CHONGQING, China (Reuters) - A year and a half ago, Chongqing Iron and Steel Corp (CISC), China's oldest steelmaker, was rescued from the brink of bankruptcy in a deal hailed as a shining example of how struggling state companies can be revamped.
Today it is profitable and earned 616 million yuan ($87.51 million) in net income in the first half of 2019.
Chongqing Steel's saviour: Four Rivers Investment Management, a private equity fund established in August 2017 by China's biggest steel producer, Baowu Iron and Steel Group, or Baosteel, which aims to benefit from a state-driven consolidation of the industry.
Involved in the fund is W.L. Ross & Co, a distressed asset specialist established by Wilbur Ross, the U.S. commerce secretary, who has backed tariffs against China's steel producers. The company has operated as a unit of Invesco since 2006, and Ross sold his shares in December 2017.
The ultimate aim is to make the firm an attractive takeover target, Four Rivers executives told Reuters. Baosteel will get first refusal rights starting at the end of next year.
"Some in the West used to call steel a sunset industry, but I want to tell everyone that there's no such thing as a sunset industry that is still increasing its assets," Four Rivers chairman Zhou Zhuping said in a speech last November.
W.L. Ross & Co has experience with distressed steel assets in the United States, buying bankrupt mills such as Bethlehem Steel, which it sold to Mittal, now ArcelorMittal, the world's largest steelmaker, in 2002.
Baosteel and Four Rivers expect China's steel industry to consolidate and reorganise. U.S. tariffs on steel could add pressure to those forces - and Chongqing Steel could benefit.
China's oldest steel mill was founded in 1890 but its modern history began during China's war against Japan, when it was forced to move to the Yangtze River port city of Chongqing to flee invading troops.
In recent years, it has struggled to compete in an increasingly crowded market, and by 2017 it was on the brink of shutting down before a rescue deal restructured 40 billion yuan of debt.
Though the company has since turned a profit, critics say the rescue mostly shows that well-connected state firms are too big to fail.
"They have let a good company (Baosteel) carry a bad one on its back, and this is the way state-owned firms have been restructured for years," said Zhang Wuzong, a parliamentary delegate and chairman of the privately owned Shiheng Special Steel.
DISLOCATION
Chongqing Steel's new management blamed the firm's plight on a 2006 government decision to move 60 miles north from an inner-city site to the rural district of Changshou.
Relocation costs eventually hit 37.6 billion yuan, more than double the original estimate, saddling CISC with annual interest payments of more than 1 billion yuan.
As a speciality shipping plate manufacturer, the firm also faced much higher logistics costs than its rivals, and it was unable to meet local demand for the cold-rolled steel used by auto and home appliance manufacturers.
"Its location is in Chongqing but its products were designed for coastal areas," said Yu Hong, a Four Rivers executive now serving as secretary of CISC's board of directors.
Making matters worse, CISC had too much capacity when the 2008 global financial crisis sent steel demand into a tailspin.
Even though it was operating at only a third of its capacity, the local government was urging it to expand further, with Chongqing's mayor, Huang Qifan, saying in 2011 it would aim to become a "100-billion yuan enterprise" within four years.
By 2015, China's steel market was entering its worst-ever slump, and in 2016 more than 70% of the country's mills were losing money. Efforts to switch to overseas markets led to dumping investigations in the United States and Europe, and raised risks of tariffs.
Chongqing Steel suspended share trading in June 2016 and in 2017 it faced thousands of unpaid debt claims from suppliers. A former staff member told Reuters on condition of anonymity that the company looked "beyond salvation."
"No one dared to take over this mess, because there was so much debt," said Four Rivers' Yu.
RESCUE
At the start of 2018, shareholders and creditors finally agreed a restructuring deal that cut CISC's debts from 20 billion yuan to 3.5 billion yuan and transferred unprofitable assets to the local government.
After years of losses, CISC turned profitable in 2018. Its interim report this year singled out Baosteel's intervention as a key reason for the turnaround.
Baosteel, the world's second-biggest steelmaker, will have the option to take over Chongqing Steel at the end of next year. The company expects to benefit from a state plan to put 60% of total capacity in the hands of its top 10 producers, up from about 40% now, and it has also been in talks to take over the smaller Magang Group.
Executives admit CISC's upturn in fortunes came amid an improvement in the steel market, with prices revived by state efforts to shut down low-grade, polluting mills. The aim is to make the company sustainable even during downturns.
"What we want to build in ourselves is the ability to be competitive in the regional market, and when everyone is doing badly, it becomes a sector problem," CISC's chief executive Li Yongxiang told Reuters.
($1 = 7.04 yuan)
(Additional reporting by Andrew Galbraith, the Shanghai newsroom, and Melanie Burton in MELBOURNE; Editing by Tony Munroe and Gerry Doyle)
