The M & A Build-Up

Despite the rush of acquisitions, the action on the cement industry has only just begun

Last week, major cement players were back to the mergers & acquisition game with a vengeance. Here's what happened.

July 9: For the first time Larsen & Toubro announced its decision to set aside the Rs 1,200 crore plan to hike its cement capacity from 10.65 million tonnes to 15 million tonnes by 2003. It will start acquiring companies now. The company has been setting up greenfield projects till date.

July 8: Gujarat Ambuja was bit unlucky this time as it had to drop its bid to acquire Delhi-based DLF Cement, following a difference in the sale price. Gujarat Ambuja has acquired Modi Cement and is reported to have picked up a stake in Priyadarshani Cement.

July 7: Grasim continued its expansion and wrapped up its third largest acquisition in four months by buying out the 32.42 per cent stake in Shree Digvijay Cement at a cost of Rs 66 crore. It had earlier taken over Dharani Cement and Shree Cement. After this, its market share will rise from 9.4 per cent to 10.4 per cent.

As The Smart Investor issues of March 23, 1998 (Cementing relations) and September 15, 1997 (A case for reinforcement) had predicted that the cement industry was all set to become an M&A hotbed. Despite all the activity, we think the action has only just begun. The predators: mostly larger cement companies in expansionist mode.

The industry is fragmented with about 115 plants spread across 50 business groups and analysts predict that at least 20 business groups will move out of this industry. In terms of players right now the major capacity holders are the Birla group, which holds more than 24 per cent of the total national capacity (before recent mergers), followed by ACC.

The players who will survive in the future will be those who are able to grow through acquisitions. With this background, let's cross-examine what some of the cement companies have acquired.

ACC

It is not surprising that this stock is called 'merger' by old-time traders at BSE indicating the growth plan the company adopted in the past. ACC is the country's largest cement producer with 13 plants in nine states, a market share of 14 per cent and a total capacity of 11 million tonnes. The company has major capacities in a number of cement states. It has been aggressively expanding up getting up new capacity and modernising existing capacities. However, in recent times, it has not looked at the M&A route aggressively. Till now it has only taken over the Madhukunda (West Bengal)-based Damodar Cement & Slag for Rs 6.26 crore in September 1996.

It has, however, been attacking some grey areas of performance. In the past three years, the company has been able to reduce the percentage of high cost wet process from 35 per cent to 5 per cent. It is also investing Rs 1,530 crore to hike its production capacity from the present 11 million tonnes to 18 million tonnes by 2000 AD.

Gujarat Ambuja Cement

Gujarat Ambuja Cement (GACL) has been on a buying spree and has been looking for sick companies. Last year it acquired Modi Cement. It holds a 93 per cent stake in this ailing company and is buying out the balance seven per cent held between K N Modi group (four per cent) and the public (three per cent). Modi Cements will now be rechristened Ambuja Cement Eastern Ltd. GACL's total installed capacity of the existing four cement plants is 4.5 million tonne per annum has been increased to 6.2 million tonnes per annum, after the acquisition of Modi Cement.

It has also invested five per cent in Priyadarshani Cement. For Gujarat Ambuja, it really makes sense as it does not have a presence in the south. Priyadarshini Cement is rated as one of the better performers in the southern region and has been operating at 134 per cent of its capacity. It has an eight per cent market share in Andhra Pradesh and four per cent share in Karnataka. However, the company has ruled out any acquisition on this company at the moment.

Its latest deal with DLF Cement failed to go through following a difference in the sale price. DLF has a 1.4 million tonne per annum cement and clinker plant located at Pali, Rajasthan. It also has a captive limestone mine. The plant was set up a total cost of Rs 397 crore and uses the dry process of cement production.

India Cements

India Cement (ICL) has expanded mainly through the M&A route and expanded its total capacity to 6.8 million tonne. In 1996-97, it acquired the ailing Visakha Cements plant, which has a capacity of 900,000 tonnes, at Taandor in Andhra Pradesh. It also acquired Cement Corporation of India's 400,000 tonne, Yerraguntla plant in Andhra Pradesh.

In 1997-98, it acquired a controlling stake in Raasi Cement. On this acquisition, India Cement has acquired Raasi Cement's 1.8 million tonne capacity, which is currently being expanded to 2.5 million tonne. It also received a controlling stake in Sri Vishnu Cement, which has a one million tonne capacity.

The acquisition will give India Cement some of the most efficient manufacturing plants at far below its replacement cost. It has also received control over the limestone rights to a site near Tadapatri. This acquisition make India Cement to enter the cement deficit regions of Tamil Nadu and Kerala and consolidate its position in the southern markets.

Larsen & Toubro (L&T)

L&T, the engineering conglomerate, is now looking for additional business from cement and not without reason. In 1997-98, portland cement sales accounted for nearly 22.7 per cent of total sales, up from just 15 per cent in 1994-95. Also, cement offers vast opportunities due expected investment in infrastructure.

Till now, L&T has not bothered with fears of overcapacity and has been expanding mainly by setting up greenfield projects. It has primarily targeted the south, which is still cement-deficit. Recently, it started operations at its 2 million tonne unit at Tadpatri in Andhra Pradesh, which will mainly cater to Tamil Nadu. It also has a 1.75 million tonne unit at Hirmi in Madhya Pradesh. L&T now plans to hike its capacity at Tadpatri and Hirmi. These two expansions would mean an addition 4 million tonne of cement production.

However, the company is changing from its old ideologies and has set aside Rs 1,200 crore to be used for acquisitions and expansions in cement business over the next three years. These funds will be used to hike its cement capacity to 15 million tonnes by 2002-03 from 10.65 million tonnes.. This is the first time L&T is setting aside such a huge amount for the cement sector, with one of the specific purposes being acquisitions.

However, L&T's track record in acquisitions is not very good. It had bid for Dharani Cements along with Gujarat Ambuja, Aditya Birla group and India Cements, but lost out to Grasim Industries. It was also approached by the promoters of DLF Cements, who wanted to dispose of the unit.

Grasim's offer for Shree Digvijay Cement

M&As give investors the perfect opportunity to exit from companies that have lost favour in the markets. They also tend to help improve sentiments way before the outlook changes. Grasim Industries, the Aditya Birla group flagship has wrapped up Calcutta-based Bangur's Shree Digvijay Cement Company (SDCC) at price of Rs 34.40 crore. Grasim had purchased 32.42 per cent from Bangurs and another 9.9 per cent from one of Bangur's associates. It is now making an open offer for acquiring additional 20 per cent at the same price of Rs 142.30 against the current price of Rs 45.90. This takes the total acquisition cost to Rs 66 crore. The open offer opens on August 20, 1998 and will close on September 18, 1998. This will be excellent opportunities for investors to exist from this scrip.

The acquisition gives Grasim a foothold in Gujarat complete with an all-weather jetty for importing coal rather than using domestic coal with high fly-ash content. This all-weather jetty can handle one million tonnes of imports and its limestone reserves are estimated to last 32 years. It also gives Grasim the advantage of a port-based cement plant like Gujarat Ambuja.

Digvijay produces 1.1 million tonnes of ordinary portland cement and speciality cement of 0.15 million tonnes at Sikka, Jamnagar. The acquisition will increase Grasim's share in Gujarat from 6.2 per cent 15.5 per cent, while the group's share at the national level increases from 9.4 per cent to 10.4 per cent.. However, Grasim will also take over existing debts of Rs 57 crore and infuse funds of Rs 69 crore into planned capital expenditure. Grasim will invest Rs 69 crore in installing diesel generator sets to lower power cost. The cement capacity is also likely to be hiked to 1.25 million tonnes and plans are on to modify the jetty to increase bulk cargo handling capacity from one to 2.3 million tonnes.

Rational thinking

Two year back, when ACC acquired Damodar Cement, it had first hand knowledge of the market potential and other advantages. Thus, an acquisition gives a company the advantage in terms of selecting an appropriate location. The cement industry being raw material intensive, availability of limestone becomes a crucial factor. But in case of an acquisition quality of limestone and its availability is known, thus the risk is reduced. Besides it there are several other reasons for which companies prefer to M&A route rather than setting up greenfield projects.

Lower cost: Slow demand growth for cement has seen most cement stocks touching their rock problem prices. "At these prices, many cement companies with capacities of around one million tonne are available for Rs 150-200 crore, so acquirers find it attractive to make a takeover bid rather than expand by setting new plant," says K Gopalkrishnan, analyst at Sunidhi Consultancy Services. In 1996-97, Gujarat Ambuja acquired Modi Cement, which has an installed capacity of 1.5 million tonne, for just Rs 166 crore. While it costs Rs 400 crore to set up a one million tonne plant.

Faster revenue generation: Another reason for M&As is that takeovers helps the acquirer accelerate revenue generation. It would normally takes around 30 months before a new plant starts generating revenue. On the other hand, if a company goes in for an acquisition it takes six to eight months before the process is completed and the plant starts generating revenues. To get an idea of the gain, let's look at India Cement. It would take a new plant three years to match the 1.6 million tonne of Raasi Cement, which has a 19 per cent share in the Andhra Pradesh market.

Excess capacity and regional difference: Turning expansionist in a market in which supply exceeds demand looks illogical. The total cement capacity as of March 1998 stood at 100.30 million tonnes and a mismatch of 2-4 million tonne existed in demand and supply. The industry is set to witness addition of capacity of 7-8 million tonnes for the next two years. "In such an environment, acquisition is better option rather than setting up a greenfield project which does will not create an imbalance in the industry," explains Vikas Agarwal, analyst, Anand Rathi Securities.

Coming to regional difference, the western and southern states are expected to turn deficit regions again in the two-three years. Analysts expect the deficit to be in the region of 2-3 million tonnes. While northern and eastern will region will continue to be surplus areas. Thus one is expected to see more M&As in the southern and western region compared to the north.

Good Prospects: In spite of sluggish demand, most analysts believe that the cement sector is likely to recover by the third quarter of 1998-99. This is mainly on account of improvement in the overall economy. The budget 1998-99 has identified housing and road development as priority sector and the sectors have been given several incentives towards speedy growth. The government has targeted two million additional dwelling units in 1998-99. It has provided Rs 500 crore for the National Highway Authority to catalyse new road projects including four laning of the existing national highways. This in turn should spurt demand for cement in the coming months. Of the total cement consumed, around 65 per cent is absorbed by the housing sector, 15 per cent by industrial projects, and the remaining 20 per cent by the government. And all these sectors have a strong latent demand for cement which is bound to grow in the coming years.