There has been a definite trend towards consolidation in the Indian cement industry. But often, these deals – both overseas and domestic – have actually resulted in value erosion. ICR takes a closer look at the dynamics behind the trend towards consolidation.

Over the past century, the cement industry in India has now reached a stage where it has become the second-largest producer of the commodity in the world. The country now accounts for approximately 6 per cent of global production.

Along with rapid growth, the Indian cement industry has witnessed a number of major M&As over the years. In fact, out of the top five largest deals announced in 2016, two were in the cement space.

Over the past three years, seven major M&As have been announced or completed in the cement sector, involving total capacity of 41 million tonnes (MT), or 10 per cent of total installed capacity, with a value of $4.3 billion.

Hunger for consolidation
If the scale and urgency of this phenomenon sounds rather unusual, it may be worth rationalising that the desire to consolidate has always been driven by the ultimate goal of acquiring more and more pricing power. In fact, one could call this trend as an "unending hunger" for concentration.

We have in the past critiqued this trend of consolidation in the context of the great big global cement merger of our times – between Lafarge and Holcim. On 7 April 2014, the global giants merged to create LafargeHolcim. The merger was the second largest announced in 2014, with the combined entity commanding a market cap of $50 billion at that time.

The deal, according to a statement issued by the merged entity, was expected to save the company ??.4 billion and create the "most advanced group" in the building materials industry.

But the combined entity has been beset by a sagging stock price, management departures and disappointing earnings. Lafarge and Holcim combined with the promise of more than $1 billion in annual cost savings, giving them an advantage over rivals after a global recession eroded demand for building materials.

So do these global – and domestic – mergers actually engage in the act of value creation? The jury might be still out on this issue, considering the nature of cement as a commodity.

In fact, the Indian cement industry was at the receiving end after its robust expansion drive between 1995 and 1997, when 40 million tonnes (MT) of capacity was added, compared to the overall production of over 140 MT. Survival of the fittest
In fact, it is not the biggest companies that will thrive, but the "fittest" who will survive. In addition, such massive mergers routinely chase mirages of value creation through blindsided cost-reduction measures, and therefore, while being dubiously beneficial to shareholders, these are certainly value destroying for other stakeholders like customers and employees.

Value erosion
Markets are unforgiving examiners of companies’ performances and even factor in the expected outcomes of management actions being planned. So, leave alone employees and customers, even shareholders have given an unequivocal thumbs-down to this particular merger. What this essentially means is that there is a confidence deficit in the ambitious cost -reduction plans announced by the management during the merger.

The case for consolidation
In India, it takes a considerable amount of time to build up greenfield capabilities, and there is an average gestation period of around three-four years before a cement company even breaks even. Ergo, acquisition of smaller players in a fragmented industry has been considered a viable option by industry players. Again, the Indian cement industry is cyclical in nature. Production reaches its peak in March, and touches rock-bottom in August and September. Though there was consolidation by domestic players starting in the mid-1990s, it was only in the late 1990s that foreign players entered the market. By 2005, leading global players who had entered India included Holcim Group, Lafarge, Italcementi SpA, among others.

But this major capacity addition has come with its own share of woes – increased production and lack of consumption, markets being flooded with excess capacity, and many companies in this space struggling to remain viable.

Therefore, there are many arguments that can be fleshed out both in favour and against this trend of consolidation. The lesson for all stakeholders is to watch these moves very carefully, and not get carried away by hyperbole of any kind.

There is however, one positive development supporting the appetite for consolidation in the cement sector in India. The government has gone the extra mile by amending the MMDR Act to give space to cement mergers by allowing transfer of mines obtained through non-auction routes, and make some extra money on the side. This might help cement players in their unending pursuit of consolidation, but the hope is that the Indian cement industry also helps customers get better products and services.

The Global Scenario
According to a report published by McKinsey & Company in December 2015 and authored by Michael Birshan, Thomas Czigler, Siddharth Periwal, and Patrick Schulze, the global cement industry could be at a "turning" point.

The report cites the performance of industries from aviation to financial services, where "big" has been considered to be "beautiful", over the past five decades, and the cement industry seems to be mirroring the trend, at least for the process under review.

"A rush of expansions, mergers, acquisitions, and consolidations has reshaped the industry. The model has not necessarily created value for companies or their investors. In pursuit of growth, they often overpaid for acquisitions, constrained their balance sheets, and were insufficiently disciplined in capital and operational expenditures," says the McKinsey report.

As a result, the global cement sector has had an erratic value-creation history. Recently, demand growth has shifted to emerging regions where urbanisation has been creating opportunities for regional companies to shine. A promising outcome of these developments has been the emergence of value-creating regional champions, according to the report.

The authors say that multinationals are now in the thick of the M&A game. But as ICR has argued, recent consolidations among top players raise important questions (See Box-3).

Globally, the highest-performing cement com-panies in the top quintile capture almost the full economic profit of the industry, whereas the next 60 percent of companies (quintiles 2 to 4) create returns just above or below the cost of capital.

Since the early 2000s, as emerging regional economies have become more important to world markets, a new type of cement player has come to prominence in Africa, Asia, and Latin America: the regional champion. These companies drew their original strength from a robust footprint in one country; they were then able quickly to expand to capture leading positions regionally.

But compared to regional players, multi-nationals have significantly higher capital invested in goodwill and intangible assets – these could be dubbed as "premiums paid for expansion through acquisition," according to the consulting company’s rationale. These investments were "made at peak prices" and "have not paid off", says McKinsey, dubbing this phenomenon as a "common story in cement-industry M&A."

Again, MNCs tend to overshoot budgets and overspend on new cement plant construction. Obviously, the means that these projects must thereafter struggle to provide decent returns.

Like we said, the jury is still out on whether consolidation and M&As will help the local – and global – cement industry. The trend will surely continue in the years to come – but stakeholders would be well-advised to go over these spectacular deals with a fine tooth comb.

Top M&A deals in the Indian cement industry during 2016
Dalmia Bharat-Odisha Cement (Value: $2.54 billion)
Dalmia Bharat Ltd and OCL India Ltd (OCL) obtained approvals from their boards to merge the two entities in November 2016. This deal created the fourth-largest cement maker in the country, with an installed capacity of 25 million tonnes (MT) per annum. Initial estimates at the time of the deal pegged the total revenue of the merged entity at around Rs10,000 crore. Dalmia Bharat holds 100 per cent in Dalmia Cement (Bharat) Ltd, which in turns owns 75 per cent stake in OCL India Ltd.
At the time of the deal, it was announced that shareholders will receive two shares of the merged entity for every share held.
Jaypee Group-UltraTech Cement(Value: $2.38 billion)
In July 2016, UltraTech finalised a deal to acquire Jaypee Group’s cement assets in Uttar Pradesh, Madhya Pradesh, Himachal Pradesh, Uttarakhand and Andhra Pradesh. The deal included a 4 million tonne per annum grinding unit, which is currently being constructed in Uttar Pradesh.
The agreement helped UltraTech to boost its cement capacity to 91 million tonnes on an annual basis.

A few major issues impacting the need for consolidation:
Companies using acquisition to stall the entry of foreign players;
The role played by cartels in a market;
The need for geographical proximity to the consumer;
Entry of major foreign players and change in acquisition values.

Consolidation: The Major Questions
Will value creation continue to be elusive in this new round of consolidation? Can the industry’s largest competitors learn from the experience of the regional companies in creating value through growth? Can big be beautiful beyond the local level? And if it can, what can be learned from successful companies?
– Source: McKinsey & Company

Reshaping the industry

Four strategic levers to create value
Strategic lever 1: Active rebalancing to create an attractive portfolio
Strategic lever 2: Improving the M&A engine
Strategic lever 3: Choosing a winning business model
Strategic lever 4: Capturing the benefits of scale
– Source: McKinsey & Company

– DEVARAJAN MAHADEVAN