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TOKYO (Reuters) - Japan's Nippon Steel Corp (5401.T) and Sumitomo Metal Industries 5405.T plan to merge to create the world's second-largest steelmaker as they battle tough competition from Asian rivals and shrinking demand from domestic automakers.
The deal, which would likely see Japan's top steelmaker Nippon Steel acquiring Sumitomo Metal, valued at $11 billion, comes as the industry grapples with surging prices for steelmaking ingredients iron ore and coking coal.
"The new group has a chance to become very competitive in Asia," said CLSA analyst Jeremie Capron. "The merged company will have the best product line-up in the industry ranging from construction steel, auto steel sheets, thick plates to seamless pipes. That's quite unique, and the No.1 company, ArcelorMittal ISPA.AS, does not have such a product line-up."
Japanese steelmakers have been hard hit as domestic automakers such as Toyota Motor Corp (7203.T) and Nissan Motor Co (7201.T) build fewer cars at home and expand in emerging markets such as India using steel from local producers.
They also face cut-throat competition from South Korea's POSCO (005490.KS) and Baoshan Iron & Steel Co (600019.SS), China's biggest listed steelmaker, as Japanese automakers seek lower prices to weather an unfavorably strong yen.
The deal, welcomed by Japanese government officials and politicians, is subject to review by Japan's antimonopoly watchdog, the Fair Trade Commission.
"I think an important decision has been made in terms of growth strategy. This is the first inspiring piece of news in a long time," Katsuya Okada, secretary-general of Japan's ruling Democratic Party of Japan, told a regular news conference.
Consolidation has long been seen as necessary for Japan's steel industry, which has five blast furnace makers, compared to South Korea's two.
It would be the world's fifth largest steel deal at about $24 billion including Sumitomo's net debt, according to Thomson Reuters data, trailing the $39 billion deal that created ArcelorMittal in 2006 and Rio Tinto's (RIO.L) (RIO.AX) $43 billion Alcan purchase in 2007, among others.
Nippon Steel, which counts Japanese automakers as its biggest clients, and Sumitomo Metal Industries, which is strong in seamless pipes used in the energy, construction and machinery sectors, said they aimed to merge in October 2012.
"They say nations are built on steel," Mazda Motor Corp (7261.T) Chief Financial Officer Kiyoshi Ozaki said. "Presuming that the union will help (the auto industry), we would like welcome any steps they can take to become more competitive."
Combining may give the companies more clout against the likes of BHP Billiton (BLT.L) (BHP.AX) and Rio which supply iron ore and coking coal, though Nippon Steel President Shoji Muneoka played down those expectations.
"We would grasp only 3 percent of the global (steel) market so we will not have a bargaining power in the coal market. Rather Chinese makers are probably strong at this area."
Prices for both coal and ore have been soaring, fueled most recently by floods in Australia, with iron ore expected to hit a record $165 a ton in the second quarter, according to a Reuters poll.
The merged company would rank No.2 in the world, with a combined crude steel output of 47.8 million tons last year, Sumitomo Metal Industries President Hiroshi Tomono said at a news conference in Tokyo.
That would still be about half the production of top-ranked ArcelorMittal but place the group ahead of Baosteel. Based on 2009 crude steel production, Nippon Steel ranked fourth in the world and Sumitomo Metal placed 19th, according to the World Steel Association.
"These are two industry goliaths. The merger of these two titans of industry looks designed to exceed anything the Chinese can do," said John Meyer, a London-based analyst at investment bank Fairfax.
"The integration...combines the production and technical skills of both companies to produce better-quality products more efficiently and more effectively. Other steel producers will struggle to compete with the new efficiencies of scale and services being offered by the joining of these titans," he added.
Nippon Steel, with a market capitalization $24 billion, and Sumitomo Metal already hold minority stakes in each other. They have not hired financial advisors and have yet to decide on the merger ratio and other conditions of the deal.
Muneoka told a news conference that he expected the FTC to approve the merger, given that the two firms have different product strengths, and said the relationship with Kobe Steel, in which Nippon Steel holds a stake of 3.4 percent, would be maintained.
Rival JFE said it supported the merger and Japanese Trade Minister Banri Kaieda gave it his blessing.
"The merger aims to strengthen global competitiveness through reorganizations of operations as global competition heats up in the steel industry," Kaieda said.
"I value such a move highly because it is line with our 'new growth strategy' aimed at realizing a strong economy."
JFE unit JFE Steel was the last major merger in the Japanese steel industry, when Kawasaki Steel and NKK combined in 2002 to form what is now the world's fifth biggest steelmaker.
Nippon Steel's Muneoka assured car makers that the union was not designed to raise prices on their main customers.
"We are not aiming to use our merger to increase our bargaining power in negotiating prices with automakers and other customers," he said.
"What we want is to become a top steelmaker in the world and provide good products for them."
Additional reporting by Yuko Inoue, Chikako Mogi, Nathan Layne, Kentaro Sugiyama, Kiyoshi Takenaka in TOKYO, Nick Trevethan in SINGAPORE, Ploy TenKate in BANGKOK; Editing by Lincoln Feast