Ambuja-ACC deal: Cost synergies seem to justify premium deal valuation

But, whether players maintain discipline or turn aggressive on pricing as new capacities come on stream will be crucial

The Adani group’s deal to buy Ambuja Cements (ACEM) and by extension, ACEM’s stake in ACC has triggered open offers for additional stakes in both companies. The deal, including open offers, should be worth something more than $10 billion and given the approximate 73 MTPA of capacity, the valuation would work out to around $170-180 per tonne. MTPA is million tonnes per annum. The deal is going through at around 8 per cent premium to market price. Given the deal ramifications and the open offers, it will take about 6-9 months to complete the formalities.

The Adani Group therefore becomes the second-largest player in the cement sector with UltraTech (114 MTPA) remaining the market-leader. The Ambuja-ACC combine has a pan-India footprint and around 12 per cent current market share. Adani is believed to be considering either brownfield or greenfield capacity expansion, doubling capacity over the long-term. Current capacity utilisation is around 80 per cent so, it cannot aggressively increase volumes without increasing capacity.

Obviously the deal changes the dynamics of the cement sector or rather, it will change by the end of the current fiscal. Adani should be able to generate cost-cutting through merger synergies since the group has a big presence in power, coal, logistics. Given that these are all big cost heads in cement manufacture and distribution, the group could improve margins by cutting costs. It is also conceivable that the Adani group could also look to move into construction-heavy infrastructure sectors such as roads to ensure offtake for this new cement capacity under its belt.

On calculation suggests Adani could gain Rs 125-150 per tonne synergy benefit from a formal merger of ACC-ACEM and it will generate Rs 50-60 per tonne savings since it would not need to pay existing royalty payment (1 per cent of sales) to Holcim. In addition, it could probably cut power and transport costs.

How Adani funds this deal – the cost of financing it – will presumably drive the strategy. The group doesn’t have a great deal of free cash-flow due to being in long-gestation, low-margin businesses. Will it look for market share, or for price realisation?

The valuation per tonne for ACEM and ACC is significantly higher than that paid in earlier deals. Back of the envelope calculations suggest that EBITDA per tonne would need to improve significantly from the current levels of just over Rs 1,000 per tonne to justify the valuations Adani has offered to pay. UltraTech for example, has an Ebitda margin which is around Rs 1,300, so this may be achievable.

While it could hope to claw out more market share, it cannot do that by fighting a price-war without damage to the P&L account. In the long-term, capacity expansions could help Adani win market share but a price war would not seem rational.

Other cement companies are also increasing capacity so we could have a scenario where prices soften, unless there’s a big pickup in cement offtake. Right now, the only serious driver is public infrastructure spending and given Budget deficits that cannot be increased much. A pickup in private consumption could help with demand but that depends on improved macro-economic variables.

Market response to the deal will be clearer in the next few days as we see the impact on the share prices of other cement companies. As of now, investors don’t see a threat of price wars.