HOLCIM LAFARGE MERGER: WILL THIS HAPPEN IN INDIA MARKETS ALSO ?

Global Cement giants Lafarge SA of France and Holcim of Switzerland have announced

their intention of merging their global operations under one roof to be named as LafargeHolcim which together will control 427 mtpa of cement capacity globally with a big focus on emerging markets contributing 60% of combined entities CY13 revenue of USD 43 bn.

The main reason for this deal was because both Lafarge and Holcim have been suffering from high debt burden because of their ill timed investments. The two entities together are sitting on a massive debt pile of ~USD 25 bn with combined Net Debt:Equity ratio of 0.57x and Debt:EBIDTA of 2.93x.

Both the companies stacked up sizable debt to expand globally but the bets backfired as housing market crashed in the U.S. in 2008, followed by a equally large problem at their home markets led by the European sovereign debt crisis, which had impacted core markets.

In 2008, Lafarge had bet heavily on the Middle East market by buying up Egyptian company Orascom Cement for USD 14 bn. Similarly Holcim had acquired aggregate Industries in 2005 for USD 4.1 bn and invested heavily for entry in Indian markets at the same time. Hence Lafarge was further hit by the upheaval in Middle East in 2011 while for Holcim return from Indian operations started dwindling in the same period

We believe the consolidation of operations of both companies under one entity will enable the companies to unlock significant synergies, increase cash flow generation to de-leverage balance sheet and re balance their presence in emerging markets.

The potential merger of the two global giants will also reshape the level of consolidation in India. If eventually Holcim and Lafarge do merge their operations in India as well, the top two groups (LafargeHolcim and Ultratech Cement) will control 35% of total India capacity.

What does this merger mean for Indian minority shareholders?

If the combined entity proposes to merge all India operations under one roof Lafarge Holcim, it will have a massive 70 mtpa domestic capacity that would be higher than Ultratech Cement 57 mtpa capacity and a better regional distribution with only 14% exposure to supply surplus southern Region vs 22% for UltraTech.

However the visibility of consolidation under one roof remains yet low and not very sure as Holcim has still not provided any clarity on merging operation for its current operation under ACC and Ambuja.

Also no open offer likely for Indian minority shareholders

Since the two entities are executing merger where in Holcim will be issuing shares to Lafarge shareholders, there would not be any change in management control for the Indian entities. And hence there is unlikely to be any open offer for shareholders of Ambuja Cement and ACC

Another possibility is that Lafarge India might remain the unlisted arm of the global entity

We expect that LafargeHolcim might not necessarily combine Lafarges India operations of 10.5 mtpa with the existing Holcim entities under ACC and Ambuja Cement. In which case the structure would be detrimental to the minority shareholders of ACC and Ambuja Cement.

We believe the global merge of the two cement giants under LafargeHolcim will reshape

the level of consolidation in the India Cement landscape and as highlighted earlier the 3

regions i.e. East, West & North are likely to see firm pricing power.

As the top 2 groups in India (LafargeHolcim and UltraTech) have a significant 70% of their volumes coming from these regions, we expect these big players to benefits from this firm pricing power in these regions.

Pricing Power: Eastern & Western the traditional price premium markets to remain attractive

Traditionally Western and Eastern regions have been fairly stable and premium pricing regions as low limestone reserves meant that minimal presence of minor price spoiling smaller player leading to very high consolidation and control by top 2-3 national players.

The potential merger between Holcim & Lafarge would mean that the top 2 groups will control 60% of the regional capacity. We believe that these two regions will continue to remain premium pricing market

Net net in conclusion we believe that while a merger of all indian companies is not expected in the near term, it is likely to happen once all regulatory hurdles are managed and more importantly after getting approval from the CCI (Competition commission of India) as this will impact pricing power quite significantly in the cement sector in the medium term.

As far as cement stocks are concerned we continue to remain positive on ACC, Ambuja Cements and Shree Cements in the large cap space.