By Christoph Steitz and Promit Mukherjee
ESSEN, Germany/MUMBAI (Reuters) - Sure, Germany's Thyssenkrupp (DE:TKAG) and India's Tata Steel (NS:TISC) agreed on Wednesday to merge their European steel operations to create the continent's No.2 steelmaker.
The deal, which is preliminary, will help the companies address overcapacity in Europe's steel market, which faces cheap imports from overseas, subdued construction demand and inefficient legacy plants. The merger will also result in up to 4,000 job cuts, or about 8 percent of the joint workforce.
The transaction will not involve any cash, Tata Steel said, adding both groups would contribute debt and liabilities to achieve an equal shareholding and remain long-term investors.
"We want to avoid our steel team restructuring itself to death," Thyssenkrupp CEO Heinrich Hiesinger told reporters, noting its steel operations would face deeper restructuring needs if they remained part of the group.
"No one is able to solve the structural issues in Europe alone. We all suffer from overcapacity and that means that everyone is making the same restructuring efforts," Hiesinger told broadcaster n-tv.
The new joint venture, Thyssenkrupp Tata Steel, will be Europe's biggest steelmaker after ArcelorMittal (AS:MT) and will be based in Amsterdam.
"Excellent news," tweeted Dutch Prime Minister Mark Rutte.
Tata Steel Europe had been a strain on its parent for a decade, burning through approximately $1 billion (£737.57 million) of cash a year.
Tata Steel will transfer 2.5 billion euros (£2.22 billion) of debt to the new company and is counting on dividend income from the joint venture to help service its remaining debt, Koushik Chatterjee, a group executive director, told Reuters.
That will free up cashflow to allow it to invest to meet growing demand in India, where Chairman N. Chandrasekaran said it will aim to double its manufacturing capacity in five years through plant expansions and acquisitions.
Thyssenkrupp shares rose 3.2 percent, bolstered by hopes the joint venture will also ease the burden on its balance sheet, which will be freed from 4 billion euros ($4.8 bln) in mostly pension liabilities.
"We believe Thyssenkrupp's medium-term goal is to completely spin-out steel ops, leaving Thyssenkrupp as a near pure-play capital goods business, and today's proposed merger structure is attractively "IPO-able", in our view," Jefferies analyst Seth Rosenfeld said in a note, reiterating his "buy" rating.
POSITIVE CATALYST
Thyssenkrupp, whose operations span car parts, elevators, construction steel and submarines, is minority-owned by activist shareholder Cevian and has faced calls to split off other parts of the business, most notably its elevator unit.
Wednesday's long-awaited memorandum of understanding (MoU) with Tata outlines annual synergies of 400 million-600 million euros.
Shares in Tata Steel rose 1.7 percent.
The company reached a landmark deal last month that will allow it to reduce 15 billion pounds ($20 billion) in British pension liabilities, long seen as the main hurdle in talks that have lasted more than a year and a half.
The UK government and unions said they welcomed the merger so long as commitments made by Tata Steel UK to safeguard jobs and extend blast furnace operations at Britain's largest steelworks in Port Talbot, Wales, were maintained.
Roy Rickhuss, chair of the steel coordinating committee representing UK unions Unite, GMB and Community, said the unions recognise the industrial logic of the deal, but will still press Tata to confirm it will invest in the relining of Port Talbot’s blast furnace No. 5.
Tata made commitments to safeguard jobs and invest in the Port Talbot steelworks in return for the unions agreeing to close their final salary pension scheme to future accrual.
Hans Fischer, Tata Europe's CEO, said the company was not planning to cut capacity, but to instead focus on higher value products.
"We see opportunities to increase or to at least keep the volumes we have today, cause there's a huge market for high quality steel," said Fischer.
The MoU will be followed by negotiations about the details of the transactions as well as due diligence before a contract can be signed at the beginning of 2018, Thyssenkrupp said.
Negotiations with German unions, who have campaigned against the plans and only this week signalled a willingness to consider them, are expected to be tough and tied to far-reaching job and plant guarantees.
The deal will require approval of Thyssenkrupp's supervisory board, Tata Steel's board of directors and European regulators.