Case: Cemex S.A. & P.T. Semen Gresik - uni- · PDF file- Multinational Capital Budgeting...

Professur für BWL, insb. Internationale Wirtschaft Cases IIInternational Financial Management Folie 1

Case: Cemex S.A. & P.T. Semen Gresik

- Multinational Capital Budgeting -

-International Acquisitions and Valuation-

- Political risk -


1. Overview 2. Multinational Capital Budgeting3. International Acquisitions & Valuation4. Lessons Learned From The Case


1. Overview2. Multinational Capital Budgeting3. International Acquisitions & Valuation4. Lessons Learned From The Case


Objectives

• Understand… basic principles of multinational capital budgeting… how to use valuation techniques for international acquisitions… significance of political risk

• Learn … how to evaluate investment opportunities abroad... how to adjust for risk... how to align an international expansion strategy with

privatization needs of emerging Asian economies

Cementos Mexicanos (CEMEX) from Mexico considers international expansion in Asia

Case


Cemex S.A.

• Largest cement manufacturer in the Americas, 3rd largest in the world

• Based in Monterey, Mexico w/ operations in 22 countries• High operating margins, crisis experienceCorporate Strategy• Leverage the core business • Maintain high growth• Concentrate on developing markets

Asian expansion in order to turn Cemex into a global player

• Market Entry 1997 Philippines (30% stake in Rizal Cement)

• New target: Indonesian market


Global and Indonesian Cement Markets I• Cement: commodity with high transportation cost

=> regionally segmented markets• Most important market in Indonesia is Java:

Jakarta- dominated by Indocement, West Java- dominated by Semen Cibinong, East Java dominated by Semen Gresik


Global and Indonesian Cement Markets II

• Asian crisis turmoil slashed relative prices across Asia• Indonesian government deregulated cement market by

abolishing the local guideline price systemprice war? Squeeze of Indonesian gross margins

– turned exporting into a beneficial business strategy within Asia (ex. Taiwan)Even US markets could be “conquered”


The FDI Decision Sequence


Market Entry ViewMarket Entry Modes• Enter by greenfield investment or by acquisition?• Decide on a case-to-case basis• Decision techniques:

– greenfield investment: CAPITAL BUDGETING– acquisition of foreign enterprise: VALUATION METHODS

multiplesdiscounted cash flow (DCF) method


1. Overview2. Multinational Capital Budgeting3. International Acquisitions & Valuation4. Lessons Learned From The Case


Capital Budget Road Map

Bottomline:(i) parent company invests US$-

denominated capital in FDI project (ii) project capital budget evaluated (iii) project cash flows are remitted

to Cemex in order to make parent viewpoint capital budget


Financial Assumption and Financing I

Financial Assumptions• PPP holds for project time horizon, inflation rates (3% p.a. for

US, 30% p.a. for Indonesia)

Up-front Investment• Cost of setting up manufacturing capacity: $150/t (industrial

countries and $110/t (Indonesia)20m mt/y capacity, exchange rate of Rp 10,000/$ leads to investment of investment of RpRp 22 trillion or US$ 2.2b (110*$20m)22 trillion or US$ 2.2b (110*$20m)… including investment in plant and equipment of Rp 17.6 trillion with an annual depreciation charge of Rp 1.76 tr (10 years, straight-line schedule)

Financing• 50% equity, all from Cemex, and 50% debt (75% provided by

Cemex and 25% by an Indonesian bank consortium arranged by the Indonesian government)


Financial Assumption and Financing IIFinancing (cnd)*• WACC

– Cemex US$ : 11.98%, – project WACC: 33.257%

• Indonesian loan: – 8 year maturity, fully amortizing– in Rupiah, 35% p.a. (fully deductible) interest

• Parent loan: – 5 year maturity– in US$, 10% (in PPP-rupiah terms: 38.835% calculated by

determining the internal rate of return of repaying the dollar loan in full in Rp)

• Debt Service schedule, cf.exhibit 18.3 (p.543)

* Given in the case, exh. 18.2, p.541


Pro Forma Income StatementRevenues• All sales are exports• Expected capacity utilization

– 1999 40% producing 8m mmt/y, thereafter 50% (year 1 = 10m) and 60% (year 2=12m)

– Export market price $58/t

Costs• Cash cost of manufacturing Rp 115,000/t for 1999 rising at the

rate of inflation (30% p.a.)• Additional production cost: Rp 20,000 also rising @30%• Loading cost of $2/t, shipping cost of $10/t rising @3%• License fees: 2% of sales• G&AE of 8% rising @1% p.a.

• Pro forma income statement to determine profitability• Break even expected in 3rd year of operation


Project Viewpoint Capital BudgetNet Present Value and Internal Rate of Return• FCF = EBITDA – taxes + chg net working capital • Chg net working capital: Days sales outstanding (DSO)

– Receivables: 50-55 days, inventories: 65-70 days– Payables and trade credit: 114 days

• Initial capital investment: Rp 22m

• Terminal value– continuing value after year 5, i.e. perpetual net operating

cash flow (NOCF) generated in the fifth year

Net DSO: 15

trillionRpRpRpgk

gNOCFTVWACC

7.19000,000,686,19 033257.

)01( 059,547,6 )1(5 ==−

+=

−+

=

• WACC = 33.257%

Exh. 18.5


Project Viewpoint Capital Budgetexhibit 18.5, rupiah mn

Project year 0 1 2 3 4 5

EBITDA 2.979.029 4.499.067 6.504.982 7.813.589 9.352.941

EBIT 1.219.029 2.739.067 4.744.982 6.053.589 7.592.941

EBT -1.138.965 -170.256 1.120.846 1.507.145 1.861.285recalculated tax (30%), based on EBIT 365.709 821.720 1.423.495 1.816.077 2.277.882

net operating cash flow 2.613.320 3.677.347 5.081.487 5.997.512 7.075.059

less additions to NWC 240.670 139.028 436.049 289.776 626.314

initial investment 22.000.000

TV 21.273.893

FCF -22.000.000 2.372.650 3.538.319 4.645.438 5.707.736 27.722.638

PVF 0,75042962 0,56314462 0,4226004 0,31713186 0,23798514

PV of FCF 1780507,07 1992585,24 1963164,13 1810105,02 6597575,9

NPV -7.856.063

IRR 18,6%WACC=33.257%

Invest? Parent View Point Matters!


Parent Viewpoint Capital BudgetRepatriating Cash FlowsWhat counts are US$ cash in- and outflows, within project time horizon, after-tax, discounted at its appropriate WACC

Parent viewpoint capital budget build in two steps:

(1) individual cash flows are isolated, - adjusted for any withholding taxes, - and converted to US$ (not taxed again in MEX)

(2) Combine US$ after-tax cash-flows with the initial investment to determine NPV in the eyes of Cemex


Parent Viewpoint Capital Budget

Exhibit 18.6 Cemex's Capital Budget for the Semen Indonesia Project: Parent Viewpoint (thousands US$)Exchange rate (Rp/US$) 10.000 12.621 15.930 20.106 25.376 32.038

Calendar year 1998 1999 2000 2001 2002 2003Project Year 0 1 2 3 4 5

Initial investment (1.925.000) Dividends after-tax (US$) - - 23.700 18.600 17.300 License fees after-tax(US$) 8.816 11.020 13.224 13.224 13.224 Debt service after-tax (US$) 209.383 210.734 212.221 213.856 215.654 Total on-going CF earnings after-tax (US$) 218.199 221.754 249.145 245.680 246.178

Terminal value (Rp) 21.273.893.000 Terminal value (US$) 664.021

Net cash flows (1.925.000) 218.199 221.754 249.145 245.680 910.199

NPV (904.027)

Required return for investment

WACC: 11.98+6% 17.98% per annum

IRR -1,12%


Parent Viewpoint Capital Budget

Parent Viewpoint Capital Budget• All cash-flows are now valued in US$, after tax

• Hurdle rate: Cemex WACC (11.98%) + 3% (domestic) or 6% (international) respectively, i.e. 17.98%

• NPV: US$ -905m, IRR of –1.12%, => Do not invest!=> Do not invest!

Problems:• Terminal Value

• what happens to project after 5 years (Sale? Expropriation?) • Without any Terminal Value project even less beneficial

IRR: –14.1%• Uncertainties and risks have to be accounted for!


Political RiskWhat is the impact of • ... blocking funds?

– f(x)= f (reinvestment opportunities, time – occurrence and release)

• ... expropriation?– f(x)= f (time – occurrence, compensation payment schedule,

compensation for book vs market value, claim structure of debt repayments, nationality of creditors, ...)

– Tax consequences? “Nice clear expropriation” often better than “bleeding to death” in terms of accounting / write-offs (tax shield)


F/X Risk and other Sensitivity FactorsF/X Risk• Depreciation assumption: PPP

Impact on revenues and operating exposureImported inputs more expensive off-set by export boost?!Natural hedge? Cash in- and outflows in $!

• Appreciation assumption: Positive impact on local sales but foreign competition might increase

Other Sensitivity Variables• Change in …

… assumed TV, capacity utilization rate, size of license fee, size of initial project cost, amount of WC financed locally, tax rates in Indonesia and Mexico, …

most of variables within control of CEMEX, project could be improved


Risk and Sensitivity AnalysisAnalysis • If we can estimate uncertainties and risks

– Probabilistic techniques (certainty equivalents, decision tree analysis, expected return values, adjust discount rates)

Adjust discount rates: does not penalize NPV in proportion to actual amount at risk, possible variations over timeAdjusting cash flows: difficult to estimate in the far future

• BUT: Probabilities are difficult to guess in unfamiliar environments

• Risks often not quantifiable => – Sensititivity analysis for changes in assumptions– Scenario analysis is useful for testing overall profitability




The FDI Decision Sequence


Global and Asian Merger and Acquisition Activity, 1990–1998


Indonesian Enterprises Slated for Privatization and Their Financial Partners

• Industries linked to infrastructure and natural resources industries• Semen Gresik one of the first privatization objects in Indonesia due to

good management, efficiency, resiliency in declining business conditions


Major Players in the cement industry in Indonesia


Target: P.T. Semen GresikCompany snap shot

• Public company (1957), • went public in July 1991 (free float: 35%)• Government-directed consolidation in 1995 through acquisition of

– Semen Pagang (West Sumatra) and – Semen Tonasa (South Sulawesi) – for a total of $476m

• Good shape: approx. 30% of installed capacity dates from 96/97• PTSG fought rising input costs

Now: privatization through partial sell-down (35% stake)


Target: P.T. Semen Gresik


Privatization Process: Chronology1998

May 5th: Indonesian government initiated negotiations with top 3 global cement manufactureres: Holderbank (CH), Heidelberger (GER), and Cemex (MEX)

6th July: Cemex is declared “preferred bidder” by the Indonesian government

Political difficulties

20th Aug: Indonesian government officials announce that the company will continue to be state controlled. Only 14% are sold instead of the 35% initially offered

28th Sept: Bids are due


Privatization Process: Bidding for PTSG First round (June 19th) bid for 207.6m shares

Holderbank: US$ .96/share (approx. US$200m) increased to$1.21/share

Cemex: - US$ 1.38/share structured bid including port facilities upgrade and option for an additional 16% stake etc (approx. US$287m), total value of control stake: US$ 417.5m

• Cemex declared preferred biddervalue equal to 1/4 of projected total privatization value of 12 firm sales (as promised to IMF)


Privatization Process: Political Difficulties

Growing political opposition• Due to falling employment levels and selling state-owned companies to

foreign investors

“Conflict of Interest”• Goldman Sachs obviously had a “conflict of interest” by advising both,

Cemex and the Indonesian government• GS withdrew as an advisor to Cemex - was replaced by Jardine Fleming

Insider Trading• Trading volumes in PTSG peaked on July 19th (bid submission day)• (finally unsuccessful) investigation into: Jardine Fleming, Bahana/GS,

and Danareksa Securities (state-controlled I-bank)


Indonesia backs off – new bidding process initiated

Public opposition to Privatization• Fear of job cuts: demonstrations in West Sumatra and Jakarta

as rumors of sacking 3,000 employees circulated• Demonstrators paid by management of PTSG subsidiaries??

new bidding process

• reduction of the stake sold by the government to only 14% (goal: maintain control over PTSG)

• Restructured stage one bid is due on Sept 28

Now: new evaluation of the company


Valuation Methods

I. Discounted Cash Flow (DCF) Method• Free cash flows discounted with weighted average cost of capital

(WACC)

II. Multiples• Compare market value with some value derived of the company’s

financial statements• Compare to precedent transaction ratios or comparable firm ratios


DCF Valuation of PTSG ISequential Valuation in order to obtain equity value• FCF = EBITDA – taxes + chg net working capital – capital expenditure • Including Terminal value• Discounted with WACC

i) WACCAfter-tax Cost of Debt• 24.5%*Cost of Equity (via CAPM)• β = 1.2*, equity risk premium RPM (km- krf) = 6%*

ke = krf+ βRPM = 33.7%* + 1.2(6%) = 40.9%

with a leverage of 50% WACC is equal to:• WACC = %debt kd (1-tax) + %equity ke

= (0.5)*24.5% + (0.5)*40.9% = 32.7%

* Given in the case, app.2 p.483


DCF Valuation of PTSG II

ii) Free Cash Flows (FCF)• FCF = EBITDA - tax - chg working capital – capital expenditure

working capital = net additions to receivables, inventories, and payables necessary to support sales growth

iii) Terminal Value (TV)• continuing business value on the basis of perpetuity of net

operating cash flows• e.g. multiple of net operating cash flows in final year considered

iii) Equity Value• found by deducting net debt and any minority interests• divided by total no of shares outstanding: fair equity value per

share


DCF Valuation of PTSG IIIAppendix 2, p. 483 (Rp bn) 1998 1999 2000 2001 2002assumed sales growth 16% 27% 20% 20% 20%EBIT 458 612 790 1003 1259

+D&A 261 276 276 276 276EBITDA 719 888 1066 1279 1535

less taxes (30% of EBIT) -137,2 -183,7 -237,0 -301,0 -378less chg WC -35,6 -69,4 -65,4 -78,5 -94,2

less capex -40 -40FCF 506,2 594,9 763,6 899,5 1062,8Terminal value 51.171,9FCF for discounting 506,2 594,9 763,6 899,5 52.234,7PV factor (WACC) 1 0,7536 0,5679 0,4279 0,3225PV of FCF 506,2 448,3 433,6 384,9 16.845,2cumulative PV 18.618,2Enterprise Value 18.618,2 assumptions:

less net debt -4.113,5less minority interest -23,1 WC/sales 14,0% ERP 6%

equity value 14.481,6 cost of debt* 24,5% beta 1,2shares outstanding (m) 593,2 cost of equity 40,9% inflation 29,4%fair value of equity per share 24.412,7 leverage 50% risk-free rate 33,7%in US$ 3,0516 tax rate 30% WACC 32,7%

f/x rate (Rp/$) 8000 TV growth 30,00%share price 6.500 disc. TV / enter.V: 89%in US$ 0,81 * ... After-tax


Valuation MethodsI. Discounted Cash Flow (DCF) MethodII. Multiples

• Traditional ratios: relationship between market to intrinsic valuesPrice-to-earnings/share (P/E), Price-to-free-cash-flow (P/FCF), Earnings-per-share growth(EPS), market-to-book (M/B), EV to earnings, EV to cash flows

• Cement industry specific ratios:Enterprise Value (EV)/EBITDA, EV/capacity– Enterprise value = market cap + net debt;

EBITDA = earnings before interest, taxes, and D&A– EV/capacity is comparable between countries

approx. US$ 160/t for 1.5m mmt/y production facility


Valuation of PTSG using Multiples I

i) P/E (Price/ earnings-per-share) Ratio• by far most widely used, often compared to market averages• indicates what the market is willing to pay for a unit of earnings• computation:

– current market price divided by Earnings-per-share

= 80 (as of Aug 28)Rp 10,500

Rp 78,000,000,000593,200,000 shares


Valuation of PTSG using Multiples II

ii) M/B (Market-To-Book) Ratio• Measure of market’s assessment of capital employed per share

versus what the capital costs• Computation:

– current share price divided by book value per share, here:(Rp 10,500/Rp4,123) = 2.55

• Comparable if not high (average =1, average M/B for six largest cement groups only 1.7)

• It is valued in excess of what stockholders invested in the firm


Valuation of PTSG using Multiples III

* p.475, March 1998


Synopsis of Market Entry Modes

1) Greenfield entry via “Semen Indonesia” (cf. Capital BudgetingSection): US$ -925.6m, IRR of –1.84%,

2) Acquisition of PTSG:• DCF: Fair equity value per share: Rp 24,412

$ 3.05

b) Multiples [country average in brackets]: EV/capacity = 80 [52] Price/FCF = 11.4 [9.2] M/B = 2.55 [n/a] P/E = 56, later 80 [9]


Major Issues in cross-border company valuation

Currency• What is the functional currency to value these assets? Rp? $?• If US$ is indeed the relevant currency of denomination a great

deal of share price volatility only reflected F/X volatility

Adjust for risk • Relative volatilities and correlations matter and have to be

analyzed on a case-to-case basis • Redoing DCF using adjusted WACC and forward rates (instead of

PPP-based exchange rateskWACC, adjusted < >17.98% (=11.98%+6%) ?!Risk-adjusted WACC is not a simple cost of capital plus 3% or 6% premium process!see chapter 18 appendix


Case Outcome: RealityNo one except Cemex filed a 2nd and final bid• Cemex acquired a 14% stake in PT Semen Gresik for $1.38/

share. • Cemex tendered market for add. 11.5% ($1.38/share).

Cemex: 25.5%, Government: 51%, Public: 23.5%total cost of $290 million for Cemex

Governance• mutual consent• Cemex will hold 2 seats on the Board of Directors and 2 seats

on the Board of Commissioners

Put optionGovernment holds the right to sell Cemex its 51% over 3 years –

price of $1.38/ share + 8.2% per annum Cemex would hold 71% of Semen Gresik and full control


The Case today: current developmentsPolitical level• Implementation of a regional autonomy law

– local administrations now demand control of their industries – late 2001: ownership of Semen Padang by the West

Sumatra government was proclaimed:- de-facto renationalization of the unit - legality was disputed by the central government

• Separatist tensions– Fear of separatist tensions in West Sumatra

• Foreign majority ownership in key industries– Foreign investors already control about 57% of Indonesian

cement production (if Cemex controlled Gresik: 93%)– No-no issue for certain politiciansGovernment backed down on the Cemex’ put option in 2001


The Case today: current developments

Intra-firm Problems• 2002 Rebellion by management at key unit Semen Padang

– Executives barricaded their offices and refused to hand over the 2002 financial statements to Gresik management

Jakarta Stock exchange even threatened to suspend Gresik’s share trading

– Gain of control in September 2003– Takeover only succeeded with help of the military following a

court order


Consequences

Indonesian central government

• Government tried to find foreign investors for Cemex’s stake– BUT: investors were reluctant to commit themselves

Issue of legal ownership of Semen Panang is still not solved

Controlling majority necessary

• considered to raise money to buy-out Cemex

• Dec 2003: Cemex wanted to rescind the 1998 agreement – asked the International Center for the Settlement of Investment

Disputes (affiliate of the World Bank) to act as an arbiter– Wanted to be awarded substantial damages

• … but was still keen to increase its stake as originally planned – Cement demand on the increase in Indonesia

Cemex


May 2005

• Compromise plan: split-off of a Joint-venture in East Java to be controlled by CEMEX fails: Semen Gresik workers

opposed the deal

• 2005: according to Indonesian government CEMEX agreed to sell stake

“they agreed to use the proceeds from the stake sale to invest in Indonesia” (Aburizal Bakrie, Minister for Economic Affairs)


What happened then?

• ICSID: case is still pending 2006: Cemex wants to end the dispute

• March 2006: government will not be able to repurchase the stakes in PT Semen Gresik due to lack of funds, but “is still reviewing Cemex’s offer to acquire additional shares in Semen Gresik”

• March 2006: France’s Lafarge SA interested to buy the 25% from Cemex

• April 25, 2006: Cemex is about to sell stake to the Indonesian Rajawali Group – the deal only waits to be agreed upon by the government (team up with private equity firms, no intend to obtain majority stake)

• At the same time: Heidelberg Cement, Holcin with majority stakes in Indonesian cement manufacturers, the latter plan to build new plant in East Java, Lafarge SA new plant in Aceh




Lessons learned from the caseCapital Budgeting• NPV from parent viewpoint matters• Compare NPV from project viewpoint with similar venture

abroad• Use sensitivity analysis to analyze importance of assumptions

International M&A Strategy• Three components: (i) identification of target, (ii) execution,

(iii) post-merger integration• Use both, multiples and DCF• DCF: adjust CF or discount factor for risk


Lessons learned from the caseAdjusting for Risk• Include possibilities of political disruptions or intervention,

restrictions, and regulations• Risks are qualitative not quantitative! Quantify prudently, use

case scenario analysis• Differentiate between project and parent perspective. Parent

perspective includes political, governance, transfer, and (residual) F/X risk (collectively referred to as country risk)

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