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Business deals

Hyundai's mega-shipbuilder plan puts China and Japan on edge

South Korean government's heavy hand raises concern over price stability

Hyundai Heavy's shipyard in the South Korean city of Ulsan is one of the world's largest facilities for constructing vessels.

SEOUL/TOKYO/SHANGHAI -- The Hyundai Heavy Industries deal announced Thursday to consolidate two of South Korea's "Big Three" shipbuilders is certain to draw the ire of rivals Japan and China as they take issue with Seoul's aid to the industry.

The world's largest shipbuilder conditionally agreed to acquire a 56% stake in Daewoo Shipbuilding & Marine Engineering from the state-run Korean Development Bank. The combined entity would create a company double the size of compatriot Samsung Heavy Industries.

"We must shift from Big Three to Big Two," the bank's CEO and Chairman, Lee Dong-gull, told reporters on Thursday.

The move comes after South Korea regained the crown as the world's top shipbuilder in 2018 for the first time in seven years, a resurgence heavily assisted by the government.

Daewoo booked a net loss of 2.12 trillion won ($1.9 billion in current rates) in 2015 as it racked up cheap orders, nearly pushing the builder into bankruptcy. South Korea provided financial aid totaling about 12 trillion won from 2015 to 2017 to keep the company afloat.

The aid helped South Korea's shipbuilding industry overcome a slump from the rise of Chinese competitors starting in 2016 and mount a recovery last year. Orders at the country's Big Three rose 69% from 2017, Nikkei calculates.

China, which lost the crown, has said that cheap orders achieved through government support are impeding competition. Analysts say Beijing might block the Hyundai-Daewoo deal on antitrust grounds.

Japan has claimed that Seoul's heavy hand likely violates a World Trade Organization agreement on government subsidies. South Korea rejects this view, saying the aid was a business decision made by banks. Tokyo launched bilateral talks with Seoul on the issue in December, which it must do to file a WTO complaint.

South Korea won the most ship orders by tonnage last year at 24 million, followed by China at 18.6 million tons and Japan at 7.2 million. South Korean shipbuilders control 90% of the global market for liquefied natural gas carriers, which were originally Japan's specialty and have high unit prices.

Tokyo and Beijing's opposition likely will grow as the industry turns in favor of South Korean rivals. A Jiangsu Province shipbuilder filed for bankruptcy last year.

The emergence of a new shipbuilding powerhouse could increase the chances of an industry-wide restructuring as well, a prospect for which Japanese and Chinese firms are bracing.

"We fear that [the Hyundai deal] will create a company that will be highly competitive on price," a Japanese shipbuilder said. These businesses are contending against a price offensive from South Korean competitors in LNG carriers.

South Korean shipbuilders are known to leverage their scale by using common designs to accept huge orders to reduce costs. It is not unusual for these companies to build more than 10 large vessels in a row and deliver them in months.

Japan's Imabari Shipbuilding received an order for four ultra-large tankers from Greek shipping company Navios Group in December. The work, however, could not be done at other domestic shipyards due to a short delivery period as well as the personnel and equipment needed to build multiple ships.

The shipbuilding industry has undergone little restructuring in Japan since IHI and JFE Holdings merged operations to form Japan Marine United in 2013. Kawasaki Heavy Industries and Mitsui Engineering & Shipbuilding, now Mitsui E&S Holdings, scrapped their merger that year as well.

Japan's shipbuilders also are bracing for headwinds as the U.S.-China trade war depresses demand for overseas shipping and the yen strengthens. Imabari will buy Minaminippon Shipbuilding from transport company Mitsui O.S.K. Lines. Mitsui E&S has partnered with Tsuneishi Shipbuilding and will launch a joint venture with China's Yangzijiang Shipbuilding in April.

Anticipating fewer orders, Mitsubishi Heavy Industries scaled down operations at its shipyard for commercial vessels in Nagasaki.

"We may have to consider shifting production to a Chinese subsidiary to save costs if we do not receive orders for large LNG carriers," Kawasaki Heavy CEO Yoshinori Kanehana said.

Under the conditional deal, Hyundai's holding company and the Korean Development Bank would form a joint venture into which the bank would transfer its Daewoo shares in exchange for a stake in the new entity worth 1.25 trillion won. The joint venture would house Hyundai's three shipbuilding units and Daewoo Shipbuilding.

"We will contact Samsung Heavy, another potential buyer, to see if it is interested in Daewoo Shipbuilding as well," said Lee, the bank chairman, explaining why the deal was only conditional. Samsung is unlikely to make a better offer, however, as its shipyards continue to face losses.

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