Investment: Aggregation of AI and Tarmac is solid logic

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The Independent Online
TALKING ABOUT consolidation in a business based on crushing stones may seem a bit of a contradiction. But yesterday's announcement that Aggregate Industries and Tarmac, the two building materials producers, are talking about a merger makes rock-solid sense. A combined group would be the UK's largest producer of aggregates - materials used in road building and heavy engineering - with sales of about pounds 1.7bn and a market value of more than pounds 1.4bn.

More important, in a market where the weight of the product makes transportation difficult, it would have a wide geographical spread, enabling it to serve virtually every corner of the country.

The economies of scale and enhanced pricing power would help AI-Tarmac push the current anaemic margins higher. And if UK construction and civil engineering were to be dragged down by an economic slump, the new entity could exploit a healthy presence in the US where demand is booming.

This logic was not lost on the market, with Tarmac shares jumping 16 per cent to 93p and Aggregate Industries up 12 per cent at 63.5p. But the road to a link-up is far from smooth.

For a start, Tarmac will have to get rid of its construction division, which has been a real drag on its share price. Despite its poor margins and dwindling returns, Tarmac's management has always maintained that construction is a core part of the group and a sale would be an amazing about-turn.

Second, the competition authorities are likely to water down the merged group's dominance of the UK market by requiring disposals in some key product areas. The example of Bardon and Camas - which merged to form AI - suggest that cost savings will be limited to pounds 15m.

But if AI and Tarmac were to consummate the merger, the shares - on a forward multiple of around 13 and eight respectively - would look very cheap. A good speculative buy