The new brick in The Wall

Updated: Jan 29 2005, 05:30am hrs
When Swiss major and the worlds second largest cement producer Holcim teamed up with Gujarat Ambuja Cements Ltd and announced its intention to acquire Associated Cement Companies Ltd (ACC) last week, there was palpable excitement in the cement sector. An excitement borne out of expectation that Holcims entry into India would finally trigger the long overdue consolidation of the cement industry. The financial institutions and banks saw an opportunity to convert loads of bad debts into productive assets (and into profits), consultants who advice on M&As could hear their cash registers ringing, analysts furiously crunched numbers to arrive at what the new valuations would be for the cement companies, if M&A activity breaks out in the sector and promoters of companies that are neck deep in debt smiled as they visualised better prices for the capacities they were sitting on.

Says Promeet Ghosh, senior vice president, Investment Banking/ M&A, DSP Merrill Lynch, This is expected to be mutually beneficial with sharing of technologies and best practices between India and the rest of the world.

Their expectations are not without reasons. Multinational corporations (MNCs), particularly in the cement sector, operate in a manner that is very different from their Indian counterparts. Says an analyst with an international broking firm, if one goes by the past behaviour of MNC firms like Holcim and others where ever they operate across the globe, they furiously buy out competition and would typically like to have just four or five major players in the field. They control production to suit demand and this ensures better prices.

This strategy also explains how companies like Holcim, Cemex and Lafarge, operating a predominant part of their capacities in matured markets like Europe and US, still post significant growth in bottom line despite a flat top line. Cement consumption in developed economies register only a marginal growth as most big infrastructure projects are complete and demand for large scale use of cement is limited.

Industry dynamics
On the other hand the Indian cement industry has been posting significantly higher consumption year after year. If one looks at Cement Manufacturers Association of India (CMA) data from the year 1981 to date, the sector has grown year after year at anywhere between a low 2% to a high 16%. The average growth rate over the 24 year period works out to around 8%. On top of this, the per capita cement consumption in India is lower than even that of similar economies in South East Asia. Without doubt, India should have long been the favourite hunting ground for MNC companies which are looking for ways to grow their top line. But that has not happened.

While they control about 40% to 60% of the capacity in Thailand, Indonesia, Philippines etc, their combined capacity (in proportion to their stake) is just over 15% in India (assuming Holcims open offer for ACC is successful). It is the fragmented nature of the industry and the consequent low prices that has deterred them from entering India in a big way. India has 127 large cement plants to produce 146.38 million tonnes of cement.

There are, of course, another 365 mini-cement plants churning out roughly six million tonnes. Future demand and ensuing shortfall in supply appears to have favoured Holcims decision to enter India disregarding some of the negatives associated with the industry here, says Mr T V Swaminathan, Joint president (operations), India Cements Ltd.

According to a Cris-Infac study, the current demand of 130 million tonnes is expected to grow 166 million tonnes by 2007-08. Total capacity across the country today is 146.38 million tonnes, if one assumes a 90% capacity utilisation (of the capacities that are up and running) the production can at best touch 126 million tonnes. Another 10 million tonnes can be added by producing blended cements and de-bottlenecking capacity.

Thus fresh capacities to the tune of over 30 million tonnes need to be created in the next few years to bridge the demand-supply gap, the study adds. In the near term, if the Indian economy grows by 6-8% as projected the surplus capacity would be absorbed by end of this year itself. And with no major fresh capacities coming up, prices would begin to look up soon, he added.

ACC acquisition also made a strategic fit for Holcim as it would, along with other MNC Lafarge have an influential 40% share of the market in the eastern region. And acquiring ACC along with Gujarat Ambuja Cements meant that Holcim-Ambuja combine will have a say in the Western and Northern markets as well.

MNCs (in proportion to the stake they hold and assuming the ACC buyback offer goes through) will have control over nearly 20 million tonnes of capacity in India (Lafarge - 5 million tonnes, Italcementi- 2 million tonnes and Holcim- 11 million tonnes).

MNC presence
Will the increasing MNCs presence bring a significant change to the cement industry in India The industry and the analysts who track it are clearly divided on this issue. Unlike in other industries where MNCs bring in technology and better practices, there is little they can offer to the Indian cement sector, says Mr A V Dharmakrishnan, senior vice president (finance), Madras Cements Ltd. We are as efficient as the MNCs or even better when it comes to fuel costs or power consumption. Over the years the Indian cement industry has really worked hard to improve the processes as the sure shot way to make profit is through cost savings rather than better realisation.

Gujarat Ambuja Cements whole time director Anil Singhvi has a different view. Soon after the Ambuja-Holcim deal was signed, he said GACL would benefit from access to Holcims business practices and processes, use of information technology, use of waste material, use of alternate fuels, various new applications of cement etc. On the issue of possible consolidation too, there are differences of opinion. Some see Holcims entry as a possible catalyst for triggering the M&A activity in the sector. Their logic:

Holcims entry by picking up ACC will force other MNC players like Cemex to look at India more closely. Cemex cannot afford to ignore India anymore.

MNCs who are already present in India such as Lafarge and Italcementi will lookout to expand their base so as to have a better say in the future.

On the other hand, domestic players are unlikely to keep quiet and lose their market to MNCs. They will actively work towards consolidating their position by picking up capacities.

Increased competition for acquiring capacities would push up valuations and consequently more capacities will be available for acquisition.

Withdrawal of sales tax related incentives in the year 2000 has made setting up of green field projects, at current cement prices, unviable. Inorganic growth has become inevitable.

Even if the prices improve and make green field projects attractive, it would take a few years for the project to go on stream and earn revenues. Acquisition, on the other hand, would enable the company to cash in on the demand immediately.

Domestic strengths
But there are those who disagree with the above reasoning and their argument is equally strong.

You dont need MNCs for triggering the consolidation of the industry. Consolidation happened even when Grasim picked up the cement division of L&T and India Cements acquisition of Rasi Cements and Visaka Cements. M&A activity happens if good capacities come up for sale and that is the key issue. In India there are many cement plants which are on the block but the problem is that they are so badly leveraged that it is unviable to takeover them. Paucity of good quality capacities will deter consolidation.

Indian market is unique in the sense that cement capacities do not go out of business even if it is neck deep in debts. They continue to operate, fragment and distort the market.

Promoters of well run but single unit cement plants do not sell out however good the offer price is.

If new capacities to the extent of 30 million tonnes need to be set up in the next few years as projected, it would cost the industry a few billion dollars. When so much of funds are required for green field projects, it would be very difficult for the companies to raise money for acquisitions. Their balance sheet may just not permit it.

There is also a view in the industry that the talk of demand-supply gap in the near future is a mere hype and it would take many years for the gap to bridge. Proponents of this theory argue that Indian cement industry is sitting on a surplus capacity in excess of 30 million tonnes mostly in the states of Andhra Pradesh, Gujarat and Rajasthan. This capacity first needs to be absorbed profitably. On top of this, new capacities continue to be created. Almost 30 million tonnes of new capacity has been created since the year 2000 when the sales tax incentives were removed.

Most Indian cement manufacturers are volume players and there have been enough instances of arrangements to control production to match demand falling apart as market share plays crucial part in the industrys psyche. This will impact ability of the industry to generate enough cash to fund M&As.

Cement prices have become politically sensitive and they cannot be raised beyond a point, even if the arrangement to regulate production holds. In Tamil Nadu, for example, a dual sales structure has been put in place by the state government to deter cement companies from increasing the prices sharply.

While this debate rages within the industry and outside, what clearly emerges is that the real consolidation is one where small capacities get picked up by bigger players and that has not happened so far in India barring isolated acquisitions here and there.

With almost all major capacities having been acquired by either domestic players or MNCs, the real test for consolidation begins now.

Additional reporting by PAPIYA DE