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In April 2017, Chongqing Iron & Steel Company Ltd (CISC) was facing delisting and bankruptcy, but within a year the company had turned its fortunes around. Yu Hong, Board Secretary, CISC, looks at the lessons to be learned from this dramatic rescue of a Chinese state-owned enterprise.

 

The judicial reorganisation of Chongqing Iron & Steel Company Ltd (CISC) started in April 2017 and was completed in December in the same year. After many trials and tribulations, this century-old steel company finally found a new lease of life. Against the background of supply side structural reforms in the steel sector and market-orientated debt equity swaps, the CISC case has attracted a lot of attention and admiration. In March 2018, the CISC reorganisation was recognised as a model bankruptcy case at the Mainland Supreme Court. The success of the CISC reorganisation is said to have established a model for handling complicated, large-scale corporate reorganisations and it has become a model for the successful reorganisation of large, listed state-owned enterprises. When visiting CISC in May, Xiao Yaqing, Chairman of the State-owned Assets Supervision and Administration Commission(SASAC) of the State Council, mentioned that the experience of CISC turning itself around through judicial reorganisation sets a good example for supply side structural reforms in the iron and steel industry throughout the nation. Below is a brief summary of the reorganisation of CISC.

Background

Established in 1997, CISC is a company dual-listed in the Mainland and Hong Kong. Before the reorganisation, there were 4,436 million shares in total, of which 2,097 million (47.27% of the total) were held by Chongqing Iron & Steel (Group) Company Ltd of the Chongqing SASAC. CISC has an annual output of 8.4 million tonnes of steel. Key products include hot rolled coils, medium gauge steel plates and wire rods.

In late 2006, CISC started a relocation and pollution control plan. In 2011, the first phase of the relocated plant went into operation, and the relocation was fully completed in 2013. However, due to a mismatch between product structure and market demand, cost-competitiveness could not be achieved.

Poor financial control in relation to the relocation resulted in high depreciation and financial costs. Production management was weak and the employee turnover rate was high. These problems were aggravated by the persistently lacklustre iron and steel market. As a consequence, CISC suffered from huge losses after its relocation. An accumulated loss of RMB14.4 billion was booked from 2011 to 2016. Taking into account nonrecurring profit and loss, including various allowances, the actual loss was RMB23.8 billion. Efforts made to find a way out were to no avail. As at April 2017, CISC was seriously insolvent, with total assets and actual liabilities being RMB36.4 billion and RMB41.7 billion, respectively. Its bank accounts and assets were frozen and its cash resources were exhausted. The Shanghai Stock Exchange (SSE) imposed a delisting risk warning on the A shares of CISC. CISC was on the verge of bankcruptcy. Pursuant to the judgment of the First Intermediate People’s Court of Chongqing, CISC formally started its judicial reorganisation in July 2017.

The reorganisation plan

In its announcement of 30 September 2017 on the progress of reorganisation, CISC announced that the Siyuanhe Steel Industry Equity Investment Fund (Siyuanhe Fund) and the Chongqing Strategic Emerging Industry Equity Investment Fund intended to participate in the judicial reorganisation of CISC as strategic investors. Structural oversupply, a structural mismatch in terms of product mix and the location of production, as well as low industrial concentration and high debt levels make the iron and steel industry an important candidate for supply side structural reform. As a pilot of state capital investment, the Siyuanhe Fund brought together China Baowu Steel Group Corporation, WL ROSS Company, US-China Green Fund and the China Merchants Group. With intimate knowledge of the industry, commercial modes of operation and strong post-investment management, the Siyuanhe Fund has demonstrated a new way of restructuring, transforming and upgrading the iron and steel industry of China through strategic positioning, system innovation and close involvement in management.

After confirming its involvement and thorough due diligence, the Siyuanhe Fund found that the Sichuan and Chongqing regions record a net inflow in terms of steel consumption. As the only large-scale iron and steel enterprise in Chongqing, CISC had a clear competitive advantage in the regional market. If the debt crisis could be effectively resolved and the market mismatch rectified, it would be possible to regain competitiveness and resume sustained profitability. On this basis, the Siyuanhe Fund drew up a step-by-step plan for CISC’s future development and came up with a reorganisation plan after several rounds of negotiations with various parties.

Key aspects of the reorganisation plan

The Siyuanhe Fund and Chongqing Strategic Emerging Industry Equity Investment Fund would provide a capital of RMB3 billion and RMB1 billion respectively to set up Chongqing Changshou Iron & Steel Company Ltd (Changshou) to participate in the reorganisation of CISC. Through an auction, Changshou invested RMB4 billion cash in exchange for the former iron production assets of CISC and 2,097 million CISC shares from Chongqing Iron & Steel (Group) Company Ltd, representing 23.5% of the total of 8,919 million shares of the reorganised company. This made Changshou the largest shareholder. Chongqing Iron & Steel (Group) Company Ltd bought the less efficient assets of CISC for RMB3 billion cash. Together with a loan of RMB3.5 billion from the State Development Bank, CISC got a total of RMB10.5 billion in cash, which was used for full repayment of preferential debts of RMB10.1 billion.

For the ordinary debts of RMB28 billion, a debt equity swap programme was introduced. Capital reserve was converted into share capital, with 4,483 million shares at a price of RMB3.68 per share issued in lieu of debt repayment. The repayment ratio of 59% is the highest among judicial reorganisation exercises.

After the judicial reorganisation, the gearing ratio of CISC dropped from 114.6% to 33% and steel production rose from 2.35 million tonnes to 4.11 million tonnes, representing a year-on-year growth of 75%. Through the reorganisation, it realised a total profit of RMB330 million, turning the company around. This positive change removed the risk of delisting. On 29 December 2017, the First Intermediate People’s Court of Chongqing confirmed the completion of the reorganisation. Trading of A shares of CISC resumed on 3 January 2018, and the delisting risk warning was cancelled on 9 March 2018.

The effect and implications of the reorganisation

Every step of the judicial reorganisation of CISC took into account the rules of the market and the requirements of the law. It worked towards the best common interest of all parties and achieved win-win for all stakeholders.
Among the RMB41.7 billion of debts of CISC, RMB10.1 of preferential debts were repaid in full in cash. RMB28 billion of ordinary debts were converted to equity. The repayment rate of 59% is far higher than that for bankruptcy and reorganisation cases in general. The interests of creditors were protected to the greatest extent, and the local financial and commercial environment was maintained intact.

For the minority shareholders of CISC, the share value of the company before the reorganisation was seriously affected by the company’s insolvency. The net asset value of each share was in the negative region and the company was in danger of being delisted. After the reorganisation, the net asset value of each share was close to RMB2 and the company became profitable again in 2017. The risk of loss in equity value was removed. The backing of the Siyuanhe Fund, with its strong resources, also brought about solid expectation of asset growth among CISC shareholders.

The reorganisation plan was overwhelmingly supported by 99.3%, 100% and 95.5% of the three groups representing employees, guaranteed creditors and ordinary creditors. The plan on adjustment of the rights and interests of capital contributors was approved by 99.3% of holders of A shares and 100% of holders of H shares, the highest rate ever attained for judicial reorganisation cases of listed companies.

Through debt reorganisation and removal of inefficient assets, CISC consolidated its total assets from RMB36.4 billion to RMB25 billion. With the removal of its debt crisis, the gearing ratio was reduced to 33%, clearing the way for financing. Clear delineation of responsibilities of its staff boosted productivity to over 1,000 tonnes per head, making it among the most productive steel enterprises in China. As the actual controller of CISC, the Siyuanhe Fund brought in the advantages of mixed ownership. Professional managers were deployed, streamlined and highly efficient modes of operation were established, and a fully market-orientated pay and reward system was adopted. The management team is working on future development plans, optimising the product structure, promoting the development of green manufacturing and smart manufacturing, with a view to creating a new CISC with strong market competitiveness. This is indeed a rebirth for CISC.

For the Chongqing Municipal Government, the success of the reorganisation has avoided the potentially significant adverse impact of CISC’s bankruptcy. It resolved at one go the issue of the guarantee extended to CISC by Chongqing Iron & Steel (Group) Company Ltd and the Chongqing Yufu Group, and maintained the financial and social stability of the city of Chongqing. The reorganisation facilitates CISC’s sustainable and healthy growth, and helps improve local employment, tax income and environmental protection. It also sets a good example for supply side reforms in Chongqing.

Lessons learned

1. The role of the party and local government

The firm guidance provided by the Municipal Party Committee and the Municipal Government was a key to success. The judicial reorganisation of CISC involved RMB36.4 billion of assets, RMB41.7 billion of liabilities, over 1,400 creditors and 170,000 shareholders. This puts it on a scale that is unparalleled among reorganisation exercises of listed companies in the Mainland. The successful completion of this large-scale and exceptionally complex reorganisation within an extremely small window of time is attributable to the firm guidance, full control and sound decisions of the Municipal Party Committee and the Municipal Government of Chongqing. They provided strong guarantees for the success of the whole exercise.

2. The role of state institutions

The strong support and good guidance of relevant ministries, committees and relevant units of the state were also essential to the success of the reorganisation. The efficient processing of the Supreme People’s Court made it possible for the reorganisation to be completed within one year. The China Securities Regulatory Commission gave detailed guidance on the massive asset restructuring exercise to match the judicial reorganisation, providing tremendous support regarding the reference formula for calculating the ex-rights price after the conversion of capital reserve into share capital, and the vetting of strategic investors. The system of the creditors committee launched by the China Banking Regulatory Commission was crucial to resolving CISC’s debt crisis. SASAC was active in securing the support of state corporate creditors for the reorganisation plan. The SSE, the China Securities Depository and Clearing Corporation and the Stock Exchange of Hong Kong rendered full support in the suspension and resumption of share trading, exemption from convening class meetings of shareholders and the disclosure of information. All these worked together towards the efficient, smooth and orderly completion of the judicial reorganisation.

3. Governance reforms

Conducting management reforms according to market principles to enhance efficiency and governance standards is the essence of mergers and reorganisations.

The judicial reorganisation of CISC drew in the Siyuanhe Fund, which has a strong industry background. This not only resolved the debt crisis effectively but also, more importantly, rectified the mismatch between supply and demand, paving the way for high-quality development. By reforming through mixed ownership, introducing professional managers and a market-oriented incentive system, the vision of development was set, the governance structure refined, operational management improved and sustainability realised. This shows that it is only by adhering to market principles and promoting fundamental reforms in the three areas of ‘quality, efficiency and motivation’ that an enterprise can develop healthily.

Yu Hong, Board Secretary
Chongqing Iron & Steel Company Ltd

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