Two European giants with global reach
For a change, this month’s mega-merger announcement does not involve American or Asian heavyweight players, but rather two giants in “old Europe”. It is not about social media, high-tech or software, and will instead rock an industry which has none of that glitz and glamour : cement.
Having flirted together but failed to reach a deal 18 months ago, the world’s two biggest cement producers (by value) are set to blend, in what is described as a merger of equals (after all, cement is cement …) as Holcim intends to acquire Lafarge and become a global giant with an annual turnover of 32 billion Euros.
A feast for the anti-trust regulators
Once combined, Holcim and Lafarge would have operations in 90 countries. This would not be the first time an industry’s two largest players are allowed to merge after letting go of some assets, as did Guinness and GrandMet in 1997 to form Diageo, but the approval of that merger required some seven months of deliberations by regulators across the world.
Holcim and Lafarge expect to be under scrutiny in at least 15 countries. This is unlikely to be a casual routinely exercise, because the cement industry has a long history of collusion and price fixing, acting as a cartel in many countries, and both Holcim and Lafarge are among the cement producers being probed under an investigation launched by the European Commission in 2010 which is still open. In that context, important concessions will need to be made to the regulators if the deal wants to have the remotest chance of closing by the beginning of 2015 as Holcim and Lafarge predicted in their announcement.
Those sacrifices are already part of the merger scenario; a Lafarge spokesperson confirmed that up to 15% of the new group’s assets might be divested to secure the anti-trust authorities approval of the deal. Two-thirds of those disposals are likely to occur in Western Europe where the overlap between the two merging companies is the most significant. Compared to shutting down plants, selling production plants to competitors avoids massive lay-offs and also reinforces competition on the market: this is evidently something that will be perceived as positive by European authorities.
However, Western Europe is the area where cement over-capacity is at its worst and the market’s growth prospects are dull. In that context, the pair’s disposals might only fetch a very low price, and if that divestment programme does not generate the projected 5 billion Euros, the business case of the merger could be quite seriously affected.
An ambitious business case
Some of the rationale for the Holcim-Lafarge merger makes eminent sense, but other components of the business case will require a real tour de force to be achieved. The merger announcement failed to cause much excitement on the markets, even though the share price rise both Holcim and Larfarge have experienced – oscillating mostly between 5 and 12% – reveals a degree of interest from investors.
Cement is bulky, heavy and of low value relative to its weight. The market catchment area for any given production plant is therefore quite limited as transport costs rapidly outweigh economies of scale. The positive side of this is that cement is one sector in which mature economies are not likely to be invaded by Chinese production, even if China now accounts for more than half of the world’s cement consumption. A producer’s geographical spread is therefore a key factor. In that sense, Holcim and Lafarge complement each other particularly well in the fast growing economies, as the former is strong in Latin America and Asia whilst the latter is well positioned in Africa and the Middle East. The pair believe that the lower risk and business fluctuations resulting from better geographical spread will reduce their borrowing costs, thereby generating annual savings of some 200 million Euros.
Holcim and Lafarge believe they can save an annual 1.4 billion Euros three years after merging, which together with to the above-mentioned saving in financing costs would include 340 million on procurement and 250 million on sales costs, to mention just the key savings areas. If they can manage that it will be quite a remarkable achievement considering their heavy involvement in France and Germany, two notoriously inflexible labour markets in which change can be slow and costly to implement.
Does the “value magic” reside in transforming the industry?
Beyond the promise of operational and financing savings, two components of the rationale for the Holcim-Lafarge merger are quite hypothetical at this stage but are potentially the most significant generators of economic value in the longer term.
Firstly, it takes a real mammoth to fight the growing competition in some of the world’s rapidly growing markets, such as China where Anhui Conch became the world’s largest cement maker last year (by volume, not by value), or Mexico’s Cemex, currently the world’s Nr 6 but growing on the fast lane to overtake its rivals.
Secondly, and this is the more exciting aspect of the merger, the pair’s combined marketing nous and R&D capability has the potential to revolutionise the market with the launch of innovative products which would transform the image of the industry, until now only too similar to the physical attributes of the product : rigid, grey and dusty … Maybe cement can really be more than cement: Lafarge in particular has developed products whose improved specifications justify higher pricing and elevate cement above its current commodity status, such as fast drying cement or even cement which can set under water. Variations in tone, texture and appearance are also on the cards, and with this comes the potential – and the expectation as far as Holcim and Lafarge are concerned – to play an active role in the evolution of architectural design and advise architects in their choices of these innovative materials.
Conceptually and intellectually, this is quite an appealing and exciting challenge, but it is difficult to imagine such transformation within the next three to five years in two companies which until now have relied mostly on size and hegemony (and some times price-fixing when the going became too tough) rather than being agile and capable of re-inventing themselves by adding a service veneer over their heavy industry core.
Another fascinating business case commences for future business school students. Let’s watch the next moves and allow three to five years before the jury delivers its verdict. We may be in for a good surprise.