Assets going for a song?
The forthcoming new edition of the Global Cement Report will not contain the usual accounts of continued high-level growth and consolidation by traditional global majors, although some of the companies following in the pack may have had some success. The situation is different in China, Brazil and other nations that were less closely linked to the USA and Europe. Unless the previously-established leaders get a new injection of cash and entrepreneurial dash, we may soon see their competitors growing more significantly.
The days of bold and large acquisitions seem long past in the post-meltdown era of world finance. There’s not very much talk of cash flow, liquidity, spreading global presence, diversifying to other building products, creating shareholder value or the other buzz-phrases of recent decades. Rather, it’s back to concentrating on the core business – even though that seems to involve significant asset disposals and only a few selective acquisitions. The largest cement makers are selling off bits of assets, seeking joint ventures and trying to interest investors and lenders in providing them with more cash. What’s behind all this and who is setting the agenda?
There has been a lot of concern about “debt ratio”: debt/EBITDA. It indicates roughly the time needed to pay off all debt, ignoring the factors of interest, taxes, depreciation and amortisation. Credit rating agencies use the ratio to assess the probability of defaulting. A high ratio suggests that a firm may not be able to service its debt and can result in a lowered credit rating. Conversely, a low ratio can warrant a relatively high credit rating. How has this come about? A few years back, companies were being praised for their use of debt to finance operations and increase leverage by investing in business operations without increasing equity – but it does come with greater risk. When a highly-leveraged investment moves against a company, its loss is much greater than it would have been without leverage. Leverage magnifies losses as well as gains. Companies have used leverage to try to generate shareholder wealth, but this strategy fails drastically when the expense of interest payments and credit risk of default destroy shareholder value. Problems become more severe when an existing loan facility needs to be renewed, with banks taking an extremely cautious view of risk, freeing up less cash for lending and setting ever more demanding conditions on the loans that are approved.
Credit ratings play an important part in lending decisions and come from independent agencies like Moody’s, Fitch and Standard & Poor. The graph below shows how the credit ratings of major cement companies have changed over recent years (1). Announcements of ratings changes heavily influence market sentiment, provoking fluctuations in share prices that may lead to instability. Of course, other factors also play a part. Notably, the level and volatility of earnings, positions in the markets where a company operates, geographic and product diversification, risk management policy, and other financial ratios such as that of cash flow-to-net debt. A key factor may be the company’s ability to generate sufficient cash flow to cover debt repayments. At the start of 2008, all the companies were classed as “Investment” grade, but things started to change near the end of the year – drastically for Cemex and HeidelbergCement, who soon ended up deep into “Non-Investment” grade territory and so became ineligible to receive funds from a good number of institutions. These companies are the main providers of headlines about renegotiated loans, bond issues and asset disposals, along with Lafarge which has stubbornly remained close to the bottom of the “Investment” grade scale, below its most highly-rated peers – CRH, Holcim and Italcementi – and on negative watch.
(1) To create the graph, alphabetic ratings from Moody’s (Baa, Ba and B) have been replaced by numbers (3, 2 and 1, respectively), so that the best ratings lie near the top of the scale. In two cases, gaps are filled by ratings from other agencies transposed to Moody’s scale.
Just what is the story behind these figures? Some key events are listed in a table below. The origin of the changes lies in acquisitions made just as the global credit crunch approached and the continuation has been helped by special factors peculiar to each company.
• Cemex acquired RMC (UK) in 2005 for US$5.8bn and Rinker in 2007 for US$14.2bn
• HeidelbergCement took over Hanson (UK) in 2007 for US$15.8bn
• Lafarge acquired Orascom (Egypt) in 2008 for US$12.9bn
Following the global financial crisis, a slump in established markets hit the income from sales for everyone. Consequently, the sources of the funds used to finance the deals came under scrutiny. Questions were raised about the dates of maturity of loans, over-reliance on short-term debt and the possibility of default unless shareholders could provide back-up or new bonds or equity could be successfully sold in a chaotic financial market. Credit ratings dropped and corporations were put on negative watch. With EBITDA falling, companies had to be seen to be succeeding with asset sales to repay loans or risk further downgrades in credit rating – downgrades that would break covenants with investors and invoke additional financial penalties.
Good ratings are essential if new capital is to be brought in at attractive terms. Agencies also advocate cuts in shareholder dividends to keep in funds to repay loans, but these have been slow to emerge.
After initially continuing with some acquisitions and internal capital spend, all three companies started on disposals, often at bargain basement prices. Promises are still made of more of the same to follow through 2011. Specific targets are given, even though companies claim – perhaps unrealistically – that disposals will now only involve non-strategic operations and will not be cut-price. Furthermore, investment in ongoing operations has been cut right back and, as a consequence, profits from a market upturn will be less than would otherwise have been the case.
A summary of divestments, based on figures reported in the media, are listed below (and don’t take into account the debt involved in transactions or precise adjustments for varying exchange):
• Cemex (initial acquisitions US$20.0bn) will have divested assets totalling US$2.9bn (forecast) from 2008 to 2011
• HeidelbergCement (initial acquisition US$15.8bn) divested assets totalling US$2.8bn from 2007 to 2009
• Lafarge (initial acquisition US$12.9bn) will have divested assets totalling US$4.8bn (forecast) from 2008 to 2011 Why so much more for Lafarge? The disposals are approximately equal to the current EBITDA, the divisor in the debt ratio, viz.
Ultimately, the groups that were less aggressive in acquisitions a few years ago, whether by design or chance, have already benefited from snapping up some attractive disposals. These groups now look better set to prosper in the short term from positive market trends and opportunities for acquisitions to grow their businesses.
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