Breaking up Semen Gresik

Breaking up Semen Gresik

The government's decision last week to break up Semen Gresik's
three cement units will automatically void its three-year
conditional sale and purchase agreement with Mexico's Cemex
company, scheduled to expire on December 14, and raise serious
doubts about the government's ability to honor its contract.

The government nevertheless hopes the new deal would meet the
aspirations of the politicians in South Sulawesi and West Sumatra
who have demanded the total separation of the Tonasa and Padang
units from Semen Gresik, but would still honor part of its
commitment to Cemex by allowing it to increase its shareholding
in Semen Gresik to 76.50 percent.

But the new proposal shows how easily the government has
acquiesced to pressures from provincial legislators. Whatever the
outcome of future negotiations between the government and Cemex,
it will affect the credibility of the whole privatization
program, especially because most of the prospective state
companies for divestment to private investors are resource-based
ventures located outside Java. Now that W. Sumatra and S.
Sulawesi politicians have 'tasted blood', state companies in
other provinces will be vulnerable to similar pressures.

Under the proposed deal, which has yet to be approved by the
investing public and Cemex which make up the 41 percent
shareholders of Semen Gresik, the government will sell its 51
percent stake in Semen Gresik to Cemex but at the same time will
acquire a majority stake in Semen Gresik's Tonasa and Padang
cement units. If the deal goes through, Cemex will hold 76.5
percent of the Semen Gresik unit and the investing public 23.5
percent. But the Gresik unit will still own 49 percent of both
the Tonasa and Padang units, with the majority 51 percent held by
the government.

The proposed deal is substantially different from the put
option under the 1998 agreement whereby the government will have
the right to sell to Cemex its 51 percent stake in Semen Gresik
and Cemex will be obliged to take that stake at the agreed price
of US$1.72/share or for a total of $520 million or almost three
times as high as the Semen Gresik price quotation on the Jakarta
Stock Exchange last Friday. But the Semen Gresik under the put
option is supposed to have three cement units with a combined
capacity of 17.25 million tons, while the new proposal offers
only the Gresik unit with 8.2 million metric ton capacity as the
Tonasa unit with 3.48 million tons and the Padang unit with a
5.57 million ton capacity will become government-controlled
stand-alone companies.

It is too technical to analyze here the formula of net present
value of discounted cash flows used by Laksamana to come up with
a net income of $200 million after the whole deal is completed.
But the value of the government's 51 percent stake in Semen
Gresik under the new deal is certainly not as high as $520
million because the efficiency and market competitiveness of an
8.2-million ton plant is certainly much lower than a 17.25-
million ton group. The new deal will forgo the economies of scale
and synergy in marketing, procurement, information technology,
accounting, management, which would otherwise be gained by Semen
Gresik with three units.

Given Cemex's great interests in the long-term outlook of
Indonesia's economy -- in fact it was the only foreign investor
willing to make the plunge, investing in the country in 1998 amid
the height of its political and economic crisis -- it may still
be interested in increasing its stake in Semen Gresik even after
the split up.

The most crucial factor, though, is what will be the legal
arrangements to be put in place to ensure that Cemex-controlled
Semen Gresik's 49 percent stake in the government-controlled
Tonasa and Padang units will be managed well. This condition
makes a lot of sense as almost all state-controlled firms in the
country are notorious for their high vulnerability to corruption,
collusion and nepotism.

Semen Gresik's consolidated financial report for 2000 showed,
for example, that Semen Padang and Tonasa were the worst
performing of the three cement units in almost all parameters of
efficiency (costs of sales, profit margin, production and
marketing performance, material and product prices).

Predictably, Cemex also will like to know how the government
will go about securing smooth execution of the proposed deal in
the two provinces.

The whole proposed deal could end up in tatters if the
government fails to force the politicians in the two provinces to
accept the transaction and if Cemex is not given a significant
role in securing efficient management of the two cement units.