The boards of global cement majors Holcim and Lafarge have unanimously agreed to merge their global operations (in 1:1 ratio) to create the worlds largest building materials entity, to be called LafargeHolcim. In India, Holcim is present through ACC and Ambuja Cement, while Lafarge is present through Lafarge India Pvt. Ltd (LIPL).
The gigantic merger will see three possible scenarios in India: (i) ACC, Ambuja, LIPL will continue to function as independent entities in India. Indirect consolidation will make it a positive for industry if the Competition Commission of India (CCI) approves; (ii) objection by CCI may result in cement assets sale to third parties, and hence neutral for industry; and (iii) LIPL is acquired by Ambuja or ACC (high probability for ACC as it has cash on its books) and CCI approves the same.
While this will be positive at industry level, the deal valuation will decide its attractiveness for the acquirer.
We await clarity from respective companies regarding execution of the merger in India. We maintain our cautious view on the sector due to continued low industry utilisations.
LafargeHolcim-the worlds largest building materials entity: Holcim will issue one share for every one share of Lafarge, valuing the latter at 10x TTM (trailing twelve months) EV/Ebitda (enterprise value/ earnings before interest, taxes, depreciation and amortisation). LafargeHolcim will have presence in 90 countries with a combined cement capacity of 427mtpa (Holcim 206mtpa and Lafarge 221mtpa). The merger, which is expected to be completed by H1 2015, is expected to generate EUR1.4bn synergies per annum after three years.
Three scenarios for India
*The three entitiesACC, Ambuja and LIPLcontinue to function as independent entities in India.
Though Holcim oversees the daily affairs for both ACC and Ambuja in India, the two entities continue to function independently. Similarly, LIPL also may continue to function independently despite the three entities having a common parent LafargeHolcim. If CCI does not object, the merger will see indirect consolidation in Indian market which will be a positive for industry, especially in the east where the combined entity will have major stake (38%) in the regions capacity. This, in our view, is one of the possibilities as CCI recently approved acquisition of 4.8mtpa of JP Associates cement assets in Gujarat by UltraTech. Post-acquisition, the two entities jointly control 45% of Gujarats capacity.
* CCI objects to independent functioning of ACC, Ambuja and LIPL, forces asset sale.
If the CCI objects to independent functioning of ACC, Ambuja and LIPL citing creation of dominant position in eastern region, they may be forced to sell some of its assets. Theres high probability of LIPLs assets being sold, as similar sale by ACC or Ambuja may be objected by minority shareholders. Asset sale to external players will not lead to industry consolidation, and hence we view this scenario as Neutral for industry.
* Acquisition of LIPL by ACC or Ambuja is approved by CCI
The third possible scenario, in our view, is acquisition of LIPL by ACC or Ambuja. Of the two, there is higher probability of ACC acquiring LIPL as it has ~R25 bn of cash on its books. Ambujas cash of ~R35 bn will go to parent company Holcim as part the recent corporate restructuring deal. This acquisition will also require CCI approval. If approved the acquisition will lead to further consolidation in industry (mainly Eastern region) and hence positive for industry.
The deal valuation will determine attracti- veness for the acquirer. We await further clarity from respective managements regarding execution of the merger in India.
Takeaways from analyst
* Merger of Lafarge and Holcim will create a world leader in building materials industry headquartered in Europe.
* A total of EUR1.4 bn of synergy benefits will be generated p.a. after three years. Of this, EUR1 bn will accrue from operational savings (operational optimisation, adopting best practices, procurements and in SG&A expenses) and the balance will comprise financing and capex related savings. Besides, working capital requirement is also estimated to reduce by EUR410m over time.
* The deal will be completed by H1 2015 with the merged entity to be listed on two existing stock exchangesSIX of Zurich and Euronext of Paris.
* The companies are looking at asset sale to meet regulatory requirements of different geographies. Such sale is envisaged to impact revenues by EUR5 bn and Ebitda by EUR0.8 bn (on CY13 basis).
* Existing CEO of Lafarge, Mr. Bruno Lafont will become CEO of LafargeHolcim, while Wolfgang Reitzle of Holcim will be the chairman of the merged entity.
* To diversify risks, no single country will represent >10% of the merged entitys revenue. In our view, the combined revenues for CY13 of all three entities in India were slightly less than 10%; hence theres no risk of asset sale from this perspective.
* Merged entity will have strict discipline on capex, focus on RoCE (return on capital employed) and a higher dividend payout ratio of 30-50%.
We maintain cautious view on Indian cement industry, as despite assuming demand growth of 6/7% in FY15/16, industry utilisations are expected to remain subdued at 74% levels.
We maintain our Reduce recommendation on Ambuja Cement and Hold on ACC.
* Production discipline-led cement price hikes will pose upward risk to our earnings estimates.
* Sharp decline in input cost.