Adani-Holcim Deal: Perfect Suitor For Ambuja Cements
Ambuja Cements likely to regain its original mojo and become a growth and cost leader again, writes Rakesh Arora.
Yes, it’s the Adani again and despite the cynicism in some corners, there couldn’t have been a better group to take over the second-largest cement business in India. The best brands have met the best execution capabilities, a strong combination.
The Adani family has signed a definitive agreement to acquire Holcim’s stake in Ambuja Cements Ltd. (63.19%) and ACC Ltd. (4.48%) at Rs 385/share and Rs 2,300/share, respectively, and make an open offer for a 26% stake in both as per the regulatory requirements. The total consideration of the deal is close to $10.5 billion, making it one of the largest M&A transactions in the country.
There is shock and awe about the speed at which this huge and complex deal has been completed. That it took just 2 months tells us a great deal about the appeal of the assets and sharp decision-making by Adani.
Ambuja and ACC are extremely well-run companies known for the quality of their products and command premium pricing above their peers. However, the business under Holcim had stagnated, lacked entrepreneurial drive, and cost overheads had started to creep up. Market share was lost, the operating margin gap to leader UltraTech Cement widened and the stocks got de-rated. Adani comes as a fresh breath for Ambuja Cements , with its sharp focus on growth and strong capabilities in two of the largest cost centres of cement business – energy and logistics.
We are convinced but the street has been raising two important questions, apparent high valuations and the possibility of market share war. Let’s examine their merit.
Deal Value At $162/Tonne: Is That The Peak?
Replacement costs stand at $90/tonne, and the deal has been done at almost 2x that. Does it mean that a large control premium has been paid and there is no upside left? Well, we don’t think so. In fact, building a greenfield project at $90/tonne is equal to buying Ambuja at upwards of $200/tonne due to the high royalty costs on new limestone mines and a strong brand premium.
Holcim’s last effort to repatriate money out of India took more than two years for want of approval from what was then the Foreign Investment Promotion Board, despite meeting all norms. Once bitten twice shy, Holcim’s focus was more on the successful and fast completion of this deal as compared to a maximisation of value. It wanted to avoid twin issues of FEMA regulation and Competition Commission of India approval. Only Adani’s deal structuring avoided both these issues with offshore funding and almost zero presence in the cement business. It is quite possible that the losing bids of the JSW Group and UltraTech could have been at a higher valuation.
Looking at valuations from a profitability point of view, Ambuja is trading at 14.3x on EV/Ebitda on CY22E consensus estimates, which is not far from the average of 13.1x over the last five years. This is lower than UltraTech’s current multiple of 15.4x. Now, if we consider the possible earnings upgrades which should follow the acquisition due to savings in royalty payments to Holcim (at 1% of revenue), the reduction in overheads, and synergy benefits from cheaper coal and logistic costs, there is absolutely no control premium which has been paid.
Would Aggressive Growth From Adani Spark Market Share War?
The Adani Group is known for undertaking aggressive growth to reach a dominant position in a sector. True to its name, in the first press release announcing the acquisition itself, Adani has set a target of doubling the capacity in the next five years. That might sound aggressive, but Ambuja-ACC had already announced plans to take the capacity to 100 million tonnes per anum from the current 66 MTPA and a lot of work has been done. That leaves some 30-40 million tonnes more to meet the Adani target. The group has not been shy of inorganic growth in its other businesses and the Indian cement industry has a big tail that needs consolidation.
Secondly, Adani is not known for predatory pricing to seize market share and with this leveraged buyout, it can’t afford to let profitability fall. It’s too early to worry about market share wars. India’s cement demand is around 350 MTPA and even if it grows at a CAGR of 7%, we are talking about 30 million tonnes of new capacity every year.
So, in the next five years, India will need an additional 150 million tonnes, giving everyone enough space to grow.
The Adanis are new to the cement business, and this is a big acquisition with lots of low-hanging fruits in form of low-cost expansion opportunities as well as cost reduction possibilities. The next two to three years should see them consolidate their position, before embarking on further inorganic opportunities.
The Blue-Sky Scenario And Wish List
After a long time, there is excitement about the prospects of a great cement business that can be built due to the capabilities of the Adani Group. There is a chance to have a combination of cost leadership like Shree Cement and strong branding like UltraTech. It presents a return of the ‘I Can’ spirit at Ambuja Cements, the way it was run before its acquisition by Holcim. In my blue-sky scenario, Adani should follow the script below for value creation:
Phase 1: Cost Reduction And Price Stability: There are multiple drivers to reduce costs by Rs 200-300/tonne. While royalty payments (Rs 50/tonne) to Holcim will stop on its own, Adani should push through a merger of Ambuja and ACC to cut redundancies and release synergy benefits of Rs 300-400 crore. Optimisation of coal procurement, fast-tracking of waste heat recovery power plants, and logistics realignment can save them another Rs 400-500 crore. That means potential savings of Rs 1,000 crore, over and above the consensus estimate of Rs 7,000 crore Ebitda in CY23E. Work towards price stability with peers and help pass through the cost increases and target Rs1500/t Ebitda margin.
Phase 2: Low-Cost Expansion: Ambuja has already lined up slag-based cement expansion in Bhatapara. This expansion will come at a low cost of $60-70/tonne due to a high conversion factor. Beyond this, Adani should put up large clinker capacities in Gujarat powered by cheap renewable power and utilise its network of ports to reach all major consumption centres across the 6,000-kilometre coastline of India. Establish split grinding units near fly-ash/slag sources run by renewable power. Achieve capital costs of below $70-80/tonne.
Phase 3: Acquisition Of Smaller Cement Companies With Large Limestone Reserves: Consolidate the long tail of the cement industry along with UltraTech and create a duopoly kind of market structure.
In conclusion, there is strong potential for Ambuja Cements to re-rate under the Adani group. The stock has little downside given the open offer at Rs 385/share and possible 100% acceptance. If the open offer is successful, there will be hardly any free float left. Even if it is not, all sellers below Rs 385/share would be taken out. UltraTech enjoyed the growth premium and it traded at 19x EV/Ebitda on average in the last five years as compared to 13.1x for Ambuja. Now is the chance for Ambuja to attract some of this growth premium. Should you rush to buy the small cement companies in expectation of further consolidation in the industry? I think it is a bit too premature for this. Will UltraTech and Shree de-rate? Well, a lot of it has already happened, so maybe not too much from here on. Ambuja’s transformation is the writing on the wall, don’t miss it.
Rakesh Arora is Founder, GoIndiaStocks.com. The author has positions in most of the cement stocks discussed in this article.
The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.
Disclaimer: Adani Enterprises is in the process of acquiring a 49% stake in Quintillion Business Media Ltd., the owner of BQ Prime.