Tanzania miscalculation that cost ARM cement billions of shillings

ARM Cement Ltd Managing Director Pradeep Paunrana during an interview with the Standard team at his Nairobi office. Photo by WILLIS AWANDU/STANDARD

It is early 2012 and Pradeep Paunrana is the richest man on the Nairobi Securities Exchange.

Together with his family, the billionaire is worth at least Sh15 billion. Paunrana, whose family is seen as the pioneer of Kenya’s cement industry, is plotting which other market to conquer.

Up to this time, the man who took over Athi River Mining (ARM) in 1984 from his late father (HJ Paunrana) had never made any miscalculation. He had grown to understand the cement business inside out.

After graduating with an MBA from New York University’s Stern School of Business, he returned home and toiled to put his father’s business on the regional map.

He prided himself in taking a path that few of his peers among the Asian billionaires in Kenya have had the courage to take- going public.

But it had to take 13 years from 1984 to 1997 before the family mustered enough courage to sell its shares to the public.

When he took over, his main goal was to transform ARM from a small producer of agricultural lime into a major publicly listed cement company. He seemed to have achieved this.

For eight years, his company’s turnover was growing at a cumulative average growth rate (CAGR) of 26 per cent. This was almost five times the underlying average GDP growth rate during that period for the region.

But this was not enough. His company needed a new challenge. He watched his firm’s share price soar 67 per cent from Sh42 in 2011 to Sh70 at the end of 2012.

This increase was also seen as an endorsement of its strategy by the market. It would continue enjoying this rise to hit a high of Sh85 the following year after its next expansion strategy was unveiled.

It was at this time that Paunrana went back to the drawing board, and started scouting for the next opportunity to expand his Rhino Cement. In any case, rhinos are large, strong, herbivorous mammals that cannot be contained in one small place, it has to expand. Its Rhino brand needed to conquer new territory.

At this time, the Tanzanian economy was growing faster than Kenya. Its cement consumption was growing at double digit per year.

Tanzania’s per capita consumption stood at 67kg, making it the second biggest market after Kenya. In 2012, every Kenyan was consuming an average of 92kg of cement a year, while a Rwandese was consuming 34kg. This was far from what an average cement consumer in Nigeria was consuming -- the Nigerian per capita cement consumption standing at 108kg.

As he looked at the numbers, the budding entrepreneur, was clear that the potential for further growth was still huge. All numbers he looked at on Tanzania looked right.

“The rationale was that Tanzania had strong growth in its economy. Cement consumption was growing faster than in Kenya at about 14 per cent year-on-year. In Kenya, the growth was about 9 to 10 per cent at the time.

"Tanzania had a lot of catch up to do as well. Market share was strong, prices were good and the country was under supplied,” Mr Paunrana told Weekend Business.

Since he did not want to miss the early advantage, he had to move to Tanzania. Besides, everyone wanted a piece of this growth and investors were fighting to throw money into this dream and it did not take long to secure Sh25 billion financing to drive its entry to Tanzania.

So he took the decision and by October 2012, ARM had completed and commissioned the Dar-es-Salaam grinding plant.

It followed this feat by launching the Rhino Cement brand in the market almost immediately and by the end of the financial year, it had grown its market share to 12 per cent.

But to secure the business in Tanzania, it had to invest into a clinker plant to support its raw material needs.

Limestone is one of the main raw materials for making cement, but before it is used to make the final product, it has to be crushed through the clinker plant.

“The strategy was to be visually diversified but having our own limestone deposit on which we are building our own clinker plant and converting that into cement. We did not just want a grinding plant with imported clinker,” Paunrana said.

The total investment that went into Tanzania for the two plants was Sh25 billion. This decision paid off, in the beginning. In its first year, the plant produced about half a million tonnes of cement. This made it at least Sh1.4 billion in earnings before interest and tax boosted the overall profitability of the company.  

Besides clinker, the plant was supposed to give ARM a significant cost advantage, with ability to increase market share and dislodge cement and clinker imports in the region.

It was fighting for market share with local players as well as imported cement that was at 15 per cent. But producing cement locally had numerous advantages and he knew that in a matter of time, he would run importers out of town.

The initial successes of the venture gave the firm the motivation it needed to go flat out in its strategy. Paunrana’s pride was evident when he presented that year’s financial report to shareholders.

The company was now worth Sh34.7 billion, and ranked 11th among the top listed companies on the Nairobi Securities Exchange. The group turnover had increased by 39 per cent to Sh11.4 billion from Sh8.2 billion in 2011.

Cement sales had grown by 64 per cent from increased market share in Kenya and Rwanda, and contribution of three months sales from Dar-es-Salaam which became operational in October 2012.

At the time, Paunrana held directly 89,680,000 shares in the company, which represented 18 per cent of the total. These shares were valued at Sh6.2 billion at the time, going by the market value of Sh70.

He was the second biggest shareholder in the company after his family-owned firm Amanat Investments Limited which had 137,481,245 shares, or 28 per cent of the shares. Together, the total value of the Paunrana family wealth was Sh15.8 billion. That was a lot of money in 2012.

The Tanga limestone deposit and the clinker plant location was meant to service some clinker needs in Kenya because Kenya is still an importing nation and it imports from as far as the Middle and Far East through the port of Mombasa.

“We are importing about 2 million tonnes between all the existing cement companies. All of us are still depended on imported clinker. We decided that by putting the plant in Tanga, we could meet our requirements for Kenya,” he said.   

By the first quarter of 2014, this dream was nearly accomplished before the business flew into its biggest storm that would later come to haunt its investment decision and test its managers to the core.

To an outsider, it was a sound strategy based on the full value chain, owning the limestone deposit, mining it, converting it to clinker, converting it to cement, to distribution.

“This was a big clinker plant, 1.2 million tonnes a year capacity, the expectation was that it would replace the imports that we were making in Dar-es-Salaam and also replace the imports we were making in Athi River.”

But several things went wrong.

In 2015, there was a general power shortage in Tanzania and this was partly because the Government had some dispute with the independent power producers who switched off their plants and there was some rationing. So its Tanga operation was affected.

The firm was unable to get power that it required to run this huge cement plant. ARM needed about 18MW but it was only getting between 6 and 9MW.

“We were therefore not able to run the plant at full capacity. We had to run our crushers in the morning and our mills in the evening and this affects quality and maintenance costs. So that meant that the increase in earnings we were expecting did not materialise,” Paunrana explained.

Meanwhile, the firm had borrowed a lot of money and it was unable to convert it into a long term bond. This was just the beginning of the firm’s problems.

In April 2015, the company was hit by a devaluation that cost it about 28 and 21 per cent of its value in Tanzania and Kenya, respectively.

“So we postponed going to the market until October. We thought that we could wait until October results and see the improvement,” he said. “But when we went to the market in October, Imperial Bank had just issued a corporate bond and it failed. So the corporate bond market dried up for everybody and interest rates meanwhile increased.”

That is what saw the firm turn to CDC, the development finance institution owned by the UK Government, to secure Sh14 billion equity investment. But it was not until the end of September 2016 that the CDC money hit the ARM bank accounts.

“So we paid off a lot of our debt and expected to move on with what was left and convert it into a long term tenure.”

The firm then put in place plans of increasing its capacities in Kenya based on the imported clinker from Tanzania. Another turbulence hit the firm when President Magufuli banned the importation of coal which meant all cement companies had to buy coal from one company.

“This one company did not have the capacity to supply all the coal needs for the cement industry. We were therefore starved of coal which is used in the manufacture of clinker,” Paunrana said.

But that was not their biggest battle.

ARM was then caught up in the battle between two cement giants -- Dangote and Heidelberg Cement -- that spilled over from West Africa.

“In West Africa, there are many overlapping countries where Dangote has moved into the traditional market of Heidelberg and Dangote’s strategy has always been to drop the price and hope for a market grab immediately,” he said.

But in Tanzania, it did not work out that way for Dangote because his plant is located at the bottom part of Tanzania whereas the main market is in Dar-es-Salaam.

Heidelberg plant on the other hand which produces Twiga Cement is located in Dar, where ARM is also located. So it had no transport costs. This left Dangote on the losing end of the cement price war. But he was not going to go down without a fight.

Heidelberg kept on dropping the price from about $120 (Sh12,423) per tonne in 2014 and by 2015, the price went down to $100 (Sh10,352). By 2016 when CDC put in the money in ARM, the price had shrunk to $88 (Sh9,110) and by end of May 2017, it was down to about $60 (Sh6,211).

“This was a battle of giants and we were all affected. At $60 (Sh6,211), we are not making any money despite the fact that we were struggling with production because of lack of coal.”

These challenges have dragged the company to post some of its worst financial results in history. For the past two years, it has posted losses of over Sh5.6 billion.

“This is what created the problem in the company. Nairobi is still making money but we were short of volume and had to subsidise Tanzania from Kenya and still repay bank loans from money we generate in Kenya on behalf of Tanzania.”

The company says it realised this problem early enough and started selling some assets that don’t make the cement part of the business. One of its main targets is its fertiliser business.

“The transaction documents have already been done and we expect its conclusion in December,” Paunrana says.

ARM says it is also talking to lending institutions to convert their loans into tenure money and give them some moratorium to reduce its cash outflows.

“We have also started a process to seek equity from strategic players and not another financial institution. We have a solid brand, good assets, a new plant and significant limestone deposits,” he says.

He adds that limestone deposit guarantees future growth of its business. “The strategic investor will be willing to pay the right price for our assets.”

The firm says the three main pillars of its turnaround are in restructuring its balance sheet, reducing its debt, but not at the cost of its shareholders. Many companies restructure their balance sheets when they are in financial distress.  

The firm says Tanzania’s situation has also improved and its plants in Dar-es-Salaam and Tanga are now back into operation. It says coal supply has been restored and prices have started improving.

“The Government of Tanzania has also banned the importation of clinker as well and this is positive for our Tanzanian market. We think that we are on the right track to repair the business and we are doing it in a way that is best for all shareholders,” he says.

In hind sight, Paunrana says the firm should not have built a big plant in Tanzania. “There were too many headwinds that created a perfect storm. But there is no point in regretting. CDC put in $140 million just last year. How could an army of experts from London also get it wrong? Nobody could predict this.”

This type of business needs a lot of capital and a strong balance sheet that can help it weather the storm.