~By Todd Callahan

~By Todd Callahan

Since 2000 national cement consumption has experienced a strong recovery and the sector as a whole is quite vibrant. Despite temporary declines on parts of Java and Bali, consumption is robust in Riau, Kalimantan, Papua and many of the outer islands. According to the Indonesian Cement Association, the industry enjoyed another high-growth year with domestic consumption topping just over 27 million metric tons in 2002. Another positive sign is that cement sales are now close to pre- crisis levels. Longer term, as the restructuring of the Indonesian economy continues, the industry can expect to benefit from even more growth. An important challenge for domestic producers is decreasing operating margins. Over the past four years, the production cost hikes at some companies have outstripped the increase in selling prices.

Beyond a slowly improving economy, one of the crucial factors driving the rejuvenation of the sector has been foreign investment, more of which the country urgently requires if it is to get back on its feet. Since the late 1990s, four of the world's top producers from Europe and North America have bought into the Indonesian cement industry. Their interest in Indonesia is a part of their overall strategy of diversification geographically into developing markets with high-growth potential. Three have already acquired majority shareholdings in Indonesian companies while the fourth, Cemex, has purchased a substantial minority position in the state-owned Semen Gresik Group. Below is a brief description of the activities of the four major multinationals active in Indonesia.

Germany's Heidelberger has acquired majority control of PT Indocement, once the country's largest private producer. Formerly an important asset in the Salim Group's portfolio of companies, Indocement was pledged to the Indonesian Bank Restructuring Agency (IBRA) to repay the government for its bailout of the Group's bank during the worst of the financial crisis. Heidelberger was named the winner when IBRA sought to divest its stakeholding in Indocement. This month an additional 3.89 percent of Indocement is expected to be sold to Heidelberger under an agreement that will net the government Rp200 billion. The put option sale will decrease the government's stake to 12.98 percent and raise Heidelberger's holding to 65.59 percent. Today Indocement boasts an installed production capacity of 15.65 million metric tons per year and a domestic market share of approximately 32 percent. Outside of Indonesia, Heidelberger operates in more than 50 countries worldwide.

Switzerland's Holcim acquired majority control of Semen Cibinong as a part of the Indonesian company's efforts to restructure more than US$1 billion in debts. Through a complicated restructuring agreement, Holcim agreed to pump over US$300 million into the troubled firm and assume responsibility for some of its obligations in return for a majority stake. Today Semen Cibinong has an installed capacity of 9.7 million metric tons per year and a domestic market share of approximately 13 percent. Outside of Indonesia, Holcim is active in more than 60 countries worldwide.

France's Lafarge acquired majority control of Semen Andalas after its takeover of Blue Circle. Although Lafarge has operated in Indonesia since the early 1980s, its holdings in the cement sector remain relatively modest. Semen Andalas is a small Sumatra-based producer with an installed capacity of approximately 1.4 million metric tons per annum and a domestic market share hovering around 4 percent. Outside of Indonesia, Lafarge is expanding aggressively and is active in more than 60 countries worldwide.

Mexico's Cemex owns a 25.5% holding in the state-owned Semen Gresik Group, which operates three units in East Java, South Sulawesi and West Sumatra. Although Cemex would like to acquire a majority stake in the firm, the sale has not occurred because of opposition from interest groups at the unit level, especially in West Sumatra. The government has not been able to force an extraordinary shareholders meeting at the Semen Padang unit to resolve the matter. Acting against central government authority, a local court in Padang has prevented the meeting from taking place. Since September 2002 the case has been awaiting a final decision from Indonesia's Supreme Court. On the matter of demands that Semen Padang and Semen Tonasa be hived off from the Semen Gresik Group, this would set a bad precedent that would almost certainly provoke claims for compensation from shareholders. Until the government as the majority shareholder is able to assert its control, privatization of Semen Gresik will remain unfinished.

Despite opposition from some quarters, all of these investments are sure to have a positive impact on the future development of the local cement industry. Prior to acquisition, many Indonesian cement companies lacked important elements of corporate governance and performance accountability. It is hoped that private investors will introduce higher levels of governance and management culpability. Another tangible way the industry benefits is from the worldwide trading networks of the global investors. Specifically, there will be more of an opportunity to export cement at a time when the local industry is still over capacity. Furthermore, foreign investors bring with them fresh capital and access to more sophisticated production and management information technology. This will boost competitiveness and modernize the domestic industry. Finally, despite concerns that these investments would exact social costs such as increased unemployment, there have been no significant layoffs at any of these companies. This was an argument grounded in fear. In fact, job security for the average worker at these companies is likely better today than it was before the acquisitions occurred.

With respect to concern these investments will lead to private monopolies that fleece the Indonesian people, the fear is genuine but it is being manipulated by vested interests. The foundation for this anxiety is that predatory monopolies were long a feature of Soeharto's Indonesia. Suspicion toward the private sector is comprehensible because examples abound of corporate Indonesia and SOEs acting against the interests of the people. That said, the foreign ownership equals monopoly argument does not hold up because monopolies ultimately cannot exist without the permission of government. In fact, the big four cement companies compete against each other all over the world. If the government focuses its attention on regulating industries, this is a non-issue. In the United States, as an illustration, more than 80 percent of the cement industry is in foreign hands but prices remain low because the regulation ensures fair competition.

On the matter of privatization, it is admittedly a controversial issue in Indonesia. Privatization itself is merely an economic prescription stemming from shock therapy and the view that the private sector was inherently good for parts of the world like Eastern Europe. It is understandable that government officials from any country that has or has had a significant public sector are hesitant to break iron rice bowls, confront unionized workforces and tackle interest groups. For the present government, there is the added risk that pushing a privatization like Semen Gresik too aggressively will make President Megawati vulnerable to political attacks in the run up to next year's election. That said, the economic argument in support of privatization is indisputable. If one wears a longer eyepiece and does good, comparative analyses, the evidence is clear that the government, industry, employees and other stakeholders would likely be better off if the Semen Gresik Group were privatized along the lines of Indocement.

The overall trend in the Indonesian cement industry is positive and strong growth is certain to continue as the country recovers. As a means to strengthen the domestic industry, foreign investors should be welcomed as partners and catalysts of change to enhance performance, ensure a competitive market and, not insignificantly, to spur additional investment and increase exports.

Consumption Statistics

Source: Indonesian Cement Association (ASI), other sources

Key Statistics: Indonesia's Four Leading Producers

Indocement Cibinong Andalas Semen Gresik Group Multinational Cement Firm's Stakeholding 61.7% * 77.3% 88.0% 25.5% Cement Production Capacity per Year (MMT) 15.65 9.70 1.40 17.25 Cement Production Volume in 2002 (MMT) 9.37 4.12 1.12 14.19 Domestic Sales Volume in 2002 (MMT) 8.73 3.52 1.11 11.86 Export Sales Volume in 2002 (MMT)

- Cement 0.86 0.96 0.00 2.27 - Clinker 1.44 1.60 0.00 0.35 Market Share in Domestic Market 32% 13% 4% 44%

* Stakeholding will increase to 65.59% pending completion of a put option sale.

Source: Indonesian Cement Association (ASI), other sources

Todd Callahan is a Senior Technical Advisor at PT Jasa Cita, a Jakarta-based research consultancy associated with CastleAsia.