PROFITABILITY ENHANCEMENT STRATEGY THROUGH CAPACITY EXPANSION AND MARKET EXPORT DIVERSIFICATION

(CASE STUDY: ACQUISITION OF THANG LONG CEMENT COMPANY VIETNAM BY PT SEMEN INDONESIA TBK)

Anandita Ade Putri

Schoold of Business and Management

Institut Teknologi Bandung, Indonesia

ade.putri@sbm-itb.ac.id

Abstract - Cement industry is expected to be grow respectively high due to demand for house building and infrastructure needs. Indonesia and Vietnam, as part of Southeast Asia region, are facing different kind of market condition. PT Semen Indonesia Tbk is Indonesia’s top leader in cement industry, who had invested major investment by acquiring major shares ownership of Thang Long Cement Company Vietnam, back in late 2012. This acquisition strategy was intended to enhance profitability and reach Southeasr Asia market. One year after the acquisition happened, this strategy needs to be analyzed whether it already goes perfectly as what expected or needed some improvement regarding company’s profitability growth. By doing Discounted Cash Flow valuation with three different scenarios; first is, when each companies stand alone independently (before acquisition), second scenario is PT Semen Indonesia Tbk acquired Thang Long Cement Company (current condition) and third scenario is post-acquisition analysis after acquisition with proposed strategy on capacity expansion and market export diversification. This final project suggested Thang Long Cement Companies to expand capacity from 2,3 mt/year to 4 mt/year, to improve sales and also open more exporting market. Vietnam’s cement industry is having excess supply, that’s why exporting cement products to another country is important. Indonesia can also fulfill its massive demand of cement from Vietnamese cement product, which it related to PT Semen Indonesia revenue and inventory availability. Thang Long Cement Companies was acquired undervalued with price of US$157million, but it doesn’t mean the company suffered loss from the transactions. PT Semen Indonesia Tbk did major improvement on management structure, business process and debt refinancing for Thang Long Cement Companies. Due diligence was also done before choosing Thang Long Cement Companies as the targetted company, based on its financial ratio analysis which also calculated in this final project. Generally, this acquisition between PT Semen Indonesia and Thang Long Cement Company is a right decision and still possible to reach optimality in profitability enhancement through proposed strategy in expansion and market export diversification. Both companies also proved having synergistic relationship on this acquisition.

Keywords: Semen Indonesia, Thang Long Cement Vietnam, acquisition, profitability, expansion, market export, financial analysis

1. Introduction

Indonesia's cement sector has shown promising increase in domestic cement production and consumption. This trend is estimated to continue for number of reasons, such as Indonesia’s current low per capita cement consumption and expanding middle class people that gives rise to new housing and real-estate development. The outlook for the Indonesian cement industry is positive, combined with strong economic prospects as well as low current consumption per capita. Total

cement exports have declined significantly over the last few years due to a surge in domestic demand.

PT. Semen Indonesia (Persero), Tbk. is the leader in terms of sales, designed capacity and production. In 2012, the company had a 41% domestic market share based on sales volume. It was followed by Indocement and Holcim with a share of 32% and 15%, respectively. The competitiveness between the other cement company is relatively tight, and that’s why PT. Semen Indonesia (Persero), Tbk. wanted to expand their business outside domestic area. Southeast Asia is considered to be the targetted region because Indonesia is still part of the area. Vietnam is chosen to be its first partnership destination region, and targetted Thang Long Cement Company, Vietnam.

Figure 1. PT Semen Indonesia’s Milestone

Thang Long Cement Company (TLCC) is among leading cement manufacturers in Vietnam with total investment budget of over 6,000 billion VND (Vietnam Dollars), including one main plant in Quang Ninh province and one grinding station in Hiep Phuoc Industrial Park, Nha Be district, Ho Chi Minh City. Thang Long Cement is proud to be founded by leading Vietnamese shareholders, of which the majority one is Hanoi General Import and Export Joint Stock Company (Geleximco) who is one of the first private multi-lines industrial conglomerates in Vietnam with key strengths in: industrial production, banking, securities finance, real estate, telecommunication, insurance and many more. Officially launched in Vietnamese market on December 18, 2008, Thang Long Cement has quickly become one of the most popular cement companies to the consumers.

2. Business Issue Exploration

High competitiveness between domestic leading cement companies and also the concern of being the biggest cement company in Southeast Asian, encourage PT Semen Indonesia to acquiring Thang Long Cement Company Vietnam. In compliance with the national eonomic growth, the domestic demand of cement for several years ahead has predicted to be increase by 8% or above the economic growth rate. As well as PT. Semen Indonesia that keeps adding more its production capacity to anticipate the future increase in cement demand. Recently, the condition of Indonesia’s cement supply is still facing shortage and PT. Semen Indonesia sees the opportunity to gain more supply from Southeast Asian countries which had excess in cement supply, such as Vietnam.

This is the first acquisition of the company and this final project will discuss yet analyze how could the acquisition gain positive mutual benefit for both companies. The valuation gave outcome that the acquisition is favorable for PT Semen Indonesia, but undervalued for Thang Long Cement Vietnam due to several factors. Vietnam cement market had faced major economic challenges such as slowdown in property market, a rise in input costs, high interest rates and exhange rate fluctuations. Furthermore, company would ensure that the acquisition will give improvement for their

performance in national and also regional area. Not only for PT Semen Indonesia, but also for Thang Long Cement Company.

The acquisition happened in 2012 and it already has been more than a year. The revenue growth contribution from Thang Long Cement Company is still unsignificant and little. This final project will comes up with strategy to generate the profit and enhance maximum performance of PT Semen Indonesia and Thang Long Cement Company.

Indonesia’s economy in 2013 grew at the slowest speed in recent four years as seen in undermined exports and higher interest rates which effect consumption. (data from Indonesia statistic bureau). Indonesia’s gross domestic product (GDP) rose 5,78% in 2013, lower than 2012 that was 6,23%. The number of GDP growth in 2013 is the slowest growth since 2009. Indonesia’s annual growth is more than 6% in recent years, strengthened by spending from its growing middle class.

Figure 2. Indonesia GDP Annual Growth

The economic condition in Indonesia is impresively rising up, seen from the number of foreign investors that come to take the opportunities. Competition is also heating up, for regional sectors or even global business competition. After passing the economic crisis in 1997/1998, Indonesia’s economic condition is showing stable recovery and heading to its greatness. The economic growth in Indonesia by year 2009 until 2013 reached approximately 5,9 % per year, which was the highest economic growth achievement of Indonesia after the crisis happened 15 years ago. Compare to another Southeast Asian’s country, Indonesia could be categorized as a country with stable economic growth.

Country Year 2011 Year 2012

Cambodia 7,1% 7,3%

Indonesia 6.5% 6,2%

Vietnam 6,0% 5,0%

Malaysia 5,6% 5,1%

Singapore 5,2% 1,3%

Phillipine 3,6% 6,8%

Brunei Darussalam 2,2% 2,2%

Thailand 0,1% 6,5%

Figure 3. Comparison of Economic Growth in ASEAN Countries

On the other side, Vietnam needs to have several challenges in order to sustain its rapid growth and development potential. Reforms to the financial system and to state owned enterprise (SOEs), it also needed to be broadened and transformed. The bad loans from commercial banking sector have to be improved through governance regulatory. Also ownership diversification of SOEs must be broadened and improved to compete as market-based enterprises.

The macro economic condition in Vietnam is unstable because of inflation rates and asset prices has declined sharply. According to Vietnam’s accession to membership in the World Trade Organization in 2007, foreign capital inflows helped the domestic credit growth, from 25% in 2006 to 54% in 2007. In the end of 2010, Vietnam faced severe macro economic instability with high inflation, high interest rates, large trade deficit and public debt. The government reacted in beginning 2011 by tightening monetary and fiscal policy. By 2012, sign of relief in the bank liquidity shortage began to emerge.

Figure 4. GDP Growth, Inflation Rates and Credit Growth in Vietnam

Cement industry expansion is clearly a big project investment and needs time to conclude for the final agreement. In this business issue of acquisition between PT Semen Indonesia and Thang Long Cement Company Vietnam, plenty of external factors are matters due to the different region (Indonesia and Vietnam). It is necessary to analyze from the external environment.

Five’s Forces Porter Analysis used in this final project. Barriers to entry for cement industry is high, due to the The cost to build one leading cement company is not cheap and needs big area to build the factory. Furthermore, brand identity of cement companies in Indonesia is quite strong, such as PT Semen Indonesia, Indocement Tunggal Prakarsa and Holcim Indonesia. That makes them even harder to compete in the market. Industry rivalry is also competitive and quite high. PT Semen Indonesia is facing competitors such as PT Holcim Indonesia (Semen Cibinong), PT Indocement Tunggal Prakarsa (Heidelberger), PT Semen Baturaja, PT Semen Andalas, PT Semen Kupang and PT Semen Bosowa Maros.

Bargaining power of buyers is low, because they could not set the price, but still they could choose the cheapest price from several cement products. Bargaining power of suppliers in cement industry is quite low. If the company could get raw material supply from several suppliers, so the company position is relatively stronger compared to the supplier. Means that supplier is not threatening the company. But if the company only rely to one supplier, the company would be threatened by the supplier. Threat of substitutes is relatively high. Another strong competitors are also produced similar cement products, with comparable quality and also competitive price. Siam Cement from Thailand now is the most dangerous threat because they will be build a plant in Indonesia.

When the company decides to expand their business to Vietnam by acquiring Thang Long Cement Vietnam, it had been through some reasonable discussion and considerstion. Except the excess supply condition in Vietnam, there are also several other reasons why Semen Indonesia chose TLCC.

Figure 5. SWOT Analysis of Vietnam Cement Industry

Internal analysis comes from the strategy perspective, which aimed to make PT. Semen Indonesia (Persero), Tbk as a leading national cement manufacturer. To achieve that, earlier before acquisition they already implemented strategies that is used for:

Increase Production Capacity and Expand Market Share in IndonesiaThe cement demand in Indonesia is growing, so the company decided to increase production capacity.

Improve EfficiencyEfficiency could be improve through optimization of production systems. Also refer to distributin and transportation cost

Explore Core BusinessPT Semen Indonesia (Persero), Tbk also strenghten its core business by removing some of its businesses, such as cement bags manufacturing, raw materials mining and other activities to its subsidiaries. This action provides an opportunity to be more focus on its primary activity which is cement producer.

PT Semen Indonesia is focus on revenue growth to gain sustain profitability. They use cost leadership strategy in cement production and distribution. The strategy is trusted to bring success for PT Semen Indonesia in years after. Another competitors were rapidly grew and PT Semen Indonesia needs to undertaken massive strategy that has not been done by its competitors.

Figure 6. Market Position of Domestic Cement Industry

To measure the company’s ability to perform and understand the reasons why they chose acquisition, this final project using financial ratio analysis for both companies. PT Semen Indonesia profitability growth based on Return on Asset (ROA) and Return on Equity (ROE) which are relatively increased over the years. Both measure companies’ ability to generate earnings from its investments.

Figure 7. Profitability Ratio of PT Semen Indonesia

Calculation on ROA and ROE also applied to analyze the financial performance of Thang Long Cement Vietnam, over the past years. The trend is often declining. ROA of Thang Long Cement Company defines that the company is not profitable enough relates to its total assets. It gives the idea that the management is not properly used its assets to generate earnings. ROE of Thang Long Cement Company is showing instability of company’s profitability by the amount of money shareholders have invested.

Figure 8. Profitability Ratio of Thang Long Cement Company Vietnam

The declining trend on ROE and ROA of Thang Long Cement Company is a result of competition between rivals, market instability and also the inability to pay overdue debts. This condition becomes an opportunity for PT Semen Indonesia as an foreign investors to acquired the company.

Asset turnover ratio measures the company’s ability to use its assets to efficiently generate sales. Ths ratio considers all assets (current and fixed), such as plant and equipment as well as inventory, account receivables, as well as any other current assets.

Figure 9. Asset Management Ratio of PT Semen Indonesia

In order to account assets and property, the term used is fixed asset. In 2010 until 2012, the graph is declining because major purchases on plant, property and machines. Asset turnover defines the amount of sales generated, which measures company’s efficiency at using its assets generating in sales or revenue. The higher the number, the better condition is. Inventory turnover shows how many times a company’s inventory is sold and replaced over a year. Low turnover indicates poor sales and excess inventory (surplus supply). Thang Long Cement Company Vietnam’s performance on its assets and inventory turnover is shown in Figure 11 below:

Figure 10. Asset and Inventory Turnover of Thang Long Cement Company

Debt ratio measure debt amount of the company stated in balance sheets compared to its equity or assets. In early 2000, crisis happened in Indonesia and it means that the company had high debt period. Eventually, the years after that the capital structure used lower leverage. Low debt to equity ratio defined lower risk, because debt holders had les claims on company’s assets

Figure 11. Debt Ratio of PT Semen Indonesia

In Vietnam, cement companies especially state-owned ones, have been aggresively finance their business with debt. Thang Long Cement Company is a private company, and held a big amount of debts, as noted in its financial statement (US$ 140 million) that sourced from several lenders and were granted before PT Semen Indonesia took over the company. Below in Figure 12 will shown the financial strength of Thang Long Cement Company Vietnam through quick ratio, current ratio and debt to equity ratio:

Figure 12. Debt to Equity Ratio of Thang Long Cement Company

As we know that Thang Long Cement Company has excess inventory and it made its financial weakens. Meanwhile, total debt to equity of Thang Long Cement Company shows very high proportion which indicates that debts were using more to finance its assets.

PT Semen Indonesia is concern about cost management, which is why the company maintain to reduce its operating cost over period. Since 2005, cost was declining but one year after the operating expense increased. Revenue and profit of the company continuously increase in recent years. But during 2000 until 2002, the company faced declining profit and revenue. Cost inefficiency was one of the reason. In 2003, margin began to increase and EBITDA margin increased continuously in 2007. This situation was relevant due to effort in controlling production cost. All indicators are divided with the net sales.

Figure 13. EBITDA Growth of PT Semen Indonesia

The smaller the ratio, the greater the company's ability to generate profit if the revenues were decreased. Gross Profit Margin shows small number which mean the operation of Thang Long Company wasn’t efficient enough. The cost of goods sold, also known as COGS, includes the expense required to manufacture a product or provide a service. This measure would include expenses such as raw materials, labor, and production overheads.

3. Business Solution

There will be scenario alternatives valuation about the financial condition of PT Semen Indonesia and Thang Long Cement Company Vietnam, related to their enterprise value and synergy value, in three scenarios; before both companies had done the acquisition project which means they stand independently as a cement company, after the acquisition project is done with current condition, post-acquisition analysis with strategy of capacity expansion and adding market export diversification to get profitability enhancement. The method used is discounted cash flow (DCF), by doing projection of free cash flow (FCF) in the future while considering the discount rate for each year. In the firm valuation of PT. Semen Indonesia (Persero), Tbk we use free cash flow projection from 2009 until 2017, because it assume that in the time length, there will be impact for PT. Semen Indonesia (Persero), Tbk for long term period. The same methods are used for Thang Long Cement Company

Vietnam. Calculation methods for analysis are depend on the data availability from each companies. Synergy value from the acquisition will be analyzed and described to know how can the acquisition benefits for the buyer company.

Discounted Cash Flow method will calculate the value of a share of common stock is equal to the present value of all future cash flow expectation. Several steps in DCF method are:

Estimating Discount RatesThe use of discount rate is to reflect the risk of cash flow. The calculation is combination from cost of debt and cost of equity (cost of capital).

Free Cash Flow MeasurementIn this step, there will be a forecasted earnings, forecasted CAPEX (capital expenditures) and forecasted net working capital.

Cash Flow ForecastingTo calculate the cash flow for projection time period, it requires terminal value at the end of the estimation phase.

Equity ValuationThe final step, firm valuation will be estimated and then converted to equity valuation method to get the value of share price.

Model Measure Discount Factor Assessment

Discounted Cash

Flow

Free Cash Flow Weighted average cost

of capital (WACC)

Works best for projects, business

units and companies that manage

their capital structure to a target

level

Table 1. Framework For DCF Calculation

The important elements in Free Cash Flow projection is also the projection of sales, EBITDA and EBIT. To determine the growth sales for the next 5 years, we use Compound Annual Growth Rate (CAGR) from the last five years, which is from year 2009 until 2013. CAGR for PT Semen Indonesia (Persero) Tbk is 3,87% and for Thang Long Cement Company Vietnam is -2,27%. Due to the financial condition of Thang Long Cement Vietnam and also the economic condition in Vietnam, the CAGR resulted is in minus amount, means still far from expectation. The number is used for growth sales in scenario 1 for both companies.

The growth rate or CAGR for PT Semen Indonesia for another scenarios (2 & 3) is using assumptions. For scenario 2, it is the most-likely condition means PT Semen Indonesia’s current condition, acquiring Thang Long Cement Company. So then, the sales growth is 7%. This assumption is based on average sales growth rate in cement industry. And for the scenario 3, it is the condition after acquisition with proposed strategy of capacity expansion and market export diversification in Vietnam. So, the sales growth assumption is 13,6%.

For Thang Long Cement Company, the growth rate for another scenarios (2&3) is also using assumptions. For scenario 2, it uses the most-likely condition, when the company’s current condition (acquired by PT Semen Indonesia). So, the sales growth is assumed to be 3%. And for the scenario 3, it is the expected condition based on improvement from capacity expansion and exporting activities. Therefore, the sales growth assumption of Thang Long Cement Company Vietnam is 6%.

In this final project, cost of debt calculation will be measured by bond rating and interest coverage ratio. To calculate cost of debt, there are three steps included; first is using financial ratio. Interest coverage ratio could be determined from EBIT divided with interest expense. Second step is, each company will be assigned a rating according to its ratio result.

Risk Free Rate 7,001Rating ATax Rate 25%Cost of debt before tax 8,55%After tax cost of debt 6,41%

Table 2. Cost of Debt PT Semen Indonesia

The cost of debt Thang Long Cement Company Vietnam is 17,92%. Cost of equity defines expected rate of return by investor since there is an uncertainty in profit earning. CAPM (Capital Asset Pricing Model) is used on the calculation. The cost of equity of PT Semen Indonesia is 22,64%. And, cost of equity of Thang Long Cement Company is 12,21%.

The method used for calculate terminal value is using Perpetuity Growth methods, by multiplying free cash flow with (1+perpetuity growth rate), and then divided by WACC minus perpetuity growth rate. The perpetuity growth used in this calculation is 6% (PT Semen Indonesia) and 12,3% (Thang Long Cement Vietnam).

Table 3. Terminal Value of PT Semen Indonesia

Table 4. Terminal Value of Thang Long Cement Company

Present value (PV) of free cash flow is calculated by multiples the free cash flow each year with the discount factor. This relates to calculate the enterprise value.

Table 5. Enterprise Value of Thang Long Cement

Table 5. Enterprise Value of PT Semen Indonesia

The acquisition price then compared to the enterprise value of Thang Long Cement Company. The value shown in Table 6 is based on scenario 1, that is the value of Thang long Cement Company as an individual company before acquired by PT Semen Indonesia. The result of undervalued price in the acquisition process between PT Semen Indonesia and Thang Long Cement Company is not a bad thing, because of several things as explained below:

The economic condition in Vietnam for recent years which lead investors to keen on buy ownership shares in lower prices

Thang Long Cement Company needed to have major restructuring to survive. Being acquired by one of leading cement companies is likely a benefit to continue its business.

Acquisition Price $ 157.000.000,00Enterprise Value

$ 186.000.000,00 (Thang Long Cement)

Table 6. Acquisition Price and Fair Price of Thang Long Cement Company

By having the three different scenarios analysis, the author suggested the company to choose strategy 3 to be implemented. One year after the acquisition, Thang Long Cement must keep up the good work to optimize their sales which will generate its revenue. The company should increase the production capacity as soon as possible, in order to gain the positive revenue growth.

Figure 14. Potential Revenue From Thang Long Cement Company Capacity Expansion

Another strategy is to market export diversification. The growth in exports capacity is driven by existing plant expansion and also new cement players who build its business in Indonesia. The export destinations are Bangladesh, Sri Lanka, South Africa, and some countries in Middle East. By assuming the positive growth on expansion capacity, the growth on cement exports also predicted to be rising up through years. Indonesia can compete more in Southeast Asia region while the market will become more excessively tight between another strong competitors from another countries such as Thailand, Malaysia, Phillipines.Thang Long Cement Company Vietnam will be expanding its production capacity and the product can be exported to another country that has potential cement market requirements. Last year, the country’s total cement output was 70 million tons. Majority amount of the product was sold for domestic supply and international markets, with an increase of 14% from last year. Vietnam should also try to diversified its market export as a result of tough competition in domestic market.

Figure 15. Vietnam Cement Exports

4. Implementation Plan

Thang Long Cement’s existing plant is in north of Vietnam, and the new plant can be build on the south of Vietnam. The capacity of the new plant assumed to be around 1,5 million tons per year. So, the overall capacity of two plants can be reached 4 million tons per year. The investment for the new plant is estimated to be around $250 to $300 million, most of which will be sourced from bank loans. To establish a new factory under the supervision of TLCC, however, Semen Indonesia will take the demographics of Vietnam into account, considering that the market in Vietnam is divided between North and South Vietnam, which the market in South Vietnam is better than the North, but the supply is dominated by North Vietnam.

No. Strategy Actions To Be TakenI II III IV I II III IV I II III IV

1 Capacity Expansion Funding Preparation (Investment)Preparing For Construction

Building The New PlantFinishing and Installment

2 Market Export Find the potential marketsPreparation before shipping time

Shipping products

Year 1 Year 2 Year 3

Figure16. Schedule of Expansion Implementation Plan

When the company already expands capacity, there will be also several risk that may occur. Besides the economic and market growth condition that only can be predicted, but still we cannot get the real overview. The proposed strategy in this final project has different risk that should be described so the companies can prepare early mitigation when it’s coming.

No. Strategy Possible Risk Mitigation Competitive pressures Regular audit

1 Capacity

Expansion Legislative and regulatory developments Compliance audit

Global, macroeconomic and politic trends Risk assesment

Fluctuatios in currency exchange rates and financial market condition Risk assesment

Technical developments Clear procedures

Natural disasters Potential impact assesment

2

Payment failure Pre-shipping payment / Letter of Credit

Market Export Shipping Delay Time estimation

Global economic downturn Risk assesment

Figure18. Possible Risk and Mitigation Strategy

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