LyondellBrasselkem – Or Something Else

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SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

November 8th, 2017

LyondellBrasselkem – Or Something Else

  • If Lyondell is going to make any acquisition, Braskem probably makes the most sense, as it combines an opportunity to consolidate in ethylene, while increasing exposure to the ethylene cycle, with a significant discount to replacement costs in terms of acquisition cost.
    • The valuation discount is driven by the history and the country risk, but presents a compelling risk/reward scenario on the assumption that Brazil can maintain economic stability, even if that stability is more volatile than one would like.
    • As noted in prior research, Praxair has seen volatility in its Brazil business, but it has been macro volatility and the business itself has been stable, has grown and has high margins
  • Braskem/LYB would also bring consolidation in polypropylene in Europe and the US. This is a business on an improving trend today but has been low margin for many years.
    • The concentration of capacity would likely warrant reviews from both the US and European regulators but given the global nature of the market would likely not be challenged.
    • Braskem would also give Lyondell a new ethylene/polyethylene complex in Mexico.
  • Braskem has a lot of debt, but LYB has a lot of cash flow – increased by a business combination and by synergies – we would expect the company to be able to pay down debt quickly – resulting in equity value increases.
    • Odebrecht has suggested that it wants to keep a piece of Braskem – LYB should work hard to persuade Odebrecht to take a stake in LYB instead, allowing for the complete consolidation of Braskem – Petrobras has already indicated a willingness to sell.
  • The idea that LYB should buy HUN is not crazy as there is the obvious PO consolidation and integration into polyols – but if that is LYB’s goal (which it should not be – see below), Covestro is the better target.
    • You have to do the deals that can be done – which may not be the one that would be perfect for you and we know that HUN is a seller while Odebrecht may be a sticking point as may Braskem.

Exhibit 1

Source: Capital IQ, Company Reports, SSR Analysis

Why Braskem makes sense

Braskem makes sense for a number of important reasons:

  • It is a consolidation in ethylene and polyethylene and polypropylene – so lots of synergies.
  • It is relatively inexpensive – buy versus build – Exhibit 1.
  • The timing is good – deal closes late 2018 – ethylene cycle looks interesting at that point.
  • It will likely lead to a virtual polyethylene and polypropylene incremental capacity expansion because of the opportunity to rationalize grades between plants – especially for polypropylene.
  • The Herfindahl indices for Europe and the US for polypropylene would be high, but given the global nature of the market the regulators would likely pass the deal in both cases – Exhibit 2.
  • Significant production management and services synergies at La Porte, TX where LYB and Braskem’s facilities are less than two miles apart – Exhibit 3 – central control room – maintenance and other services would be possible.
  • Investors like it – or at least they liked the rumor – versus the reaction when LYB made a general statement about acquisitions.
  • The negative is the county risk.

Exhibit 2

Source: IHS, SSR Analysis

For reference the index is interpreted such that an index of 1500 begins to suggest a concentrated market and 2500 is a red flag. An index of 100 is “highly competitive”.

Exhibit 3

Source: Company Reports, Google Maps

Why HUN is Less Interesting – For LYB – Maybe OK On Its Own

If LYB were to go down the polyurethane integration route instead of consolidating in ethylene there are a couple of significant issues:

  • No consolidation – a little with ethylene and PO with HUN but not significant.
  • LYB is one of the largest sellers of PO in the world and does not compete with its customers. Buying HUN or Covestro would put the company in direct competition with its PO customers – Covestro in the case that LYB buys HUN – and LYB would lose leverage, and probably volume. Covestro might link up with Shell and encourage Shell to build more PO capacity.
  • Covestro is more interesting than HUN.
    • Larger – much more PO integration – more synergies.
    • Businesses were together at one point – some working history.
    • Cheaper – much lower EV/EBITDA multiple.
    • Less baggage – fewer “other businesses” – though HUN’s epoxy business is probably worth having.
  • But HUN is a willing seller – Covestro may not be.

The PO/polyol markets and the polycarbonate markets are improving, which is why both HUN and Covestro are preforming – delinking from Clariant was good for HUN shareholders even while probably disappointing for the family.

A purchase of HUN by LYB could be good, but would reduce ethylene leverage to a degree and much would depend on the price and the synergies – both HQ’s in Houston. We prefer LYB stand-alone.

A Covestro deal would be better – though ethylene leverage diluted further – synergies higher, etc. – Covestro cheaper – indifferent versus stand-alone.

A Braskem purchase probably has the most upside for LYB holders – pure consolidation and cheaper – better than stand-alone.

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