There are more sellers, fewer buyers in cement space: Dalmia

The big deal inked between Jaiprakash Associates and UltraTech Cement has put the spotlight on cement as a sector to bet on.  The sector has seen some action in the form of Reliance Infra selling assets to Birla Corp, too.  The deal street is also very attractive with new entrants having deep pockets. Nisha Poddar of CNBC-TV18 was joined by Puneet Dalmia of Dalmia Bharat, Anil Singhvi of Ican Investments Advisors and Vikram Hosangady of KPMG to understand the big deal between JP Associates and UltraTech Cement, and other deals in the offing. Below is the verbatim transcript of Anil Singhvi, Puneet Dalmia and Vikram Hosangady's interview to Nisha Poddar on CNBC-TV18. Q: What is it that is driving the aggression to acquire at a time when globally per capita cement consumption is declining in the developed markets? For the Indian cement companies, is it a race to command influence and dominance as far as pricing is concerned and also the fact that we have to grow to sustain in this industry? Dalmia: As far as the global players are concerned, very few of them have the management resources or capital to focus serious resources towards India. If you look at Indian companies, UltraTech Cement has been an acquirer. We have been an acquirer and currently the whole demand/supply situation is loaded in favour of buyers. There are more sellers and less buyers and after the JP deal, I think Ultratech also has done a fairly serious commitment to this sector and I think they would probably pause for sometime unless they find something which is extremely strategic. As far as we are concerned, we have also made some significant capital commitments over the last few years and we are currently focused on integrating our acquisitions. So unless something is very strategic, I don’t think people are going to spend too much money at this point in time. Secondly, the market expectations as the economy is reviving has the demand/supply situation of cement turns favourable, the asset valuations are running ahead of what the cash flows are. Q: If you are saying that there are more sellers than buyers then probably that supply/demand scenario will take care of the valuations dynamics, but Puneet Dalmia is voicing what all cement buyers have been saying at this point in terms of valuations. Are they two high, you have headed a large cement company, what is it that you assess the valuations on? Singhvi: Valuation is a matter of two factors. One is that you are buying a cement asset versus you are buying a cement business. In case of Lafarge, what is under offer is a cement business. So there is a difference, there is a huge value for cement business versus cement asset. Secondly, the location -- if you are located in an overflowing market like Andhra Pradesh, even somebody is paying USD 100 will look very high pricing but in the eastern market, USD 125-130 because it is a consolidated market, you have 10 million tonne play offered by Lafarge, you have a business offered by Lafarge, obviously it will be USD 125-130. In case of Ultratech, it is a mixed basket, you have some assets in north, some assets in Central region and some assets in Andhra. So when I look at the average of the three, USD 120 is a good pricing. So I think the pricing is a mechanics of both, asset play and which geographical location you are but my sense is that between USD 105 and USD 110 is what the replacement cost is. What value you are going to pay, what premium you are going to pay, on top of it will depend upon what kind of assets, what kind of business you are buying. So metrics will be between USD 120 and USD 150. So to compare Ultratech with Lafarge we will be comparing to some extent apples with oranges. Q: Of course these two deals are not totally comparable as you have said but what about brand value and the captive mining reserves? How much of valuation of these two factors really come into play? Singhvi: Limestone definitely yes, because it is a critical raw material. Limestone acquisition which was earlier by way of more of an allocations by the state government will go through the auctioning process. However, your proposition on the brand and I have a situation here like in case of JP it has being brought by UltraTech Cement. So, JP brand will be killed because UltraTech is not going to be use the JP brand, nor JP will be allow UltraTech to use that brand including Lafarge. So, Lafarge is also not selling the brand along with it so whosoever is a new buyer will have to really work around the brand. So, there is no brand premium in these two. However, tomorrow if there is any company like Ambuja Cements or ACC whenever these companies got sold to any other company which has a huge brand and that brand can be used by the buyer for all the time to come like Ambuja is being used or ACC is being used by wholesome they will definitely be a premium for the brand. However, these two assets definitely does not have any brand value because these brands are not transiting to the buyer. Q: How do you analyse and compare the recent deals in terms of the valuations? On a dollar per tonne basis remember the current JP – UltraTech deal is seen at around USD 117 per tonne and the last one was also around those similar levels? Hosangady: If you look at valuation and the key drivers for it one is clearly the size of the asset. If you look at an asset which is above 10 million tonne the valuation will be quite different from something that is 3-5 million tonne. 3-5 million would typically have a scarcity premium, they would be far more numbers of bidders. Above 10 would call for a very different kind of asset class. That is one key factor. The second factor is geography, where are the plants located, very important. What is the demand-supply in that region? Because that will determine pricing in the future so, if you look at the east today, the east is widely regarded as most attractive market and profits margins are quite high. That is because supply hasn’t caught up with demand. Now if some of the Brownfield, Greenfield plants do come up then prices in that region could also come off. Again, I think it is critical to see which region the plants are located. Then of course the question is consolidation. If today an international player is not in the market please remember most of these international players are currently in markets where there is no growth and they have no choice but to be in emerging markets like India. China they already have a presence or in Africa - Latam. So, to that extent the scarcity premium will also drive up valuations. Q: What is it that Dalmia Bharat is eyeing at this point? Is it in terms of geographies or just expansion of capacity, what is it that you require? Dalmia: We can’t share our detailed strategic criteria but all I can say is that one of the things which is very important is that we should be able to have good synergies with asset that we buy. We must be confident that we are getting an asset which is in a market which is stable and which could potentially offer good growth over a long-term. Q: When the competition commission had barred Dalmia Bharat from participating from the LaFarge deal. You contested that in the court. You think the regulation is too restrictive for deal making for the country?Dalmia: We had a difference of opinion in how the law was applied and interpreted by the commission and we wanted to participate in this M&A process but the regulator felt that people who have five percent market share in eastern region should not be allowed to bid for this asset but then when the scope was enlarged we felt that we should be allowed to participate in the new scope but then it is fine. There can always be healthy difference of opinion. There can be healthy debates and ultimately the law evolves based on such debates.Q: So, what happened finally, why did you withdraw your plea then?Dalmia: We felt that the whole process was getting held up and ultimately if we go into the finer details of the change in the mining act mining leases are allowed to be transferred but the prospecting licenses are not allowed to be transferred and some of the assets which we were interested in, in Lafarge-Holcim we found out later while closely scrutinising the law that prospecting licenses are not allowed to be transferred and hence if you have an asset sale instead of share sale some of those assets in which we were interested in would become unviable. Hence we thought that it is prudent not to hold up the process and withdraw.Q: There are many regulatory aspects that you have mentioned. One of course is the competition commission's role and the second one coming into the MMDR Act which has been amended. But there are still certain issues there. What is your point of view?Singhvi: I will touch upon this regulatory framework which you talked about and I will talk more about competition commission here. The Competition Commission of India (CCI) as far as cement is concerned is an evolving process. I don't think they have really been able to put their viewpoint very clearly. In case of LaFarge one saw a very flip-flop situation. They wanted to have first 5 million tonnes to be sold out. They put the same condition for 10 million tonnes which does not make any sense. Why did you prevent many other buyers of LaFarge in India by putting the same set of conditions.So, CCI hasn't been able to really put their act together as far as cement is concerned. They have been to a very large extent very impulsive and many time wrong decisions have been taken on that. I wish and hope CCI really does a good job going forward in looking at transactions like Ultratech and all that and apply their mind on it that is it really creating a concentration of the capacities and can you have abuse of oligopoly or monopoly. In India monopoly will never happen but even oligopoly on that.With Mr Piyush Goyal now being the mines minister he needs to apply his mind and same situation should be there for the states. When you look at it how limestone mines will get transferred from seller to a buyer and they should not create so much of regulatory hurdle and try to make money out of transfer of those assets by permitting those because then the whole game will be completely different situation. You are again having errand seeking situation by the state which is not really needed in the current environment particularly for an asset like cement. Power is a different play than cement. Limestone is not such a big and critical raw material as coal is.Q: So far the Indian companies have done far better than the foreign strategic in the cement deals that we have seen. What is it, more aggression by the domestic players or do you think that the regulations make it difficult for the foreign players to commit quickly?Hosangady: For the foreign players it has been a situation where some of them have lost out on price, some of them perhaps believe that this was not perhaps the right time to invest in India. So, a combination of that. And in fact some of them also had trouble globally. Many of them had stressed balance sheets themselves. So, their ability to pay up was a challenge. Having said that in the recent past we are seeing lot more interest that has come back. And it is players not just in Europe, we are seeing players from Latin America, we are seeing players from China and the like. So, it would be fair to say that the international community is very actively looking at cement assets today.Q: How do you see the entire consolidation going on going forward? Do you see enough action in the smaller cement players as well?Hosangady: So the current deals in play have been about 10 million tonnes which would classify them as large deals, but we do expect activity in regional states and these would typically be between 3-8 million tonnes. Will they be interest definitely there would be consolidation plays, would it mean international players will come in, maybe not because I think most international players would like to buy it plants of at least 8-10 million metric tonnes and clearly small regional plays may not be attractive for them.Having said that domestic players or even private equity players could potentially be buyers, in fact, we believe private equity players could be creating platforms that roll up some of these regional plays and then make a fairly sizable business for sale in the next 4-5 years.Q: How much is your company going to participate, is it going to be active on the deal street?Dalmia: Over the next 12-18 months deleveraging consideration will play a very important role in further driving M&A activity, banks still have many non-performing assets (NPAs) to handle and steel, power, cement these are three sectors where they have assets were debt is too high and there could be potential opportunities driven by high debt.Q: You know the industry in and out, more scope for deals you think?Singhvi: I think the consolidation has been going on, in fact, if you look at last 10 years how cement industry has really evolved, there has been considerable consolidation. Today, when I look at Ultratech it’s almost 100 million tonnes plus if you include Century’s cement assets which are by and large in the same fold of Kumar Mangalam Birla, so there is a fairly good amount of consolidation, the first two players that is Holcim-Lafarge and Ultratech put together is about 50 percent of the cement capacity in India which is fairly good.Now you have a very clear situation where you have first two players holding almost about 50 percent, then you have the second tier companies like Dalmia, Shree Cement and all that those are around 25 million tonnes, so I think there is a very good if you look at 10 year perspective. I think there is a very, very subtle but definitely in right directional consolidation in the chain which is happening in cement and which augurs very well when you look at next five years how cement demand will really pan out versus what capacities which are there in pipeline, so the consolidation will definitely help cement players, the larger players to take benefit of good demand, good capacities under their command and sweating the assets.The important factor here is that the capacity utilisation in the industry is just about 70-72 percent. I think it is likely to go up to 80-85 percent which is what I believe is the peak of this. Industry hasn’t seen 90 percent capacity utilisation ever because there are many plants who have very inflated capacities, so when you look at the broader structure and frame of the cement industry it looks very, very interesting.Q: Now that we have seen so much interest in the cement industry and the assets here. Some of the Indian guys have really warmed up, now do you think that some of them maybe left high and dry because everybody will not manage to buy and satiate their hunger for buying out these assets, so don’t you think that Indian company would be venturing overseas as well?Hosangady: I think you make a good point. If you look at most of these groups today, they are looking at other emerging markets, in fact, if I look at 3-4 years back many of these groups were very interested in Africa, the Middle East and Latin America and there were a situations where some of them had participated in a bids, I think that’s going to comeback clearly, so I would imagine that countries in Africa, the Middle East again I think the recent strife has not helped the cause, but clearly these are geographies that the group you mentioned would be actively looking at in terms of asset plays.