No-Brainer: A Tata-ThyssenKrupp Merger Would Be Good For European Steel

| About: ThyssenKrupp AG (TKAMY)

By Raul de Frutos

The combination of rising Chinese steel exports and weak demand has led to an unsustainable situation for steel producers that are losing money day after day. The issue is particularly bad in the U.K., where its steel industry is not enjoying the same protectionism that the U.S. is.

Last week, India's Tata Steel announced its intentions to close its business in the U.K. if it cannot find a buyer. Tata Steel's giant Port Talbot, Wales, steel plant would be shuttered if it cannot find a buyer and that would all but bring steel production in Britain to an end.

Consolidation Factor

Tata will only produce steel in the Netherlands once it sells/closes its U.K. business. The announcement has increased expectations of Tata merging with Germany's ThyssenKrupp (OTCPK:TKAMY) (OTCPK:TYEKF). ThyssenKrupp is one of the world's largest steelmakers and the company also provides components and systems for the automotive industry, elevators, escalators, material trading and industrial services.

ThyssenKrupp's Steel Europe unit is profitable and so are Tata Steel's Netherlands operations. Both companies have held talks about combining their operations before. If an agreement materializes, it would help both companies achieve scale and cost savings. Also, a reduction of its steel exposure would help ThyssenKrupp focus on its engineering business. The move would likely please investors, at least that seemed to be the case as ThyssenKrupp's shares jumped to their highest level this year on the news of the possible merger.

How to Save European Steel

The consolidation of the steel sector in Europe makes a lot of sense. Indeed, the industry has waited too long to close or merge underperforming operations, and that has led to a crisis where many business are now cash flow negative. If European steelmakers knew prices were going to get this low, they would have probably reacted earlier. Shutting down capacity is always an undesirable option as companies are unwilling to let their competitors win market share.

ArcelorMittal (in black) laggin US Steel Corp (in red)

ArcelorMittal's (NYSE:MT) stock price (in black) lagging that of U.S. Steel Corp. (NYSE:X) (in red). Source: MetalMiner analysis of @StockCharts.com data.

Combining Tata Steel's Dutch plant with ThyssenKrupp's operations would create Europe's biggest steelmaker after Luxembourg-based ArcelorMittal, which is no stranger to the steel crisis in Europe, itself.

ArcelorMittal gets around half its revenues from Europe. Its high European exposure helps explain why its stock price is lagging far behind companies such as U.S. Steel Corp. (see chart above). And U.S. Steel's stock isn't even in great shape, itself.

A Tata-Thyssen merger - at least in Europe - would allow the combined company to cut capacity and perhaps even support steel prices, and hopefully, those developments would finally spark some movement in Europe's steel industry.

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