CCNN.NL -Downgrade to SELL due to material dilution   

02 November 2018 : Late yesterday, analysts received the scheme of merger document which finally provided the much-needed clarity required on the expected dilution to shareholders of CCNN from the proposed merger of Cement Company of Northern Nigeria (CCNN) and Kalambaina Cement Company Limited (Kalambaina) – a wholly owned subsidiary of BUA wherein the new cement plant (1.5MT) in Sokoto sits. The consideration now signals a substantial dilution for minority shareholders following an unexpected premium on the construction cost infused in intangibles of N207.3 billion. Management is proposing shareholders meeting to be held on the 29th of November 2018, wherein shareholders are expected to approve the terms of the merger.


In analyst's earlier report on the proposed merger published in July 2018 following the press release by management on the share conversion ratio (See report: One game before the Finals), wherein analysts adopted a net asset valuation approach in valuing the $350 million construction cost using prevailing exchange rate of N360/$ (Scenario 1) and average exchange rate over the 3-year construction period of N251/$ (Scenario 2) which translates to asset value of N126 billion and N87.9 billion respectively. To analyst's surprise, while the addition to property, plant and equipment (PPE) from the proposed scheme was not too far from their estimates, the management included an additional value of the sale in goodwill. For context, the enlarged CCNN post-merger PPE is expected to increase by N107.5 billion – implying that management adopted an exchange rate of N307/1$ in treating the construction cost of $350 million – to N119.8 billion. However, the enlarge CCNN’s intangible assets increased to N207.3 billion from just N499 million in FY 17.


Accordingly, analysts estimate total cost of the conversion to shareholders of N308.9 billion, including increase in PPE and goodwill. While analysts find the value of the increase in PPE quite justified, as it is closely related to the construction cost of $350 million using an exchange rate of N301/1$, analysts believe the associated premium in terms of the goodwill requires more explanation on the part of management as analysts understand it is not associated with any right – in the form of mining of limestone – as the plant is situated in the same location as CCNN.


Any ‘STEW’ for minority shareholders. Recall, management of CCNN announced the consideration for the merger will be based on 100,000 shares of Kalambaina for 19,811,372 shares of CCNN (1:198) using the 30-day volume weighted average (VWAP) closing price of N25.99. Examining the impact of the proposed consideration on shareholders, using analyst's estimated proposed conversion cost of N308.9 billion and overlaying that on the VWAP, analysts arrived at additional shares of 11.9 billion (in line with the scheme of merger document) which cascades total shares outstanding to 13.1 billion from current of 1.3 billion. Thus, analysts see a significant dilution to shareholders from the proposed consideration of the merger.


Analysts believe the significant deviation between their expected additional shares of 6.10 billion and proposed 11.9 billion shares results from the additional goodwill on the transfer of the asset to CCNN. Ex-goodwill, analysts estimate that additional shares created from the merger would have been 4.1 billion shares which is in line with their estimate.


Float to fall below NSE requirement. After the conversion of the 60,000,000 shares outstanding of Kalambaina, BUA holdings in the enlarged CCNN is expected to increase to 92.27% with a float of 7.73%. To address the lower float relative to the NSE requirement, management intends to implement appropriate strategy to best address the issue. Analysts estimate three possible scenarios:


  1. Rights issue, with the parent company exempted from taking its rights


2. Tender offer by the parent company to minority share holders at a price not lower than the conversion price of the plant to CCNN, assuming they intend to take the company private, and


3. Offer for sale of some of the shares of the parent company to the public at a negotiated price.


Volume consolidation ahead of merger. In analyst's recently published cement sector report (See report: Still room for strategic selection), analysts stated that the cement volumes reported by CCNN was inclusive of sales from Kalambaina. True to analyst's words, the scheme of merger revealed that the reported revenue of N12.1 billion (+425 YoY) over H1 18 is that of the enlarged CCNN. For context, analyst's suspicion was on the back of the estimated volume over H1 18 of 284,454 tons, which suggests that remaining expected production from the plant for H2 cannot exceed 215,546 tons to sum up to the expected annual capacity of the plant of 500K ton. However, using analyst's H2 17 and H2 16 estimate of 264,496 and 263,808 tons respectively, analysts believe it is unusual for the plant alone to have produced so much in H1 18.


While analysts maintain their volume and earnings expectation for the company over 2018 and beyond, the increase in shares outstanding informed a material adjustment to their FVE to N17.01 from previous estimates based on their expected 6.10 billion shares of N28.47, which translates to a SELL rating on the stock. CCNN trades at a current P/E and EV/EBITDA of 5.9x and 3.65x relative to Bloomberg Mena peer average of 9.31x and 17.32x.

Management is proposing shareholders meeting to be held on the 29th of November 2018, wherein shareholders are expected to approve the terms of the merger.


Reporting for EasyKobo on Friday , 02 November 2018 in Lagos, Nigeria


Source: Oluwasegun Akinwale from ARM Securities Limited


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