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Equity Commentary - CCNN Plc: Downgrade to SELL due to material dilution

• Late yesterday, we received the scheme of merger document which finally provided the much-needed clarity required on the expected dilution to shareholders of CCNN from the proposed merger of Cement Company of Northern Nigeria (CCNN) and Kalambaina Cement Company Limited (Kalambaina) – a wholly owned subsidiary of BUA wherein the new cement plant (1.5MT) in Sokoto sits. The consideration now signals a substantial dilution for minority shareholders following an unexpected premium on the construction cost infused in intangibles of N207.3 billion. Management is proposing shareholders meeting to be held on the 29th of November 2018, wherein shareholders are expected to approve the terms of the merger.
• In our earlier report on the proposed merger published in July 2018 following the press release by management on the share conversion ratio (See report: ), wherein we adopted a net asset valuation approach in valuing the $350 million construction cost using prevailing exchange rate of N360/$ (Scenario 1) and average exchange rate over the 3-year construction period of N251/$ (Scenario 2) which translates to asset value of N126 billion and N87.9 billion respectively. To our surprise, while the addition to property, plant and equipment (PPE) from the proposed scheme was not too far from our estimates, the management included an additional value of the sale in goodwill. For context, the enlarged CCNN post-merger PPE is expected to increase by N107.5 billion – implying that management adopted an exchange rate of N307/1$ in treating the construction cost of $350 million – to N119.8 billion. However, the enlarge CCNN’s intangible assets increased to N207.3 billion from just N499 million in FY 17.
• Any ‘STEW’ for minority shareholders. Recall, management of CCNN announced the consideration for the merger will be based on 100,000 shares of Kalambaina for 19,811,372 shares of CCNN (1:198) using the 30-day volume weighted average (VWAP) closing price of N25.99. Examining the impact of the proposed consideration on shareholders, using our estimated proposed conversion cost of N308.9 billion and overlaying that on the VWAP, we arrived at additional shares of 11.9 billion (in line with the scheme of merger document) which cascades total shares outstanding to 13.1 billion from current of 1.3 billion. Thus, we see a significant dilution to shareholders from the proposed consideration of the merger.
• Volume consolidation ahead of merger. In our recently published cement sector report (See report: ), we stated that the cement volumes reported by CCNN was inclusive of sales from Kalambaina. True to our words, the scheme of merger revealed that the reported revenue of N12.1 billion (+425 YoY) over H1 18 is that of the enlarged CCNN. For context, our suspicion was on the back of the estimated volume over H1 18 of 284,454 tons, which suggests that remaining expected production from the plant for H2 cannot exceed 215,546 tons to sum up to the expected annual capacity of the plant of 500K ton. However, using our H2 17 and H2 16 estimate of 264,496 and 263,808 tons respectively, we believe it is unusual for the plant alone to have produced so much in H1 18.
• While we maintain our volume and earnings expectation for the company over 2018 and beyond, the increase in shares outstanding informed a material adjustment to our FVE to N17.01 from previous estimates based on our expected 6.10 billion shares of N28.47, which translates to a SELL rating on the stock. CCNN trades at a current P/E and EV/EBITDA of 5.9x and 3.65x relative to Bloomberg Mena peer average of 9.31x and 17.32x.
• Management is proposing shareholders meeting to be held on the 29th of November 2018, wherein shareholders are expected to approve the terms of the merger.