THE SECOND WIND OF IRON AND STEEL INDUSTRY – PRIVATIZATION OR RESTRUCTURING?
The state of affairs in the Ukrainian iron and steel industry has been rather whimsical since the early 1990s. From 1992 till 1996 the whole industry suffered through a recession brought about by a more than twofold reduction in demand from the part of mechanical engineering, military-industrial complex, transportation, construction, etc. The signs of recovery in 1996-1997 did not last for long. The 1998 financial crisis in Southeast Asia and Russia (the two largest purchasers of Ukrainian metals) once again led to a recession. However, production performance greatly improved in the year of 1999. For example, average profitability rates of Ukraine’s mining companies and metallurgical mills were at the negative of -2.6% in 1998 and climbed to +6.9% in 1999. As regards ironmaking and steelmaking, the International Iron and Steel Institute reports that the 1999 crude steel output totaled 26.757 million tonnes, 1.4% greater than in 1998, and iron output amounted to 22.517 million tonnes, 7.6% more. How durable is this new upswing?
If one subjects business performance of all the 14 Ukrainian integrated mills to an analysis, it turns out that the figures are extremely heterogeneous. Selected metallurgical mills make unquestionable, though meager progress. For instance, Alchevsk Iron and Steel Works (Alchevsky metallurgiyny kombinat) has managed to grow from the past financial losses to the current profits. This company earned 68 million Ukrainian hryvnyas worth of profits in 1999, while losses incurred in 1998 equaled 118 million hryvnyas. The current profitability rate is 6.5%, and costs per one hryvnya of commercial products amount to 90 kopecks. Meanwhile, Alchevsk Iron and Steel Works held 270 million hryvnyas of accounts receivable and 820 million hryvnyas of accounts payable as of the 1999 year-end. Financial performance of Dneprospetsstal Electrometallurgical Works (Electrometallurgiyny zavod "Dneprospetsstal") and Azovstal Iron and Steel Works (Metallurgiyny kombinat "Azovstal") is very much alike the mentioned figures. At the end of 1999 Dneprospetsstal had accounts receivable totaling 79.568 million hryvnyas, payables worth of 131.39 million hryvnyas, it received gross profit of 29.37 million hryvnyas, and had a profitability rate of 6.24%. Azovstal held 588.793 million hryvnyas of receivables, 743.819 million hryvnyas of payables, and earned 23.843 million hryvnyas of gross profit with a 1.15% profitability as of the 1999 year-end.
Efforts of employees who run Ilyich Iron and Steel Works of Mariupol (Maryupilsky metallurgiyny kombinat im. Ilyicha) deserve a special analysis. Back in 1993, the staff leased this iron and steel works; and has invested over US$400 million in development and upgrade of manufacturing facilities in the subsequent 7 years. The number of employees doubled from 27,000 to 50,000 people, and the staff earned 36% of shares in Ilyich Iron and Steel Works. Nonetheless, this company is still encumbered with debts, namely, with 533.772 million hryvnyas of accounts receivable and 630.59 million hryvnyas of accounts payable as of the 1999 year-end (with gross profit of 72.726 million and a rather small profitability rate of 2.18%).
Zaporozhstal Iron and Steel Works (Metallurgiyny kombinat "Zaporizhstal") has done better in business. In the course of 1999, this company was greatly ahead of its budget in terms of gross profit earned (namely, 366.9 million Ukrainian hryvnyas), and managed to boost output of all metal products manufactured. The major reason for greater profits was a markup in wholesale metal prices in the world (255 million hryvnyas raised), with the minor reason being a reduction in product costs (additional 105 million hryvnyas of profits). Last year, the company also contrived to get rid of the shortage of current assets (current assets totaled 85.2 million hryvnyas as of January 1, 2000). Zaporozhstal has also made a major breakthrough in profitability, namely, costs per one hryvnya of end products were 84.07 kopecks in 1999, 6.53 kopecks below the budgetary rates and 14.4 kopecks below the 1998 performance figure.
Perhaps, the company owes this success to a US$30-million loan issued for production hot-rolled and cold-rolled steel by a foreign banking syndicate this April (notably, two British banks Fortis Mees and Piersonu KBC, Switzerland’s BBL, and Germany’s WLB). The Ukrainian company’s management made a decision to finance production development and equipment upgrade with the borrowed money. Zaporozhstal has conducted a thorough repair of blast furnace No.2 and has modernized its open-hearth furnaces and a hot-rolling mill.
The ways of Donetsk Metallurgical Works (Donetsky metallurgiyny zavod) were about as successful. After a non-commercial tender in 1997, British corporation MetalsRussia Ltd. was made eligible for a 40% interest in this metallurgical mill provided a three-year investment of US$55 million worth of equipment in building of an electric arc furnace. Having discharged its liabilities, the British company has become an owner of this interest recently. This metallurgical mill is almost 100% privatized, with the rest of shares being held by the mill’s employees. A year ago, Donetsk Metallurgical Works was partially restructured, namely, the general stockholders’ meeting decided to set up seven limited liability companies using the mill’s assets (i.e. DMZ-steel, Oxigaz, Trubostal, Ferrit, Metall Service, and SIM-invest).
Today’s output of steel and rolled products in Donetsk Metallurgical Works is very close to production figures of the relatively successful year of 1991. Nevertheless, the company has failed to meet its annual production schedule, while metal costs have turned out to be much greater than expected. It was mainly the apt commercial schemes employed that brought in 6.9 million hryvnyas worth of the company’s profit. Gross losses incurred last year totaled a little more than 49 million hryvnyas compared to 52.2 million hryvnyas worth of losses back in 1998.
At the same time, Donetsk Metallurgical Works has achieved the several years’ record-high labor productivity within the frames of a production intensification strategy pursued. Notably, steel output per worker added 10% against 1998 coming to 135.7 tonnes in 1999 as a result of management replacement. Shortage of current assets acted on the general production effectiveness in an adverse way. To cope with this problem, the company’s marketing service launched a practice of substituting barter transactions with money-payment contracts on Ukraine’s and foreign markets in the second half of 1999.
New technologies of making steel grades that comply with DIN and ASTM standards have been introduced to expand the markets. As a result, the range of this company’s products acquired 15 new grades of steel. Besides, the rolled product mix has dilated greatly owing to both introduction of rolling technologies for new shapes and sizes, and renewal of the grade mix. It is anticipated that the ISO-9002 quality management system (phased in back in late 1999 and certified by TUV NORD in January 2000) and a new technologies program will facilitate further enlargement of the company’s markets.
Though remaining 100%-state-owned, Krivorozhstal State Ore Mining and Metallurgical Works of Krivoy Rog (Kryvorizsky derzhavny girnycho-metallurgiyny kombinat "Kryvorizhstal") has improved its performance significantly. This company left the losses behind in 1999 and earned 43.014 million Ukrainian hryvnyas of gross profit compared to 82.687 million hryvnyas of losses suffered back in 1998. Krivorozhstal enhanced output of all the products manufacturing 4,608,300 tonnes of iron, +2.5% against 1998; 5,284,300 tonnes of steel, +11.9%; and 4,365,400 tonnes of rolled steel, +10.8%.
Regrettably enough, there are exceptions to this pretty picture. For instance, arbitration court of Dnepropetrovsk region has instituted bankruptcy proceedings against Petrovsky Metallurgical Works (Metallurgiyny zavod im. Petrivskogo). Vladimir Zhukov, director of Makeyevka Iron and Steel Works (Makiyivsky metallurgiyny kombinat), is not too happy with business accomplishments of his company either. This company has been spending 97 to 98 kopecks per one hryvnya of commercial products ever since July 1999. Though output gained 2 to 2.5 times in 1999, Mr. Zhukov believes that this is as much as the company may produce because in-house production growth reserves have been depleted and the company urgently needs at least US$10 million of investment money to rearrange its production. Meanwhile, the Makeyevka director doubts that any private owner would become interested in acquiring this company because of huge accounts payable piled up (i.e. more than a billion Ukrainian hryvnyas).
Indeed, a whole pack of problems has come to a head in Ukraine’s mining and metallurgical complex on the whole and in the iron and steel industry in particular, definitely thwarting a lengthy recovery and radical overcoming of the crisis. Technical re-equipment, reconstruction, and upgrade of manufacturing facilities are the most crucial issues that are unachievable without large investment from the outside. The Ministry of Economy reports that Ukrainian integrated mills require US$5.3 billion of investment. In this case, it is not really about borrowing funds, but rather about raising money by selling metallurgical mills. This means that, besides to paying the commonly high price for stocks, the potential owners would have to deal with the debts and investment needs of the acquired mills. It is a rather painful problem that Ukrainian mining and metallurgical companies utilize 30 to 70% of their capacity, whereas tangible fixed assets are more than 50% deteriorated now. Much money is required to phase out the excessive capacities. Metallurgical mills would be able to handle these expenses only in case of restructuring with participation of medium and small investors.
To ameliorate the state of affairs in mining and metalmaking, Ukraine’s Cabinet of Ministers issued a regulation on October 1, 1999 approving a list of mining companies and metallurgical mills partaking in the economic experiment. The experiment awards the participating companies with various incentives, such as corporate income tax rate equaling 30% of the regular effective rate, deferment of the other taxes payable till January 2002, debt restructuring, and the like. This regulation has defined the financial and manufacturing criteria, which are applied to determine whether a company is eligible for incentives and privileges.
Ten integrated mills representing the iron and steel industry are on this list, namely, Krivorozhstal State Ore Mining and Metallurgical Works of Krivoy Rog, Ilyich Iron and Steel Works of Mariupol, Azovstal Iron and Steel Works, Zaporozhstal Iron and Steel Works, Donetsk Metallurgical Works, Dneprospetsstal Electrometallurgical Works, Dneprovsky Iron and Steel Works named after Dzerzhinsky (Dniprovsky metallurgiyny kombinat im. Dzerzhynskogo), Makeyevka Iron and Steel Works, Petrovsky Metallurgical Works of Dnepropetrovsk, and Yenakievo Metallurgical Works (Yenakiyivsky metallurgiyny zavod).
Due to the economic experiment, Ukrainian ironmaking and steelmaking mills have been able to concentrate their resources on a breakthrough, and most of them have actually succeeded. Furthermore, the incentives granted by the government give the domestic metal industry a chance to fully transfigure itself during a crucial period of the coming three years. Therefore, potential investors will find themselves in an advantage and will not wait for long deciding whether to come to this industry. There are at least two alternatives for the future development of the Ukrainian iron and steel industry. The first one is mentioned in the 2000-2002 National Privatization Program, while the second one has been worked out by Dr. Hanns W. Narberhaus, expert with the German government’s Privatization Consulting Project in Ukraine. By the way, Dr. Narberhaus has already done well restructuring a number of ironmaking and steelmaking companies in Russia.
In compliance with the first alternative, this year, the State Property Fund of Ukraine will put up for sale big stakes in four integrated mills, which take part in the economic experiment. A 25% interest in public joint-stock company Zaporozhstal Iron and Steel Works and a 45.56% stake in public JSC Azovstal Iron and Steel Works are offered in commercial auctions. It is also scheduled to sell a 50% interest in public JSC Makeyevka Iron and Steel Works on a tender and a 10.86% interest on a stock exchange. Right now, shares in Zaporozhstal are scattered among numerous owners, with financial company Favorit being the largest stockholder controlling a 23% stake. Private joint-stock company Trading House Azovstal (Torgivelny dom "Azovstal") is the major shareholder in Azovstal possessing 43.48% of this integrated mill. Meanwhile, the privatized 39.14% in public JSC Makeyevka Iron and Steel Works are almost completely owned by the lessees’ organization. It looks like privatization of public JSC Ilyich Iron and Steel Works of Mariupol will be rounded off on special terms. In fact, the Ukrainian Parliament is now polishing off a bill on specific features of this company’s privatization stipulating for sale of the state-owned 50% interest to the company’s employees on preferential terms.
So, should the strategy approved by the Ukrainian Parliament and the Cabinet remain valid, Ukraine will need three mighty investors in the near future, most likely, the foreign ones. This is more than practicable. Furthermore, if the 2000 privatization is assigned to bring in greater revenues to the country’s budget (that is what the State Property Fund’s officials have been talking about during the last couple of months), large stakes in five more metallurgical mills probably will be put for sale next in turn.
According to the second alternative devised by the German government’s Privatization Consulting Project in Ukraine, all the 14 integrated mills shall be subject to comprehensive restructuring. German experts believe that at least two-thirds of these mills are potentially unprofitable. This is the main target for reformatory efforts of the foreign colleagues of the State Property Fund. All the viable divisions of huge integrated mills will last out by going public into the hands of medium and small investors, while the remaining divisions will be phased out. Some of the mills will have to go out of business, while the ensuing social problems will have to be coped with.
Keeping in mind that 3 of these 14 integrated mills have been almost fully sold now (namely, Donetsk Metallurgical Works, Yenakievo Metallurgical Works, and Dneprospetsstal) and three more, which will be joined by Ilyich Iron and Steel Works soon enough, have already been put up for sale (namely, Azovstal, Zaporozhstal, and Makeyevka Iron and Steel Works), the German experts do not have much room for their alternative, i.e. only a half of Ukraine’s metal industry is suitable for their plans. Actually, it is not even quite so, because there are people holding petty stakes in five of the remaining seven mills, and these people can well make their own plans for the future.
Three-fourth of shares in Kramatorsk Metallurgical Works (Kramatorsky metallurgiyny zavod) and Alchevsk Iron and Steel Works have been sold up to date. It is hard to imagine that the state-owned 25% stakes would give potential purchasers enough opportunity to exert any influence. For instance, management of Alchevsk Iron and Steel Works is pleased with the current investors, namely, with USA-based limited liability company Logoimpex (part of Interpipe corp.) and stock house ATON, which hold 15% and 25% interests respectively. Most definitely, these very investors will be inclined to buy the shares remaining state-owned, if these stakes are offered for sale. Possession of a 35% interest in Comintern Metallurgical Works of Dnepropetrovsk (Dnipropetrovsky metallurgiyny zavod im. Cominterna) would hardly open broad business opportunities. Well, there is also a 50% stake in public JSC Dneprovsky Iron and Steel Works named after Dzerzhinsky that was transferred to trust management of influential Ukrsibbank, which committed itself to lend US$5 million to this integrated mill. Yet, the bank will scarcely let this company simply go away. The only things remaining are a 50% stake in Petrovsky Metallurgical Works (i.e. the company, which is claimed to be insolvent) and the two 100% state-owned integrated mills, namely, Krivorozhstal and K. Liebknecht Metallurgical Works (Metallurgiyny zavod im. K. Liebknechta). Well, it looks like little is left for thorough restructuring.
Meanwhile, there are still the open questions of how metallurgical mills are sorted out by business performance within the framework of the German concept; what the business relations with large shareholders in metallurgical mills will be; what the destiny of specific companies will be; and how the social problems relating to companies’ liquidation will be tackled. Unfortunately, there will be no answer until the concept is approved, if it really becomes approved some time in the future. The project’s experts have been negotiating introduction of this concept with the Ukrainian Cabinet of Ministers and the Parliament for four months now. The German government’s Privatization Consulting Project in Ukraine has been refusing to share the details of the project so far.
COMMENT
Alexander POZHIVANOV, professor, Doctor of Technical Sciences
What is, in you opinion, the cause of the crisis in iron & steel industry?
There are two main reasons, namely, the downswing in mechanical engineering and implementation of barter settlements. As a result of barter, companies are left with almost no current assets. Barter payments allowed exporting raw material at a certain price and importing at a whole different price, laying one’s hands on the difference. At the same time, recession ravaged the domestic mechanical engineering, which is the major consumer of iron and steel.
What do you view as a main problem of the Ukrainian iron & steel industry?
Now, many metalmaking divisions, such as cold rolling mills, roasting, finishing, and cutting shops do not meet contemporary quality and technology requirements. We are proud of the fact that the metal industry furnishes about 40% of the total export revenues of the country’s budget. These are billions of US dollars. However, if we try to analyze export structure and pattern, it becomes clear that the metal industry has a much greater latent potential. We export cast iron, flat-rolled steel (not the ready-made sheet steel, but semi-finished coils), and wire rod. In other words, 90% of our export are semi-finished products. For instance, working of flat-rolled coils into cold-rolled sheets does not take much efforts and inputs, while the price doubles. We can see the same situation with steel billets. Our clients order alloy and low-alloy steel and manufacture reinforcing bars on their facilities. It turns out that we lose 30 to 40% of the profit we might have had.
What Ukrainian metallurgical mills export high-quality finished products now?
It is Azovstal (Metallurgiyny kombinat "Azovstal"), Zaporozhstal (Metallurgiyny kombinat "Zaporizhstal"), and Ilyich Iron and Steel Works (Metallurgiyny kombinat im. Ilyicha), which supply sheet steel of high quality, and Krivorozhstal (Kryvorizhstal), which manufactures construction steel and rebars.
Today there are two strategies for reforms in the iron and steel industry, namely, the strategy of the State Property Fund envisaging sale of large stakes in 4 integrated mills (25% in Zaporozhstal, 45.56% in Azovstal, 60.86% in Makeyevka Iron & Steel Works (Makiyivsky metallurgiyny kombinat), and, most likely, an interest in Ilyich Iron and Steel Works), and the German government’s Privatization Consulting Project in Ukraine, which proposes comprehensive restructuring of metallurgical mills. For the time being, the German project is considered, while the SPF strategy is implemented. How do you see the future of metallurgical mills subject to privatization?
Despite the economic crises, Mariupol-based Ilyich Iron and Steel Works has recently phased in two continuous casters in the basic oxygen furnace shop, and has partially reconstructed the mill 1700. To become competitive on international markets, this integrated mill has to complete the mill 1700 reconstruction, which requires some US$40-50 million, and to reconstruct the cold-rolling facilities, which also requires significant funds. Now, this integrated mill is a true tidbit, and its privatization will naturally involve the clash of various interests. That is why there is a risk of getting unscrupulous investors, like it has already happened to Yenakievo Metallurgical Works (Yenakiyivsky metallurgiyny zavod) or Azovstal Iron and Steel Works. No money has been invested in these companies, while time runs away fast…
Azovstal is also among the most attractive metallurgical mills in Ukraine. In the time of the Soviet Union, it had one of the best BOF shops and employed the latest advanced technologies. Besides, Azovstal specializes in production of highly valuable products, such as shipbuilding plate steel and railing (by the way, Azovstal now holds all the certificates needed for this kind of products). That is why the strife for this integrated mill began at the early stage of its privatization, and it is likely to continue now.
Ilyich Iron and Steel Works and Zaporozhstal – i.e. manufacturers of sheet steel – are the most promising Ukraine-based integrated mills, because superb-quality sheet steel is a universal commodity. Unfortunately, equipment and technologies of these integrated mills have become deteriorated and obsolete. It is now up to their future owners whether these mills would take the first lane in this business or not.
The prices asked for large interests in big integrated mills, which need technical re-equipment and hold considerable accounts payable, are quite high. In this case, only a powerful investor can become the buyer, though it is a difficult task to find such investors. Perhaps, the recent strategy of selling metallurgical mills by fragmentation of their authorized capitals into 3 to 5 stakes was a correct choice, wasn’t it?
Owing to this strategy, numerous petty shareholders were exposed to the public, while the main owners remained in the shadow. The petty shareholders are pleased when they do nothing for their company, while the true owner creams off the best pieces. What is more, later on, this situation leads to institution of lawsuits, appeals to courts of arbitration, etc., like in case of Yenakievo Metallurgical Works. At the moment, this works runs comparatively well, but it is not enough. The modern Ukrainian metal industry is unable to function without investments.
What metallurgical mills were luckiest in this respect?
It is Zaporozhstal Iron and Steel Works, for instance. The integrated mill has always kept its feet on the ground, but the true growth has begun recently. What is the mill 1680? It is a mill brought from Germany after World War II. How long can it operate? It also has a limit of service life. That is why there is a need in permanent investment in renewal of equipment and respective technologies. Owing to investments, Zaporozhstal is working on full capacity now. Like in Ilyich Iron and Steel Works, employees of Zaporozhstal are not familiar with late payment of wages and salaries, and the like.
What is, in your opinion, the possibility of emergence of such powerful investors, who could buy the offered stakes and successfully manage the mills’ business?
It is a complicated task. The future owner firstly thinks about payback periods and estimates potential profits. In the present situation, which is not really civilized, good investors are unlikely to come up.
Where would the future investors come from? Can it be the CIS or rather non-CIS countries? Maybe, Ukraine has its own potential investors, doesn’t it?
Russian investors are unlikely to take over Ukrainian iron and steelmaking mills, because they have plenty of these in Russia. However, I do believe in domestic investors. Moreover, I am sure that Ukraine already has the qualified and wealthy investors. But their money is far away and to attract their capital in Ukrainian production there have to be the auspicious laws, i.e. the preconditions for long-term management, and a capital amnesty so that nobody could inquire where the money is from.
What do you think about restructuring? In this case, it will be much easier to find investors, and, consequently, production can be renewed faster.
It is not that easy. Splitting into small enterprises is not always possible. Each integrated mills is an indivisible manufacturing and technological system, from sinter to finished products. For instance, Krivorozhstal State Mining and Metallurgical Works of Krivoy Rog made attempts to segregate certain production sections. So, what is in the outcome? In the outcome, someone will live in clover, while the others won’t. It is possible, for example, to split a new rolling mill into a separate company, but this mill will need billets, while production of billets starts in the sintering mill, which uses, say, obsolete blast furnace and open-hearths. Therefore, reforms need to be thorough. Splitting of linked productions, which are in unequal start positions, is not good.
According to the Ministry of Economy, ironmaking and steelmaking mills of Ukraine need a total of more than US$5 billion of investment. How, in your opinion, the bankroll can be raised?
Firstly, by the economic experiment in force, secondly, by the Comprehensive Development Program for Metal Industry till 2010 adopted by the Cabinet of Ministers. Loans are the most important things. The whole world leaves on credit. Today one can buy anything on the market from blast furnace to any kind of a mill. Any leading corporation, which specializes in metalmaking machine-building, can provide you with everything you need. Therefore, there is no reason to be afraid of borrowing and investing in production development.
What do you consider the main effect of the economic experiment under way?
Owing to the experiment, there was a fundamental change in business performance. A set of granted incentives allowed avoiding barter and building up current assets, which are in principle the sources for technical re-equipment. Therefore, besides to borrowing, the main resources for breakthrough development are the potential capitals of domestic investors and in-house funds. Nevertheless, appearance of true investors, who concern with the business interests, but not the quick money, is of paramount importance.
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