RPM – More Upside from A Likely Sale

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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

August 29th 2018

RPM – More Upside from A Likely Sale

  • The Elliott led management restructuring at RPM and now the removal of the “poison pill” provision is setting the company up for a sale and we would expect something to come to light relatively quickly – driving more than a further 20% in the share price.
    • Private Equity is possible but driven more by the surplus of available PE money on the sidelines today rather than compelling opportunity.
    • Rationalization/integration/synergies around SG&A, raw material purchases and logistics are the opportunity here and consequently a strategic buyer should be able to pay more.
  • Strategic buyers would fall into two camps – those that have similar processes and technology and those that have the same customer base, with the former having more raw material synergies and the latter having more SG&A and logistic opportunity.
    • Most coatings companies fall into both buckets, but the process/technology is peripheral rather than a direct overlap, and the customer overlap is more relevant for Masco (MAS) than for SHW or PPG – although the VAL acquisition makes the fit with SHW better.
    • Other possible interested parties would be SWK and OC – but only because there would be significant customer synergies.
  • If we assume that a buyer of RPM could achieve the same proportion of synergies (as a percent of cost of goods sold and SG&A) as SHW is targeting with Valspar – RPM EBITDA would increase to around $1.05BN.
    • At a 12x multiple this would suggest 19% upside to the stock today.
    • Reducing RPM’s SG&A to 20% of sales (Exhibit 1) would increase EBITDA by 80%, suggesting as much as 30-40% upside.
    • The likely outcome is somewhere between the two and either end of the range makes the stock still interesting today.

Exhibit 1

Note SHW ratio inflated by addition of VAL and limited synergies LTM

Source: Capital IQ and SSR Analysis

Details

Despite showing as one of the few EPS misses in Q2 – Exhibit 2 – without a real excuse for it, RPM is in the stock performance “winners” category for last two months and is now up 28% year to date, despite the miss and negative revisions. The march higher, which began when Elliott announced its agreement with the company around management and governance changes in July – Exhibit 3 – was helped last week by the company removing a “Poison Pill” provision, effectively opening the door for a bid.

Exhibit 2

Source: Capital IQ and SSR Analysis

Exhibit 3

Source: Capital IQ and SSR Analysis

The question now is how much further upside there could be in a bid – as the stock is no longer cheap on a stand-alone basis – Exhibit 4. There is likely plenty of both strategic and private equity interest in RPM, although the company is not as straightforward an opportunity as Axalta or Valspar as it has multiple branded product lines with different end uses and relies on third party retailers for most of its sales – in that respect it more closely resembles SWK than a coatings company. RPM has significant exposure to Home Depot, Lowes, Walmart and other sellers of home improvement products. It probably has most end customer overlap with Masco and SWK, and then SHW (but only because of the Valspar deal).

There are no pure play comps. From a raw material and process perspective, it does look more like Masco, PPG or SHW (more the VAL piece), but from a marketing perspective it looks more like Masco (again), SWK or the Buffett building products businesses or perhaps OC. Masco may look like an obvious fit, but valuation is not working in Masco’s favor right now.

Exhibit 4

Source: Capital IQ and SSR Analysis

Anyone buying the company is going somewhat off-piste, and a Private Equity bidder would have to see either significant cost opportunities or a break-up. The opportunity is the SG&A, which at $1.65 billion is 2.4x EBITDA. If you were to assume that you could run the company with half the current SG&A. EBITDA could increase to $1.5bn – the stock could have 40% further upside and still sell for 10x potential EBITDA.

As shown in Exhibit 1, RPM has the highest SG&A to sales of all the suppliers in the home improvement space, and SHW should step down when the full Valspar synergies are achieved.

Earnings have been relatively stable and the miss in Q2, while not uncommon for the company was higher than the long-term average – Exhibit 5. Consequently, any potential buyer is likely to haircut estimates, but only by 4-5%.

Exhibit 5 Source: Capital IQ and SSR Analysis

Looking at return on capital, it is not obvious that there is much upside in RPM as a stand-alone company as all three companies have converged to the same point – SHW as a consequence of the Valspar acquisition and the other two seeing recent increases because of the better economy in the case of RPM, and lower capital in the case of PPG – Exhibit 6. On a stand-alone basis, SHW offers the more interesting opportunity of the three as it has deployed capital and should see the benefits of improvements on that capital base as well as the benefits of paying down debt with its healthy cash flows. Any non-strategic buyer of RPM would need to believe that they can manage the company to improve already reasonable returns. If we did not believe that RPM was likely to be sold, we would not be recommending the stock.

Exhibit 6

Source: Capital IQ and SSR Analysis

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