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Monday, August 6, 2007

Cement firms merger will create regional giant to fend off Asian import competition

The Kenya government has received a proposal for the merger of the two largest cement producers in Kenya, Bamburi Cement Ltd and East Africa Portland Cement Ltd, marking the beginning of what could be the most comprehensive restructuring of the cement industry in Kenya in years, with ramifications likely to be felt throughout East Africa.

If the proposal for the merger — which, incidentally, is supported by East Africa Portland Cement — is approved, French cement conglomerate Lafarge, the most influential player in the region with plants in Kenya, Uganda and Tanzania, will have a chance to consolidate its interest in the region.

The new development points to a thawing of relations between Lafarge and the government, which until fairly recently was still pressing the French conglomerate to relinquish part of its stake in East Africa Portland, arguing that its involvement in the shareholding of the three major producers in Kenya constituted a conflict of interest.

Lafarge has a 41 per cent stake in East Africa Portland and a 17 per cent stake in Athi River Mining Ltd even as it retains a controlling stake in Bamburi — allowing it to enjoy a strategically dominant position in the cement industry in Kenya with representation in the boards of all three cement manufacturers.

In Uganda, the French company has a controlling stake in Hima Cement Ltd, while in Tanzania, one of the major cement producers, Mbeya Cement Ltd, is a subsidiary.

The merger is being supported on the grounds that the two big producers have to merge to create one strong East African champion capable of fending off competition from cement exporters from Southeast Asia, India, the Middle East and Egypt.

East Africa currently remains a high-cost cement producer, partly due to high electricity prices, exorbitant freight costs, high fuel costs and inefficient railway systems, but mainly because the market has for many years been sheltered from competition by high trade barriers.

Although cement companies have over the years been making profits, the industry has been protected by both a 25 per cent import duty plus a 30 per cent suspended duty.

The merger proposal is based on the grounds that this level of protection is unlikely to be sustained in the near future. Under the Customs Union of the East African Community, these duties must be reduced to zero by the year 2010.

Indeed, cement manuf-acturing in the region operate with high fixed costs that are linked to the relatively small sizes of cement plants in the region, thus compounding the problem of high production costs.

The consequence has been ever increasing consumer prices of cement in the region, the impact of which has been that per capita cement consumption in East Africa is one of the lowest in Africa.

According to industry estimates, Kenya’s annual per capita consumption stands at 54 kilogrammes; in Tanzania, it is 37kg in Uganda 32kg. South Africa’s per capita cement consumption is estimated at 200kg.

Clearly, the regional cement market is ripe for consolidation. What is surprising is that even in the face of these grim statistics, recent developments show that the cement industry in East Africa is progressively moving away from consolidating.

Instead of consolidating, nearly all individual cement producers in East Africa are acting as if oblivious to the increasingly hostile international environment they have to operate in.

Each of the major players is currently involved in a race to increase its own market share, spending millions of dollars in costly capacity expansion programmes.

In Kenya, medium producer Athi River Mining Ltd has only recently commissioned an additional kiln in Mombasa. In Uganda, Bamburi is progressing with doubling of the capacity of its Hima plant, while Tororo Cement is moving into the Kenya market with plans to erect a clinker plant in Mombasa and a grinding station in Nairobi.

In Kenya, East Africa Portland is spending millions of dollars to enhance its cement production output, while Bamburi is planning a multimillion dollar greenfield plant.

Yet it is clear that even after the completion of the new plants and facilities, the capacities of cement producers in East Africa will still remain small and comparatively inefficient compared with the big exporting facilities of Southeast Asia.

Several other factors are likely to conspire to keep cement production costs high in the near future while eroding the industry’s position vis a vis imports.

First, it is now estimated that ocean freight rates — which are currently at an all-time high, thus providing artificial protection — will drop by $10-15 in the next five years.

Secondly, with Kenya aggressively modernising its Mombasa port and Tanzania developing its Tanga Port facility to include cement import terminals, inefficiencies and delays in East African major ports will no longer provide the local cement producers with the artificial protection they have been enjoying.

Thirdly, all indications are that the three East African economies of Kenya, Uganda and Tanzania are entering a regime of consistently higher power tariffs.

Fourth, industry experts say that big new low-cost producers from the Middle East are planning a new offensive in the East Africa market very soon. They cite the case of Saudi Arabia, which alone is in the advanced stages of completing 18 cement factories currently under construction.

According to industry estimates, the cement plants in East Africa will have to reduce their manufacturing costs by at least $20 per tonne to survive competition from low-cost producers from the Middle East.

This will require production plants to reach a critical size and streamline the location of their manufacturing plants to minimise logistics — the type of restructuring that is only possible if the existing businesses merge.

The current projections are that the merger of Bamburi and Portland Cement will lead to an entity with a market share of 55 per cent in East Africa — especially after Lafarge’s stake in Mbeya Cement becomes part of the merged regional operation.

Industry sources also believe that the merged company will have the financial and strategic muscle to reach into other inland markets including the Democratic Republic of Congo, Rwanda, Burundi and Southern Sudan.

Proponents of the merger also say that with Bamburi’s sound financial standing in the Kenyan capital markets and ability to raise funds, a merger with East Africa Portland can be achieved at a very low cost and without compromising the interests of the government.

Indeed, Bamburi remains the best candidate for the merger with Portland, because no third party can provide the same synergies, especially considering that the respective production facilities of Portland and Bamburi fit into each other as a result of the tight grid of cement facilities in Mombasa, Nairobi, and Uganda.

How is the merger to be effected? Five proposals have been advanced:

First, allow the current shareholders of East African Portland wishing to exit to receive sale proceeds either in cash or shares.

Second, integrate Lafarge’s stake in Mbeya into the new company.

Third, offer a sales premium by maximising the assessed value of East African Portland through the combination of its current value with a projected value generated by the potential synergies with Bamburi.

Fourth, maintain or increase the local shareholding stake in the merged company.

Finally, consider cross listing of the new company on the three East African stock exchanges.

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