Mergers and acquisitions are an easy way to create economic value for shareholders in theory, but notoriously hard to do in practice. The merger of the two military-owned cement companies in Pakistan – Fauji Cement and Askari Cement – should have been a relatively easier one to manage, and in many ways, it has been successful in achieving its aims of generating shareholder value.
The simplest way to measure the success or failure of a merger – at least in the case of publicly listed companies – is whether the market value of the company in question increased. On that score, the merger of Fauji Cement and Askari Cement is unquestionably a success. On the eve of the merger, Fauji Cement’s market capitalization – the total value of the company – was Rs17.7 billion, and it paid Rs27.3 billion to acquire Askari Cement in an all-stock deal, implying a combined value of Rs45 billion at the close of the transaction. The market capitalization of Fauji Cement as of the close of trading on Friday, October 18, 2024 was Rs70 billion, implying that the company is currently valued at considerably higher than the entity at merger.
If one were inclined to be uncharitable, one might argue that stock prices alone are not a great way to determine whether a merger was accretive (created value) or dilutive (destroyed value), since stock prices can be volatile and dependent on the vicissitudes of the market that go beyond just the intrinsic value of the company itself.
A better set of metrics might be to explore the operational performance of the company to see if it is doing better than its combined predecessors, since that would judge the company on whether it achieved the core drivers of value in the first place: increasing revenue, reducing costs, improving overall profitability. Even on that set of metrics, it is hard to argue that the Fauji Cement merger with Askari Cement was anything other than a success.
But before we dive into those metrics, let us first examine the history of both of these companies, why the merger happened in the first place, and then examine the extent to which it succeeded in creating shareholder value.
A tale of two military-owned cement companies
Askari Cement is the older of the two companies, having first been established in 1980 under the name Associated Cement. In 1993, the company was renamed Wah Cement Company, and in 1997, it became Askari Cement Company. It was the smaller of the two entities, with two production plans located in Wah, a suburb of Rawalpindi, and in Nizampur, a small town in Nowshera, Khyber-Pakhtunkhwa. Both factories have a combined production capacity of 2.68 million tons per year.
Fauji Cement was the newer of the two companies, having been established in 1992 as the Potohar Cement Company though its name was quickly changed to Fauji Cement Company in 1993. The company’s sole production facility is in Fateh Jang in Attock, Punjab, and has a production capacity of 3.5 million tons per year.
Both of these were fairly ordinary cement companies that rode the wave of the Musharraf-era boom in cement manufacturing that saw the country nearly triple its production capacity from 15.5 million tons per year in 2001 to 45.3 million tons per year by 2010. In the nearly decade and a half since then, production capacity has nearly doubled again, to 83.1 million tons per year, according to data from the All Pakistan Cement Manufacturers Association (APCMA).
So why the merger? Well, it was always a strange thing that they were separate companies to begin with. Both were majority owned by the Fauji Foundation, the charitable foundation originally established in 1954 with seed capital left behind by the British government to serve the needs of British Indian Army veterans of World War II.
In 2020, Waqar Ahmed Malik, the former CEO of ICI Pakistan (back when it was a subsidiary of the British industrial multinational conglomerate) became the first civilian to become the CEO of the Fauji Foundation and he set out about implementing a plan to simplify and modernise governance in the military’s industrial interests.
The two military-owned cement companies were not the only ones to be merged. The two fertilizer manufacturers owned by Fauji Foundation also completed their merger just last month. The two food companies have also consolidated into a single structure. In all, the military now owns the same assets through a smaller set of corporate entities, likely significantly simplifying corporate governance.
In the case of the two cement companies, however, it was not just a case of combining management structures. Immediately following the merger, the combined Fauji Cement Company embarked on a significant expansion of its production capacity by opening up a facility in Dera Ghazi Khan that can produce up to 2 million tons per year, and came online in February 2024. Aggregate cement production capacity for the company has now hit 9.3 million tons per year.
Once the merger was finally finalized at the end of 2021, it was expected that Fauji Cement would become the third largest cement manufacturer in terms of capacity after Lucky and Bestway. The company also commanded a hefty market share of around 13% and there was an opportunity to expand into markets both local and international. In relation to the industry, it seems that Fauji has moved the needle in terms of its past performance, however, there is still much to be desired in relation to its competitors.
Synergies realised… sort of
The merger was designed to capitalise on cost efficiencies, but the devil, as always, is in the details. Financial metrics indicate that Fauji Cement has indeed improved gross margins from 25% in 2021 to 32% by 2024, a positive sign of reduced costs. Operating margins have similarly climbed from 20% to 25% during the same period, suggesting the company is doing a better job at managing operational expenses. But there’s a catch: net profit margins fell from 14% in 2021 to 10% in 2024, well below the 12% benchmark set in 2019.
What’s dragging profitability down? Interest rates and taxation. Pakistan’s high interest rates have made servicing the combined company’s debt expensive, eating into profits. Higher taxes have also taken a toll, exacerbated by rising revenues that push Fauji into higher tax brackets. While the merger did achieve some cost savings, these external factors have limited the company’s ability to fully reap the benefits.
Compared to competitors like Lucky Cement, which has seen net margins rise from 22% to 24%, and Cherat Cement, whose margins doubled from 12% to 24%, Fauji’s margins have not quite kept pace. It perhaps does not help that its expansion plans were financed almost entirely through debt. As of June 2021, the company held very little long-term debt, less than Rs0.5 billion. But it added about Rs19 billion in 2022 in order to finance the expansion.
That expansion, however, has yet to result in significant increases in revenue. While production capacity has increased, Fauji Cement has yet to begin utilizing that capacity, and hence it finds itself in the position of paying interest on debts taken on to fund a project that is not yet yielding cash flows, at least not meaningfully.
That may be judging the company a bit harshly, though. The latest financials available are from June 30, 2024, and the Dera Ghazi Khan plant only came online in February, barely enough time to make a dent in total production. It does not help that this production came online at a time of record inflation and interest rates, meaning that the level of construction activity taking place in the economy is considerably constrained.
Indeed, Fauji produced less cement in 2024 than its predecessor entities combined produced in the financial year ending June 30, 2022. The recession, in short, has hit the company hard just as it had taken on a massive debt-financed expansion plan. At one point or another, every Pakistani cement manufacturer has been hit with overcapacity issues, and they usually come at the inopportune time when interest rates are high. Fauji had managed to escape that cycle during the 2008 financial crisis. It appears it is now the company’s turn to live through this.
Rivals have been more adept at turning operational efficiency into bottom-line success, leaving Fauji playing catch-up.
Exports: slow growth
One of the key goals of the merger was to boost exports, particularly to neighbouring Afghanistan and Central Asian markets. Before the merger, Fauji Cement exported Rs72 crore worth of cement in 2017. By 2024, this figure had risen to Rs 6 billion—an average growth of 24% annually. While this growth is commendable, it pales in comparison to the explosive export gains seen by competitors. Cherat, for example, saw exports grow by an average of 64%, while Attock Cement’s exports ballooned from Rs 3 billion in 2017 to Rs 11.4 billion in 2024, a 54% increase per year.
Even in relative terms, Fauji’s export growth has been sluggish. Exports as a percentage of total sales have crept up from 2.6% in 2017 to just 6% in 2024. By comparison, Cherat now derives 10% of its sales from exports, while Attock has managed to lift exports to a striking 31% of its total sales. The gap is even starker in the first quarter of 2024, where Fauji saw a 12% decline in exports, while competitors like DG Khan and Lucky Cement posted export increases of 98% and 84%, respectively.
The tepid export performance underscores the fact that, while Fauji Cement has grown its international presence, it has not kept pace with competitors who are increasingly relying on foreign markets to offset falling local demand. Cement manufacturers across Pakistan are shifting their focus to exports to counteract domestic market challenges, and Fauji’s relatively slow growth in this area could limit its potential in the long run.
Conclusion
Has Fauji Cement’s takeover of Askari delivered on its promise? The short answer: partly. The company has made undeniable strides in improving its gross and operating margins, suggesting that some of the hoped-for synergies have materialised. But external pressures, particularly rising interest rates and taxes, have blunted the impact of these efficiencies on net profits.
On the export front, the company has seen growth but lags significantly behind more aggressive competitors. This underperformance in international markets raises concerns about whether Fauji Cement can fully exploit the potential of its larger scale.
In a highly competitive market where rivals are nimbly adapting to both local and international challenges, Fauji Cement has shown it can walk—but has yet to prove it can run. As the industry continues to evolve, the company will need to quicken its pace if it hopes to unlock the full potential of its merger. Otherwise, what was once seen as a bold move to consolidate and grow could instead turn into a cautionary tale of unrealised promise.
