouraging that," says Zhang. That's Beijing's way of keeping weak companies afloat, but it doesn't help Shougang's efforts.

Meanwhile, the company is still feeling the effects of its earlier acquisition spree. Analysts figure Shougang overpaid for its Hierro iron-ore mine in Peru. Shougang also pledged, analysts say, to avoid layoffs at the mine, but now it may consider selling out, since profits at the mine remain elusive. And while Shougang once had a ready source of loans through its majority control of Huaxia Bank, the company was forced to dilute its share to 20% after the Zhous' corruption scandal. Now, these cheap loans are not available.

An obvious step for Shougang would be to sell its nonsteel assets--most of which are unprofitable--and focus on steel, which does generate some profit. Other steelmakers around the world have made similar moves. But Shougang says it has no intention of selling its ships, air-conditioner factory, Hong Kong-based insurer, or remaining stake in Huaxia Bank. Yet the conglomerate sorely needs restructuring. From a payroll of 220,000, Zhang figures maybe a third are not needed. Shougang may create more jobs by building and operating hotels and offices on company-owned land in Beijing. And it wants to expand its electronics operations, including a semiconductor-chip venture with Japan's NEC.

BREATHING FIRE. Finally, Shougang is facing a major new challenge from China's nascent environmental movement. Prevailing winds carry most of the main mill's sulphur dioxide, nitrous oxide, carbon dioxide, and dust emissions over Beijing's 12 million people, prompting calls for a cleanup by local officials and activists. Some even want Shougang to move its mill. "Shougang is the single largest polluter in Beijing," says Liang Congjie, president of Friends of Nature, China's first private environmental organization. "How can you justify such heavy industry so close to the capital?"

Liang recently raised Shougang's environmental record at the annual meeting of the Chinese People's Political Consultative Conference, a central government advisory body. Environmental regulators and Shougang have just completed a survey of the pollution problem, according to activists. But in a possible measure of how serious the problem is considered, Shougang and the government refuse even to confirm the survey's existence. Vice-President Zhang says the company plans to invest in new equipment to reduce emissions. According to local sources, Chicago-based Nalco Fuel Tech came close to selling several million dollars' worth of desulphurization technology to Shougang--but the deal is on hold as the steelmaker struggles to come up with the cash.

Give Shougang credit for owning up to such problems as a bloated workforce and polluting emissions. But no one should expect a swift transformation of this behemoth into an efficient, market-focused company. For Shougang, like China, the problems facing it are too deep to go away without hard and painful work.

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