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Business deals

Hyundai's new 23% market share forces shipbuilders to bulk up

Birth of mega-shipbuilder triggers race for economies of scale

Hyundai Heavy Industries, the world's largest shipbuilder, operates this shipyard in the South Korean city of Ulsan. (Photo courtesy of Hyundai Heavy Industries)

SEOUL/SHANGHAI/TOKYO -- South Korea's Hyundai Heavy Industries signed a definitive agreement to acquire compatriot Daewoo Shipbuilding & Marine Engineering on Friday with Daewoo's top shareholder Korea Development Bank, creating a leviathan that will control more than one-fifth of the global market.

Hyundai Heavy Industries Holdings and KDB will take shares of roughly 29% and 8%, respectively, in a new company that encompasses shipbuilding subsidiaries Hyundai Heavy Industries, Hyundai Samho Heavy Industries, Hyundai Mipo Dockyard and Daewoo. The new company will hold about 68% of Daewoo's stock.

The three Hyundai Heavy subsidiaries and Daewoo built vessels totaling 15.54 million tons in 2017 for a roughly 23% market share, according to the latest data from Japan's transport ministry. No shipbuilding group has controlled over 20% of the global market since 2000, as competition for economies of scale accelerates in the crowded field.

But the agreement -- which consolidates South Korea's "Big Three" shipbuilders including Samsung Heavy Industries into a "Big Two" -- faces regulatory hurdles in China, Europe and Japan over antitrust concerns. Beijing also seems to take issue with South Korean aid to Daewoo.

Hyundai Heavy, the world's largest shipbuilder, will purchase the roughly 56% stake in third-ranked Daewoo held by KDB as early as the end of 2019, the state-run bank said.

"Hyundai Heavy will essentially use Daewoo as a subcontractor to raise its competitiveness," said a source in South Korea's shipbuilding industry.

Hyundai Heavy has its shipyard in the southeastern city of Ulsan while Daewoo's is located in the southern city of Geoje, home to one of the world's largest docks at 131 meters wide. The combined company intends to cut costs and shorten delivery times by building large vessels like cutting-edge containerships in Geoje and focusing construction of liquefied natural gas carriers -- an anticipated source of growth -- in Ulsan.

But South Korea is wary of the risks posed by such restructuring. South Korean shipbuilders bolstered their competitiveness in the 1980s by hiring Japanese engineers who left the country after two restructuring efforts led by Tokyo.

Should Hyundai Heavy mismanage the merger, "South Korea's competitiveness could be harmed as Daewoo engineers head for Chinese competitors," a South Korean analyst said.

Hanwha Investment & Securities estimates that shipping companies will order an average of $112 billion in new vessels yearly from 2019 to 2027, a 70% rise from 2018, as they address new environmental regulations that take effect in 2020 and 2025. Yet that figure still represents less than half the peak seen in 2007.

The shipbuilding industry appears headed for even more reshuffling. Rumors have floated in China since last year about a merger of China Shipbuilding Industry and China State Shipbuilding, both of which control many yards. The two state-owned groups combined to produce vessels totaling 6.38 million tons in 2017, which would make them the world's second-largest shipbuilder if merged.

Combining state-owned enterprises into one massive entity as a way to raise their international competitiveness is a well-worn tactic for the Chinese government.

Japan's industry is led by Imabari Shipbuilding, followed by Japan Marine United. Attention will shift to how smaller Kawasaki Heavy Industries and Mitsui E&S Shipbuilding respond to the birth of a new South Korean giant.

Antitrust watchdogs in China, the European Union and Japan likely will scrutinize Hyundai Heavy's mega-shipbuilder deal. The two shipbuilders boasted 72 outstanding orders for LNG carriers -- an area Japan views as a growth pillar -- at the start of this year, for 60% of the global market. The deal could face restrictions should regulators determine that such a dominant market position distorts competition and hurts the interests of shipping customers and consumers.

Each of the three markets likely will reach a decision by the end of this year, South Korean sources believe. But Beijing apparently takes issue with the government's virtual support of Daewoo.

Daewoo has a history of undertaking unprofitable orders that have put it in financial straits. The shipbuilder was unable to find a buyer even after coming under KDB's control in 2000, and it posted net losses for five years straight starting in 2012. The company returned to profit after receiving 12 trillion won ($10.6 billion at current rates) in aid from a government-affiliated financial institution to reduce its debts.

"Antitrust regulators will take their time to review the deal and may not approve the merger," said a Chinese source in the shipbuilding industry.

A rejection of the shipbuilding merger would deal a blow to South Korea's government, which is betting on the industry as a major source of employment. South Korea leads China by more than three years in shipbuilding research and development, larger than the gap of nearly two years for green automobiles and nearly three years for semiconductors, according to the Korea Institute of S&T Evaluation and Planning.

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