Last week Dangote Cement (DangCem) announced that it is in talks with PPC of South Africa regarding a potential acquisition of 100% of PPC’s share capital. Although full details of the offer have not been provided, reports indicate that the offer consists of cash and DangCem shares. DangCem’s offer comes in the aftermath of a rejected bid from Afrisam and Canada’s Fairfax which sought to purchase 22% stake in PPC for US$154m.
Following the announcement, DangCem’s shares shed -4.3% compared with its prior week close. Given the multinational scope of PPC’s operations, we believe that DangCem’s key motivation for the deal is the immediate exposure to about six different countries (in Southern, East and Central Africa markets); PPC provides access to additional capacity of around 11.6million metric tonnes (mmt). In addition, being the largest cement producer in South Africa, we believe that the scale of PPC’s operations in South Africa – 7 plants with estimated capacity in excess of 8mmt, which is much larger than the 2.8mmt of capacity currently owned by DangCem – is a big incentive for the deal.
Apart from being a mature market with declining to flattish unit volume growth, the average realisable price of cement in South Africa is around US$70 per tonne compared with US$130 per tonne in Nigeria. Based on read-across from both DangCem and Lafarge Africa which both have operations in South Africa, EBITDA margin for South Africa at around 10% is significantly lower than those of their Nigerian peers which stand at 24.2% and the 50.5% (2017E EBITDA margin) for Lafarge Africa and DangCem respectively.
We forecast DangCem’s 2017E group sales at around US$2.3bn. As such, group sales for the new combined entity could be close to US$3bn (PPC’s estimated sales of around US$700m). We believe that the sell-off in the shares likely reflected investors’ concerns around the potential for margin dilution given that PPC’s 2017 EBITDA margin of 21.4% is much lower than the 41.8% that DangCem delivered for 2016.
Assuming DangCem acquires a 100% equity stake in PPC, it will have to issue around 1.3 billion additional shares assuming a direct share swap is made based on PPC’s current market capitalisation of around US$761m. This excludes any premium or goodwill. On that basis, we estimate a potential EPS dilution of around 7% to the combined entity’s 2017E EPS. Given there are other interested parties, we believe the market would react even more negatively in the event that Dangote bids aggressively.