The death of ARM: How cement maker hit rock bottom



Anyone familiar with the tribulations of the giant cement maker Athi River Mining (ARM) Cememt for the past three years would have predicted that its fall from corporate glory was imminent. But few expected the slide to be that rapid and severe.  

Mid August, ARM’s days of magnificence came to a screeching halt.

On August 18, the Nairobi Securities Exchange (NSE) floated manufacturer was put under administration, bringing on board global audit firm PwC to run the business.

This marked the end of an era for a firm that has for years been Kenya’s second-largest cement maker behind LafargeHolcim’s Bamburi Cement, another NSE listed cement maker.

Whichever way you look at it, ARM has been a classic poster child for the cement industry’s struggles. For the year ending December 2017, ARM reported a net loss of Sh6.5 billion, 2.3 times more than the negative position it had reported the previous year. Its short-term liabilities were Sh13.4 billion higher than current assets, a deficiency signaling financial distress that left the company at a high risk of default on its obligations.

It blamed the loss on decline in cement demand in Kenya, a ban on imported coal in Tanzania, a poorly performing Tanzanian unit and pricing pressure for both Kenya and Tanzania.

So, what went wrong? Did ARM dig for itself a hole too deep? Is this the end of the 44-year-old corporation founded by Harjivandas J Paunrana?

Just before going into insolvency, things were looking up for ARM, if recent announcements were anything to go by. The firm had said on August 16 that Pradeep Paunrana, the late Mr Paunrana’s son had bowed out of his position as the CEO in a management shake-up that saw tycoon Linus Gitahi, former Nation Media Group CEO take over as the chairman, replacing Rick Ashley. The changes in the board, which led to the exit of the chairman, also saw the departure of some of the board members – with nominees being experts in turnaround situations and financial restructuring and M&A. The changes, analysts said, were largely an effort to lift the dwindling fortunes. But with the entry of the administrators, the Board of Directors stood inactive.

In February and as part of its continued restructuring, ARM received approval for the sale of its non-cement business to Switzerland-based Omya and Pinner Heights Kenya (majority-owned by Pradeep Paunrana), in a 51%/49% respective split. The sale price of Sh1.6 billion was to be used to offset some of ARM’s debt, leaving its short-term loans at Sh1.19 billion after the sale. ARM decided to sell this business due to the high working capital requirements of the low margin non-cement business and ARM’s liquidity constraints. At that point, ARM had yet several other options in the works to get out of the woods.

First, it planned to refinance the remainder of its short-term debt to a longer tenor (three-year moratorium) through a development finance institution. Secondly, it was considering a possible equity stake sale, or an asset sale. Thirdly, it was banking on improved operational performance in Tanzania, to restore a healthy financial position. Fourthly, it was mulling over building a 2.5 million tonnes integrated clinker and cement plant in Kitui, Kenya and increase the Rwanda grinding plant capacity by 1 million tonnes. As fate would have it, none of these went as per the plan.

At some point earlier this year, ARM was staring at improved fortunes. While coal supply remained sporadic in Tanzania, the cement operation’s performance improved on higher cement prices. The firm took advantage of the government’s restriction on imported clinker to focus on the sale of clinker over cement from its clinker capacity plant. This marginally improved cash flows and the plants’ utilization rate. But it wouldn’t last long enough to drive a complete turnaround. At the end of 2014, ARM had added an additional 1.2 million tonnes per annum clinker capacity to its Tanga plant in Tanzania, funded by the CDC Investment, one of the shareholders. This, analysts then projected, would help the firm to capture the surging growth in the region, thereby increasing its market share.

In 2012, four developments played a central role in determining the current state of affairs. ARM secured 50 convertible notes worth Sh4.3 billion from Africa Finance Corporation at a premium in September 2012.  At that point, the firm held Sh2.3 billion in short deposits and the rest, about Sh2 billion was disbursed immediately. This carried the risk of dilution to equity shareholders if the notes were to be converted into approximately 85.94 million shares in 6 years on the date of maturity. It also worsened the debt position while increasing the fixed finance cost with the company paying 5% interest annually payable quarterly plus about 2.5% accrued interest payable upon maturity.  

Secondly, it launched the grinding plant in Dar. Thirdly, it introduced the Rhino Cement brand in Tanzania, capturing 2% market share in Tanzania in year one. Fourthly, key events like the exhaustion of accelerated investment deductions that ARM enjoyed from 2011 from prior investments drove the effective tax charge higher in 2012 which meant that net income grew only by 8% to Sh1.25 billion despite profits before tax growing by a massive 31.7% to Sh1.79 billion in 2012.

Last year was however the most defining period for ARM. The Group post disappointing results that included a first time gross loss of Sh1.2 billion, caused by a dramatic 32% reduction in ARM’s topline mainly driven by tough operating conditions and working capital constraints that hampered production. In April 2017, as part of the restructuring efforts, ARM management reached out to IFC for help to restructure the group to a tune of Sh1.2 billion.  IFC responded positively to the management’s request for relief and considered the debt-refinancing offer (Sh900 million term loan and Sh300 million in working capital lines). IFC also recommended that management seek a Sh500 million equity injection to plug holes in the balance sheet.  Secondly, imported clinker was banned in Tanzania. This opened up the market for ARM.

At the Renaissance Capital East Africa Investor Conference held in October last year, ARM’s management stated that it was in early-stage talks with an international strategic investor on a possible stake sale. Renaissance projected that the suitors could be either Heidelberg or Dangote.

In November 2017, Renaissance saw the end of ARM.  CDC and the Paunrana family had just provided a Sh1.5 billion bridge loan to support the business and meet its financing costs and working capital requirements over the next few months.  “However, if ARM is unable to raise new equity and conditions in Tanzania do not improve significantly, we see a risk of insolvency, given its $25m and $14m in annual debt repayments and finance costs, respectively, over the next three years,” it said.

The tale of a troubled stock

Investors in ARM must be ruing the day they placed their bets on the stock. The market price for the Athi River based cement and clinker manufacturer in 2012 rallied from Sh31.60 recorded on the 3rd of January 2012, to hit the all time high of Sh97.50 on the 9th of January 2014.

“The price during this period was mainly driven by investor exuberance as they assumed that the high growth during the period would continue to hit newer heights, with expansion to Tanzania a key catalyst” said AIB Capital in a recent note to investors. “Analyst sentiments during the period also helped fan the investors’ over-confidence with general analyst consensus remaining a buy even when the stock was trading at a premium of the comparable cement companies in Sub-Saharan Africa due to high growth projections at the time,” said the investment bank. The announcement of disappointing numbers in the Half Year of 2015 forced the market to readjust its future expectation starting on July 2015. Disappointing annual and half results in 2015 and 2016 continued to push prices downwards to Sh20 by March of last year when the book value per share was Sh28. The profit warning released by management in March of this year was the final straw that broke the camel’s back.   By the time the stock was suspended at the NSE on August 18, the counter was trading at slightly below Sh5 apiece.

The making of failure: Players, rivalry and pricing

Cement demand in Kenya has been lackluster, despite a booming construction industry. The consumption contracted by 8.2% last year, with the construction sector adversely affected by the prolonged election period, delayed large infrastructure projects, constrained access to credit for developers and a general slowdown in the individual home builder segment.

Poor access to coal in Tanzania also resulted in diminished capacity utilization of the grinding plant in a very competitive market.  Demand is estimated to have stood at 6 million tonnes per annum in 2017, a 5% drop from 6.3 million tonnes the previous year.  Domestic production is dominated by Bamburi, which accounted for over 32% of total cement produced in Kenya in 2016, while East African Portland Cement (EAPC) and ARM each control 14% of the market. In terms of installed capacity, Bamburi has controlled 30% in Kenya for some years. Following the entry of Rai Cement’s 2 million tonnes-capacity cement plant late last year, though, Bamburi’s market share by capacity has dropped to 23%. Rai Cement now controls 20% of market share by capacity, with Mombasa Cement and Savannah Cement controlling 16% and 15%, respectively, data by Standard Investment Bank shows. Bamburi is increasing its grinding capacity to 1 million tonnes, a project that should be completed in the coming months, implying that Bamburi’s market
share by installed capacity should increase to 30%.