OLN – Time For Some Outside The Box Thinking

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SEE LAST PAGE OF THIS REPORT Graham Copley / Anthony Salzillo

FOR IMPORTANT DISCLOSURES 203.901.1629 / 203.901.1627

gcopley@ / asalzillo@ssrllc.com

September 26th 2018

OLN – Time For Some Outside The Box Thinking

  • Olin’s underperformance, since it confirmed the acquisition of the Dow Chlorine Products Business in early 2015, was initially the consequence of weakening global chlor-alkali, but since chlor-alkali bottomed, all of the problems appear to be self-generated by OLN.
    • The company either paid too much for the Dow business – failing to do adequate due diligence at the time, especially around the epoxy business; or,
    • The due diligence was appropriate, but subsequently something happened to Dow’s epoxy business, specifically, to cause it to disappoint meaningfully.
  • We suspect that the first reason is the most likely as other businesses have disappointed relative to peers in addition to epoxies.
    • OLN does not seem to have the same chlor-alkali profitability as others.
    • Winchester is a steady business, but likely a drag on valuation.
    • The Chlorinated Organics business (ex-synergies) is not making much progress.
  • Investors have lost confidence/interest in the stock this year – despite better earnings – and OLN is one of the worst performers YTD among all of the Industrials and Materials names (only TiO2 has fared worse).
    • Part of the problem is continued overconfidence from OLN management – earnings have now been overestimated for 5 years in a row – Exhibit 1 and the constant negative revisions, as we have seen with other stocks, result in lower multiples.
    • Plus, we have the added uncertainty of the weakening basic chemical margins globally and higher ethylene costs in the US.
  • OLN needs a fresh set of eyes and possibly a radical path change to create value from here – we have suggested a tie up with Chemours but there are other options also.
    • There is a “no-mans-land” of smaller commodity names that no one cares about today – teaming up may be the best path – either that or PE ownership: both CC and WLK look more interesting today.

Exhibit 1

Source: Capital IQ and SSR Analysis

Details

Is it time for a radical change in thinking at OLN? The stock would suggest that investors are not interested in the status quo: – either in the current plan, the slightly better numbers this year or the leadership. In Exhibits 2 and 3 we show a couple of measures of valuation, one relative – and on the same basis as our recently published “peak returns” piece – and the second absolute, looking at straight EV/EBITDA. The first chart is more concerning than the second as it shows that there has been an increasing lack of interest in the name even as returns on capital have risen.

The primary issue with Olin, in our view, is that the company has never really admitted to, and therefore never tried to truly deal with, the fact that it overpaid significantly for the Dow Chlorine Products business. While the price paid may have been necessary to win in a competitive bidding situation (however, we suspect Olin overpaid meaningfully next to Dow’s next best offer), the company clearly did not do the required due diligence to pull apart the assumptions around the business that Dow presented at the time of sale – Dow did an extremely good job of maximizing value for its shareholders, at the expense of OLN in our opinion.

  • OLN has underperformed in an improving chlor-alkali market, to which it doubled its exposure through the Dow deal.
  • OLN has failed to deliver any of the targets set for the Epoxy business, losing money in 2017 and making almost nothing in 1H 2018, while one of its main competitors, Huntsman, has shown steady profits and healthy margins in its Epoxy segment in both years.
  • With the Dow deal, OLN was able to secure ethylene supply at “cost” from Dow to meet its needs for EDC production – OLN paid up front for this. Since the new Dow ethylene plant came on line and the contract started, ethylene costs have been at or above ethylene pricing in the US, so OLN has not had luck on its side either.
    • This is not OLN’s mistake, as anyone negotiating for the Dow assets would have taken an ethylene deal from Dow at the time the deal was done.

Exhibit 2

Source: Capital IQ and SSR Analysis

Exhibit 3

Source: Capital IQ and SSR Analysis

Strategy From Here?

So, what should OLN do next? Our best idea would be to sell – at less than 6x EBITDA the company looks inexpensive, but it is unlikely that too many offers are going to come in with the current uncertainty around US feedstock costs and trade. However unlikely a third-party bid might be today, it appears that nothing OLN has done over the last couple of years has found real buy-in with enough of the investment community. OLN is trading at less than 10x what 2019 earnings were forecast to be in January – estimates have since fallen ( a common theme).

OLN needs some fresh ideas and a fresh strategy (and possibly fresh blood) – and perhaps the best way to get there is to start looking for business combinations – ones that would bring synergies, diversity, and scale, but also perhaps some more creative management talent. When we suggest diversity, we do not recommend straying from the commodity roots of the company – just adding, adjacent, similarly valued and complimentary product lines. There are plenty of companies in the same low multiple hole that OLN is in today – Exhibit 4, and a strong argument could be made that OLN should not trade at a premium to WLK based on WLK’s earnings performance and its very different optimism history compared to OLN: Exhibit 5.

Exhibit 4

Source: Capital IQ and SSR Analysis

For example, in a recent piece we suggested a merger between OLN and Chemours (CC). This would do a couple of things:

  • Provide synergies through corporate overhead rationalization and through the business combination of the chlorinated organics segments.
  • Provide some back integration to chlorine for CC.
  • Hopefully put a fresh set of eyes on the epoxy business and come up with a plan that makes sense around where those assets sit in the competitive landscape and how best to create value.
  • It would make sense to offload Winchester before any deal, and OLN needs to accept that what may look like a dilutive sale (most likely into private hands) will still likely give valuation a boost.
  • CC must be more frustrated than most these days with valuation, given the growth in the refrigerant platform and the significant cost advantage that the company has in TiO2.

The more exploratory discussions that OLN has with other companies and/or experienced industry consultants/investment banks, the more likely the company is to come up with something that works and adds value. No one seems to be interested in the current OLN story, largely because it is not believable based on recent history – over the last 5 years OLN has over-estimated earnings substantially – Exhibit 1 and is the worst in the chemical sector after CF (Exhibit 5). 2018 is looking no different directionally so far. Haircutting 2019 estimates by the average miss over the 5 years through 2017 you would get $1.49 for earnings in 2019, which more than justifies the current valuation and could make an argument for downside. Note that we had a math error in our weekly findings piece of last week and had a slightly lower EPS estimate in the analysis above – conclusions unchanged.

It’s time for a new plan at OLN, the question is whether the management team realizes this and has the skill set or motivation to change tack.

Exhibit 5

Source: Capital IQ and SSR Analysis

©2018, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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