Just about one year ago, Egypt was at the centre of attention. Sparks of discontent had ignited the passions of the masses in the Middle East, and revolutions toppled once well-seated regimes in Tunisia, Egypt and Libya. Investors particularly looked at Egypt, which is one of the region's main economic powers, with an active stock exchange, and a nation in control of the strategically important Suez Canal. At the height of the protests around Tahrir square in Cairo, the Egypt stock exchange was closed for several weeks and trading of depositary receipts and ETFs (EGPT) (EGYP), which was still ongoing, was very volatile. Paradoxically, the interest in Egypt's stock market was at its highest when it was closed. There were quite a few articles published on this website focusing on the Egyptian market at the time, and CNBC even reported live from the Cairo stock exchange on the day it was reopened. But as soon as trading was going again, interest quickly faded. It has come to the point where some blue chips now trade at prices that were last seen during the sell-off panic at the beginning of the revolution.
One such company, and one of the main blue chips of the Egyptian market, is Orascom Construction Industries (ORSCY.PK). It currently has a market capitalization of around $8.4 billion, and its ADRs and GDRs are traded on main bourses such as London or New York. Orascom Construction is one of the companies of the Orascom conglomerate founded by Onsi Sawiris, and which has been divided among his heirs. The development of hotels and resorts, Orascom Development, is headed by Samih Sawiris. At the telecommunications company, Orascom Telecom (ORSTF.PK), the family recently struck a deal with the Russian telecom giant Vimpelcom (VIP). The construction business, which was the founding pillar of the Orascom empire, is run by Nassef Sawiris (CEO), while Onsi Sawiris remains chairman of the group. In 2007-2008, Orascom Construction sold off a main part of its business, the cement operations (Orascom Cement) to one of the main global cement companies, Lafarge (LFRGY.PK). The sale netted Orascom a total amount of 8.8 billion Euros, which the company used to pay a massive total cash dividend of 300 EGP per share (in case readers would wonder about the huge drop of the share price in 2008).
The businesses retained by Orascom Contruction were the construction and fertilizer businesses. The construction part of the group is one of the top global contractors for large commercial, industrial and infrastructure projects. These operations are complemented by investments in manufacturers of steel products, glass, paints and steel pipes. The fertilizer part of the group has shown impressive growth during the past years, and mainly produces and sells nitrogen-based fertilizers.
The revenues and earnings from the fertilizer group rose from only 35% of total EBITDA in 2009 to currently nearly 70%. The construction business remains important ($6bn of backlog as of Q3 2011), but the fertilizer business is currently the main driver of the group and the name "Orascom Construction" no longer seems fitting. Also, the lower valuation the market currently gives to construction and contracting companies is leaving the shares undervalued. As a remedy, the management of Orascom Construction recently proposed a separation of the group, via a spin-off of the construction part of the group. Orascom Construction would become a pure fertilizer company (and most probably change its name), while a new entity containing the construction businesses would be created and its shares distributed to shareholders as well as ADR/GDR holders. This would allow both units to have a better focus on their respective businesses, and hopefully lead to a more adequate valuation by the stock market. In my view, both businesses face good prospects. As a contractor for big industrial and infrastructure projects, Orascom is well-positioned to profit from (re)construction projects in the Middle East and Africa. (Many parts of the infrastructure of neighbouring Libya have been destroyed and need reconstruction, Libya is oil-rich and has the means to pay. Also, the discontent across the region came in a large part from unemployed youths, and infrastructure projects are a well-established tool of governments to reduce unemployment). The fertilizer business, for its part, is of course driven by global food demand, and especially in the MENA (Middle East and North Africa) region which experiences high population growth rates.
What is the current valuation of Orascom Construction? At a market value of around $8.4bn (corresponding to about 40$ per share), the shares are changing hands at about 2.8 times book value, 5.6 times EBITDA and 11 times earnings - based on the Q3 2011 numbers. Taking a longer time frame (average of the last ten quarters), these numbers are 7.6 times EBITDA and 14 times earnings. Not a very demanding valuation given around 30% annual growth in EBITDA and net income over the past ten quarters, and a dividend yield of 5% (based on last year's payout of $2.10 per share).
The fact that the construction business has remained stable (which in itself is remarkable given the financial crisis) has masked the growth of the fertilizer business. While the growth in overall earnings and EBITDA over the last ten quarters has been very good, the EBITDA from fertilizer has grown by an impressive 65% annualized over the past ten quarters, more than double the growth of total EBITDA. At takeover multiples of seven to eight times EBITDA (like the valuations given to CF Industries (CF) and Terra (TNH) during the takeover battle with Agrium (AGU)), the fertilizer division of Orascom construction could be worth as much as the entire current market capitalization. This leaves you with the global contractor and its ancillary businesses with $450m in annual EBITDA 'for free'.
The press release announcing the intent to spin off the construction business was released late last year around Christmas time (Dececmber 21st) and has probably been really noted by the market only recently (the shares have been rallying since the start of the year). Unfortunately the writing of this article has been delayed by a few weeks, so the shares are not as cheap anymore as they were at the start of the year. However, I believe they are still attractively priced.
- The spin-off of the construction business will leave a pure fertilizer group of a large size that will be on the radar of equity funds focused on the food and agriculture sectors. It is likely that the fertilizer business will trade on multiples comparable to other major nitrogen fertilizer companies, and may also be the subject of a takeover bid by a global fertilizer company like Agrium , Potash (POT), Mosaic (MOS) or Yara (YARIY.PK).
- The construction group has a good order backlog and a solid position in the market, as well as interesting stakes in various manufacturing businesses related to construction. It should trade on valuations comparable with other major international contractors. Recent international M&A activity in the sector could be a boost.
- The political landscape in Egypt remains a risk. There are clearly tensions between Muslim and Christian communities, and the Sawiris family belongs to the Coptic Christian minority. I do not believe that this is a major issue, but potential investors should be aware of this fact.
Disclosure: I am long ORSCY.PK, MOS. I am long Yara International ASA and a shareholder of a company that has a very significant holding in Lafarge SA.
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