PPG – Georgia Gulf Business Combination – Sensible

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As a stock research analyst I covered PPG for 7 years (from 1997 to 2004) and the one word that I would have used then to best describe the company and the management style was “sensible”.  Not flamboyant, or aggressive, or conservative, or inconsistent, or fantastic, or terrible.  Sensible was the right word then and it looks like it is still very appropriate today.  Chlor-alkali has been a bit of a headache for PPG for 10+ years; it is inconsistent with the rest of the portfolio and it has often been a distraction from the core strategy because of its margin volatility and lack of growth.  The analyst community has been calling for divestment for years.  To PPG’s credit, management has been patient and has resisted the pressure because almost every option open to them was likely to be earnings dilutive and cash flow dilutive – while not core, the business has thrown off a lot of cash.

Patience appears to have paid off, in that we are at a point in time where the investment world feels better about the chlor-alkali business, because of cheap natural gas/electricity and because the improving new home market will likely reduce PVC exports from the US (profitable today) and increase domestic consumption of PVC at greater profit margins.  Further, Georgia Gulf is now at a phase of its evolution where this move makes very good business sense.

The deal structure is one which minimizes the risk of cyclical miss-valuation, creates the scale that the new GGC needs to compete without the potentially crippling costs of a premium driven acquisition.   PPG shareholders can elect to hold the commodity company or sell it.  If they liked the old PPG structure they can still own the pieces – but with a larger and more efficient commodity piece.

However, these deals are never without risk and we offer a few thoughts:

  • Already we are seeing the popularity of the deal and a divergence in valuation.  GGC is up 12% as of 3:00 – PPG is up 6.5%.  There is the risk that valuations diverge dramatically prior to the deal close – in either direction.  The structure of the deal looks like it can accommodate this without GGC feeling like it is overpaying or PPG feeling like it is being underpaid.  However, there are examples of deals where some unanticipated arbitrage opens up and throws valuations off balance, complicating the process.
  • Candidly, and with no personal experience of current GGC management, our view is that “sensible” would not have been an appropriate description over the last 10-12 years – on a split adjusted basis this was a $500 stock in 2007.  GGC has turned down an offer at $35 per share already this year, which, in the light of better housing numbers in the US and cheaper energy, was probably the right thing to do.  However, the focus will now be on whether they can deliver the synergies and integration benefits.  As a PPG shareholder, post deal close, you can always sell the stock if you do not like the story.
  • A risk to the deal following on from the point above is that GGC has operational or other disappointments before the deal closes.  If GGC were to trade at levels that suggested its business was worth less than other chlor-alkali businesses, PPG could reasonably get cold feet.

The fundamental issue with the global commodity chemical industry is that there are far too many competitors – too many to suggest that the industry has much of a chance of consistently earning its cost of capital through the cycle, despite the recent trend – see chart and prior research.  Consolidation attempts have resulted in many deals that have hurt shareholders, as often cash has been paid at the top of the cycle or premiums have been paid to get the deal done that have either diluted the acquirer’s earnings or raised debt to crippling levels.

This proposed transaction looks to take most of the risk away from both the effective buyer and the effective seller, while at the same time achieving the scale and consolidation that should benefit the new company – sensible.   

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