Last week, the Nigerian Stock Exchange added a new member to its Trillion Naira Cap Club (TNC). BUA Cement joined MTN, Dangote Cement, Nestle and Airtel as stocks with a market capitalization in excess of N1 trillion. Unlike its predecessors, it got there in a rather inorganic way, a merger of three Cement making companies.
The journey started two years ago when we observed the share price of CCNN, the relatively unknown Cement Company started gaining momentum. By May 2018, the share price had gained 385% and trading at 10x earnings per share. By the third quarter of the year, the company reported it was planning a merger with Kalambaina cement.
CCNN and Kalambaina were both owned by BUA Cement, one of Nigeria’s leading building materials company and a dominant force in the Cement Business, in the northern part of Nigeria. The merger raised a few red flags but not enough to affect its successful conclusion by the start of 2019 and segueing into its main plans, the reverse listing of BUA Cement. Now, according to the company, the merger is expected to yield immense benefits for all its operating companies.
“The proposed merger will increase the production capacity of the enlarged company to 8 million MTPA. It is anticipated that in addition to meeting the demand from customers in the core regions in the country, the enlarged company would be positioned to distribute its products in new geographical markets, creating the potential for additional shareholder value creation.
“We expect the proposed merger to provide opportunities for significant cost savings and improved operational efficiencies by streamlining operations and optimizing the use of combined resources.
“It will also provide a platform where the enlarged company benefits from economies of scale in procurement, distribution, and manufacturing of the products offered to customers.”
Mergers and Acquisitions are expected to produce synergies, which is why investors like to describe it as simply one plus one equals three. But does this merger achieve this depiction? It’s surely too early to tell but a cursory look at its result may provide useful insights.
Since CCNN’s first merger with Kalambaina, its valuation has soared astronomically. Its last published accounts, which is 2019 nine months interim report, shows a share premium of N312.3 billion compared to an issued and fully paid capital of N6.2 billion. This suggests the share premium to issued share capital multiple of a whopping 52x. To put this into context, Dangote Cement share premium to issued capital multiple is just 5x.
A share premium is simply the difference between the nominal capital of a stock versus the market value. For example, if a stock was first issued at a par value of N1 per share and it’s now sold for N5 per share the share premium is N4 per share (N5-N1). The company retained earning out of which dividends can be paid is just N17.8 billion. Share premium are useful when a company wishes to setoff negative retained earnings and paving the way for future dividend payments. Thus, for now, all that money is paper value.
The wider the multiple, the more obvious it is that a company has raised a significant amount of capital at a lofty valuation. Companies that raise capital very often have a high share premium to ordinary share capital multiple especially if they raise capital at a higher valuation to par value.
Another reason for the multiple could be due to outcomes of mergers and acquisitions where the purchase consideration comes at a much higher valuation. This appears to be the case for BUA and as expected has significant consequences. A look at CCNN’s 2019 9 months result is a case in point.
The company posted a top-line revenue of N10.3 billion compared to N7.4 billion a year earlier. Profit was N1.47 billion compared to N1.4 billion the same period the year before. So, despite a N3 billion revenue growth, profits were basically flat because the company booked a distribution cost of N2.4 billion compared to N760 million in the same period in 2018.
Also, the flat profitability growth could be attributed to another N1.24 billion the company booked as technical and management fees (t&m) compared to N560.3 million a year earlier. The t&m fees were actually about 85% of profit after tax.
Sadly, mergers, especially when it results in a single majority shareholder often result in t&m fees. In fact, most companies with single majority shareholders often charge this fee. Despite these incidental spikes in cost, the company at least still reported profits of N1.4 billion so this may not be an immediate worry for smaller shareholders.
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A more disturbing metric is the company earnings per share. This is a better measure of the one plus one equals three mantra. Based on the same result mentioned above it appears things have gotten far worse. CCNN’s earnings per share at the third quarter of 2019 was 67 kobo compared to 319 kobo per share the same period last year representing a 79% drop.
What does this mean? It just means there are more shares to feed for the same amount of profits made a year earlier. If things stay this way with the second merger in less than two years then expect share price to underperform.
CCNN closed 2019 with its share price down by 7%.