From Asia Times

Jun 2, 2006

Indonesian cement deal cracks open
By Bill Guerin

JAKARTA - Cemex SA de CV, the world's third-largest cement maker, and Indonesia are parting ways after a bitter, protracted contractual dispute. The Mexican cement maker's hurried departure sends another cautionary signal to the foreign investors President Susilo Bambang Yudhoyono is now trying to lure into the country.

Yudhoyono had promised to resolve the issue quickly on taking office in October 2004, but has met a wall of resistance from local-level authorities. Recent reforms promoting local autonomy have greatly limited his ability to intervene in the workings of West Sumatra province, where Cemex has been embroiled in an ownership conflict with the local administration for a local cement plant since 2000.

The province's unorthodox grab for Semen Padang, a subsidiary of a publicly listed cement company, represents one of the biggest tests yet for Indonesia's decentralization reform drive, which aims to devolve more decision-making authority to the local level. If the Cemex case is an indication of how Jakarta and emboldened regional administrations will share power in the future, then foreign investors aiming to do business in the country's resource-rich hinterlands should definitely beware.

Leaders of West Sumatra's staunchly Islamic provincial legislature, the governor and top management in Semen Padang took the law into their own hands five years ago, insisting they had the legal power and right to take over the locally run subsidiary of the publicly listed PT Semen Gresik, Indonesia's biggest cement producer. After years of protracted negotiations and failed attempts to control the subsidiary, Cemex in May agreed to sell its 25% stake in Semen Gresik to the Rajawali Group for about US$337 million.

The 1998 sale-purchase agreement, however, stated that Cemex could only sell its shares if the government agreed. Predictably, perhaps, the government is resisting on nationalistic grounds. Coordinating Minister for the Economy Boediono and Minister of Finance Sri Mulyani Indrawati have pointed out there is no money in the 2006 budget for the state to exercise its right of first refusal to buy out Cemex's stake.

But State Enterprises Minister Sugiharto, who has demonstrated a general disdain for privatization, has insisted that a consortium of state-owned enterprises would act on behalf of the government to acquire the shares in a bold bid to scupper the deal between two private enterprises. Cemex has declined that offer, and it's unclear exactly what will happen next.

Messy from the start
The Cemex deal was messy from the start. When the 1997-98 financial crisis hit, Cemex was one of the few foreign companies willing to pour new money into Indonesia's ravaged corporate landscape. In 1998, Cemex anted up US$500 million for a 25% stake in Semen Gresik, one of the 12 companies the government had agreed to privatize as part of an International Monetary Fund bailout and structural-reform program, which aimed to generate cash for depleted state coffers and open the economy to more foreign participation.

Under that arrangement, Cemex was offered the right to buy a 35% stake from the government and a further 16% from the public, which would have given Cemex the 51% majority control it desired. That arrangement, however, quickly came unraveled. The political backlash against the government's privatization program, which aimed to transfer the management and ownership of local enterprises from powerful Indonesian tycoons to foreign investors, combined with the chaos of decentralization measures, quickly embroiled Cemex in nettlesome sovereignty issues.

The Padang community (Padang is the capital of West Sumatra province) opposed the Cemex deal and demanded that Semen Padang should not be considered part of Semen Gresik on the grounds that it would be controlled by foreigners. The plant's managers and 2,400 workers fought vigorously to have the local plant's operations spun off as an independent state-owned enterprise, aimed at restoring the status it enjoyed before a government-ordered merger with Semen Gresik in 1995.

Under pressure, Jakarta reneged on its original offer and invited Cemex to a new deal where the government would first sell it a mere 14% stake. The sweetener was a three-year put-option agreement that would gradually allow Cemex to take a majority stake. With that understanding, Cemex agreed to buy the 14% stake for US$114 million, which at the time represented a whopping 112% premium over the company's market share price.

In 1999, Cemex bought another 11% of Semen Gresik's shares through open market transactions, raising its stake to 25.53%. Under the agreement, Cemex then had the right to buy the state's remaining 51% stake for $520 million, or around $1.72 per share, at the time nearly three times Semen Gresik's market share price.

The put option, however, guaranteed a purchase price of $1.38 per share for the government's remaining shares. Semen Padang management, backed up by the provincial executive and legislature, was put off by the put option's low price. The hasty implementation of the regional autonomy law in 2001 had sharply devolved public and bureaucratic power from the center to the periphery, and the terms of the Cemex deal gave Padang legislators and power brokers nationalistic cause to flex their new muscles.

In November 2001, the legislature passed a decree expropriating Semen Padang until it could be separated from Semen Gresik and, by its own reasoning, was no longer subject to the government's original deal with Cemex. The declaration, signed by the Indonesian Council of Ulemas (MUI) and the Association of Indonesian Muslim Intellectuals (ICMI), gained unanimous support from the 13 factions present.

Controlling only a minority of board seats and faced with the legislature's resistance, Cemex was unable and unwilling to institute the profit-boosting measures it deemed necessary, including new investments in distribution. In January 2004, Cemex finally sought legal redress for breach of contract against the government, including arbitration proceedings at the International Center for Settlement Investment Dispute (ICSID), a Washington-based affiliate of the World Bank.

Foreign domination
In retrospect, Cemex picked the wrong target for acquisition. Since the late 1990s, four of the world's top cement producers, including Cemex, have taken significant stakes in the Indonesian cement industry, which is expected to grow robustly in the coming years.

World cement giants Holcim, Heidelberger and Lafarge each have controlling stakes in Semen Cibinong, Indocement, and Semen Andalas, respectively. Together with the Semen Gresik group, including PT Semen Padang and PT Semen Tonasa, foreign players dominate the industry and account for 93% of national cement production.

Switzerland's Holcim Ltd, the world's second-biggest cement maker, controls PT Semen Cibinong, the third-largest cement producer in Indonesia. Holcim acquired majority control of Semen Cibinong through a complicated restructuring agreement, which saw Holcim pump more than $300 million into the company and assume responsibility for some of its debt obligations in return for its majority stake.

Holcim's two factories in Narogong and Cilacap, with a total production capacity per year of 7.9 million tonnes, account for 16% of Indonesia's cement market. It plans to build a new cement plant in Tuban, East Java, at an estimated cost of $300 million and with a capacity about 3 million tonnes per year. Heidelberg Cement AG, Germany's largest cement company, paid $300 million for a controlling stake in PT Indocement Tunggal Prakarsa, Indonesia's second-biggest cement producer in terms of sales.

Analysts are now forecasting boom times for local cement producers, after several years of decline. Domestic sales tallied 31.5 million tonnes last year, up 4.9% from the previous year. They also note Indonesia consumes considerably less cement per capita than regional neighbors such as Thailand and Vietnam.
Industry experts predict that planned new housing projects and infrastructure development needs assessed at about $170 billion over the next 10 years will drive strong future sales and investment growth. Post-tsunami reconstruction in Aceh province will create a peak annual demand of up to 800,000 tonnes of cement by the end of 2007, and a national cement deficit is predicted from 2008 onward.

Monopoly risks
The anti-monopoly group Monopoly Watch has expressed its concern that the increasing foreign domination of Indonesia's cement sector could lead to a market-manipulating cartel, which could in turn lead to uncontrolled soaring prices. The nationalistic argument for some government control over the market, from a regulatory point of view, would then appear to have some merit.

But the way the government is handling the case is on national versus foreign lines. Parliament has recently pressed the government to maintain its majority ownership in Semen Gresik, ensuring that Minister Sugiharto's plan to purchase Cemex's stake and scupper the deal with the Rajawali group will likely get political mileage and financial backing.

At the same time, scrapping a contractual agreement with a major foreign investor will beg big questions about the sanctity of Indonesian contracts and represent a big blow to Yudhoyono's professed pro-foreign-investment credentials. Foreign investors, it seems, were already uneasy about upcountry rumblings. Foreign direct investment approvals through April were down by 36% from the same period last year, falling to $3.14 billion from $4.93 billion. The signal from the Cemex debacle has already triggered alarm among resident investors, particularly among those that do business in the provinces.

Cemex has already declined Jakarta's proposal to buy its stake in Semen Gresik, pointing out in a letter that the proposal went against the original 1998 deal where Cemex first bought a 14% stake in the company. Minister Sugiharto has warned that the government would refuse to approve the Rajawali transaction if Cemex ignores Jakarta's request to end the arbitration case at the ICSID. But as the conflict grinds on, it seems the only viable path to resolution would be some sort of outside mediation.

Bill Guerin, a Jakarta correspondent for Asia Times Online since 2000, has worked in Indonesia for 20 years, mostly in journalism and editorial positions. He has been published by the BBC on East Timor and specializes in business/economic and political analysis related to Indonesia. He can be reached at
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