Thursday Findings – March 29th, 2018
SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES
Graham Copley / Nick Lipinski
March 29, 2018
- Chart of the Week
- Akzo – Benefitting From A Cash Rich Private Equity Market – What Now?
- HB Fuller – Is The Goodwill Worth It?
- Weekly Winners & Losers
It is surprising that there was no strategic buyer of Akzo’s chemical assets that could derive enough synergies to outbid private equity. After all, Carlyle has some ability to cut costs, albeit slowly given the largely European platform and the agreement to keep the headquarters in the Netherlands, but does not have (yet) another like business to drive cost of goods sold and SG&A synergies. There should have been any number of existing chemical companies, with similar borrowing costs that could have derived more cost opportunities – so what do we learn from this:
- We learn that there is plenty of private equity money sitting around looking for something to do.
- Any strategic bidder looking at the PX/LIN divestments is going to have to pay up to beat private equity looking for a levered return on cheap debt – outbidding PE might not yield an accretive deal.
- We are also reminded of what we already know – which is that chlorine is toxic!
- If you are not in the chlorine business you do not want to get into the chlorine business. This limited the number of potential strategic bidders to only those with chlorine today – Ineos too big; Olin still busy with the Dow integration; leaving WLK as probably the only serious strategic competition for the PE guys and unable to compete at the multiple paid by Carlyle – chart of the week.
- WLK would have needed to find over $500 million of synergies to justify the Carlyle multiple without taking on a value dilutive deal – something we know WLK will not do.
- Unless Carlyle has a side deal or two already lined up, this acquisition may not be that great of an investment – if they plan to keep the portfolio together they can cut some costs but at the end of the day, whether or not this turns out to be a good deal depends on chlorine more than anything else.
- Carlyle is taking commodity risk a long way from the bottom of the cycle – which is unusual for a PE investor. There must be confidence on a number of fronts, including the stability of the economic advances in India – by now by far the largest incremental PVC growth story.
- Alternatively, there is simply a cash supply and demand issue – too much money that needs to be put to work.
It’s a good time to put a business up for sale! ASH has just announced the intent to sell a couple of its businesses – demand should be high.
We have written this week about the plusses and minuses of a chemicals industry with cash! The “new-build” landscape has all sorts of demand and cost uncertainty today, at a time when available investment dollars within the industry are at an all-time high, and – as we have clearly seen this week – private equity has a few dollars to throw around. So how do we think about Akzo with a ton of cash?
The story has been, and remains, that much of the net cash from the chemicals sale will be returned to shareholders, but the last thing any CEO would want to do in a situation like this is suggest he is going elephant hunting as any and all possible targets would appreciate in anticipation. Akzo has been a management disaster for the last few years, with the promise of Ton Buchner cut short by the PPG bid and ill health and otherwise a very poor track record of returns, corporate strategy and delivering on almost any target. Do we believe that Akzo will return the cash from this acquisition to shareholders – probably not! Shareholders might see some, but the risk that the company buys something expensive is just as high in our view. And it will be expensive – everyone in the coatings space is looking for consolidating moves to offset slower growth.
If we add Akzo to the analysis we published on Monday, its average is in the range of the US companies though poor – note that the average is an average of individual years. The chart above is a sum over the 17-year period and the negative overall shows up in Akzo’s volatility, which is out of step with the US group – second chart below. When Akzo destroys shareholder value it does so dramatically and such that the risk/reward does not make it worth holding the stock for the long-term. We do not get a sense that the management team at Akzo understands this and we would not recommend owning the stock.
FUL looks like an interesting story – underperforming and a value destroyer in 2017 based on the work that we published earlier this week and summarized in the last chart in the previous section. FUL has taken on a significant level of goodwill with its Royal purchase and consequently its return on capital – as we define it – has collapsed – first chart.
In the work we published late last year on “what makes a good company” we concluded that the absolute level of goodwill and other intangibles on the balance sheet does not make for a bad company – as shown in the next exhibit, the better companies have higher levels of goodwill and other intangibles than the poorer performing companies. The poor companies have much higher write downs – second pair of charts. So it’s not about the goodwill – it’s about whether the goodwill is worth it.
If FUL’s goodwill is appropriate then we should be thinking about the earnings potential of the new larger company and the possible stock upside (compare with SWK post its Black and Decker acquisition). A new (trend return on capital based) current normal earnings for FUL becomes $5.45 per share – way above the $4.72 consensus for 2020. Normal value is well north of $100 per share!
FUL does have a track record of integrating acquisitions – but much smaller ones than Royal – and this was no different for SWK with the Black and Decker purchase (note that SWK volatility post that deal was because of other (off-piste) acquisitions in security rather than the on-piste Black and Decker deal). Royal is very much an on-piste deal for FUL.
Sadly, there are as many deals where things do not go according to plan (Dow/Union Carbide, Dow/Rohm and Haas, DuPont/Danisco, Lyondell/Arco Chemical for example) as there are deals that work. However, FUL is well off its Q4 highs and the risk/reward profile looks interesting. We are adding FUL to our preferred list.
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