JOINING HANDS: The Hebei Iron and Steel Group is strengthening efforts to increase integration between subsidiary steel-makers and achieve synergy (WANG MIN)

Although it is too early to tell whether the steel-making sector has emerged from its gloom, a big divide is opening between China's large and small producers. While most of the marginal players are still reeling from a market contagion, steel titans like the Shanghai-based Baosteel Group Corp. and Hebei Iron and Steel Group (HBIS) have raised their steel prices, signaling their relative immunity to the crisis. A deeper look at the HBIS could offer an insight as to how the scale effect and technological edges can justify price increases.

HBIS is the product of a merger in June 2008 consisting largely of Tangshan Iron and Steel Group Co. Ltd. (Tangsteel), Handan Iron and Steel Group Co. Ltd. (Hansteel), and the ferroalloy producer Chengde Xinxin Vanadium and Titanium Co. Ltd. (CDVT). All three are based in the province of Hebei, which encircles Beijing and is home to one fifth of China's steel output. HBIS recorded a combined annual steel output of 31.75 million tons, based on 2007 figures, displacing Shanghai-based Baosteel as China's No.1 steelmaker by productivity.

China's desire for a stronger, cleaner steel industry is deep-rooted. The pressing need for efficiency and higher value-added products precipitated a shakeout that squeezed many smaller, more heavily polluting mills out of business. Bolstering its bargaining power in the international iron ore price negotiations also required crunching the crowded, weak sector into a few bigger players through mergers and acquisitions.

On top of those urgent trends came the sweeping global economic downturn. For the past several years, the industry skirted the risk of heavy overcapacity by becoming a substantial exporter—but the sharp recession in the West took that protection away.

Steel is not the only sector that has sagged under the heavy weight of shriveling demand—but its woes were exacerbated by a build-up of inventory that depressed prices. These chilly headwinds forced HBIS to idle some of its capacities in October 2008, but months later a mild recovery got quickly underway. In June this year, the giant raked in a profit of 270 million yuan ($39.5 million)—nearly three times its May earnings.

The government stimulus effectively widened domestic demands, and most importantly, synergies of the restructuring are starting to be felt, said Zhao Zhicheng, a senior analyst with the Shenzhen-based Essence Securities Co. Ltd., in a report. For three independent entities that have their own advantages, the close tie-up, he added, was truly a hard-won achievement.

But if history is any guide, mergers do not necessarily deliver real integration. The dead marriage between could serve as an open alarm. In August 2005, for example, two Liaoning Province-based steelmakers—Angang Steel Co. Ltd. and Benxi Iron and Steel (Group) Co. Ltd.—merged into one company. However, due to intractable financial disputes, both have adhered to separate operations, watering down the so-called "tie-up."

Obviously, the three subsidiaries of HBIS have taken this lesson to heart. On May 22, the three listed subsidiary units officially agreed to an acquisition program that allows the Tangsteel to take over the other two sister companies via a share swap. Shareholders of Hansteel and CDVT, meanwhile, were permitted to receive cash compensation—even if they chose not to participate in the swap.

This move will deliver a boost to the three-way combination, marking a significant step for HBIS toward a unified listing of its prime steel-making assets, said the group in a statement.