INSIGHT: Huntsman/Rockwood deal can be seen as cheap or expensive

18 September 2013 16:37  [Source: ICIS news]

By Joseph Chang

NEW YORK (ICIS)--In the high stakes mergers and acquisitions (M&A) game, there is a big focus on valuation – what is paid for a business and how that compares to past and expected future cash flows.

Specific to the chemical sector – a cyclical business in itself in which a number of diverse businesses have varying degrees of cyclicality – there is a greater level of complexity and it is even more important to get the valuation right.

In Huntsman’s announced acquisition of Rockwood Holdings’ assets comprising titanium dioxide (TiO2), colour pigments, timber treatment and other chemicals, the valuations vary widely depending on how you look at it.

Often the selling company wants to highlight to its investors that it is divesting assets at a good, robust price – just as the buyer would like to convey that it is getting a bargain, or at least not overpaying.

In this case, the seller Rockwood mentions that in addition to the $1.1bn (€825m) sale tag, it is unloading $225m in pension obligations through the deal with Huntsman, for a total enterprise value of $1.325bn.

Enterprise value (EV) is a well-used component in the EV/EBITDA calculation in determining M&A valuations. EBITDA is earnings before interest, tax, depreciation and amortisation.

The EV part includes the price being paid by the buyer, plus any debt or other obligations and liabilities that will be assumed.

In this case, the businesses being sold to Huntsman generated $107m in EBIDTA in the last 12 months (LTM) up to the second quarter of 2013.

So based on LTM EBITDA, the assets are being sold at an EV/EBITDA multiple of 12.4 times – a very robust transaction multiple for a chemical business. Even excluding the pension obligations, you get an EBITDA multiple of 10.3 times – still high.

But there’s more than one way to skin this cat.

For one, the TiO2 portion of the business has performed poorly in the past year with prices plunging from their peak in August 2012. This is a cyclical commodity chemical business with peaks and troughs.

Rockwood’s TiO2 pigment business posted EBITDA of just $33m in the 12 months to Q2 2013 – down from $270m in the prior 12-month period to Q2 2012.

So arguably, these are trough TiO2 earnings that a portion of the valuation is based on, making the multiple unusually high. And as a buyer of a cyclical business, you rarely pay a price based on trough earnings but rather estimate a normalised earnings stream for such a business.

Huntsman takes a different valuation tack in its announcement of the deal. It mentioned that the cash price of $1.1bn represents just 5.5 times its estimated EBITDA of $200m for 2014. And with expected annual cost synergies of $130m, the multiple comes out to just 3.3 times – either way, a relative bargain.

This is a perfectly valid exercise for the buyer, as it has to evaluate the target asset’s future cash flows. Huntsman sees the acquired businesses almost doubling EBITDA in 2014 versus the 12-month period to Q2 2013, prior to cost synergies being realised.

Much of the improvement would come from an expected upturn in the TiO2 business in 2014.

Adding in the $225m in pension obligations Huntsman is picking up with the Rockwood assets, and basing the EV/EBITDA valuation on Huntsman’s estimated 2014 cash flow for the assets, you get a multiple of 6.6 times – a much more reasonable valuation for a mixture of a cyclical commodity chemicals business and a steadier performance additives business.

And assuming Huntsman can squeeze $130m in cost savings from combining part of the Rockwood assets with its own TiO2 business, the EV/EBITDA multiple shrinks to 4.0 times – an attractive deal for the buyer.

So in this case, it’s arguably a win-win for both companies. Rockwood gets a strong valuation for its asset sale based on past 12 months earnings, while Huntsman pays an attractive multiple for its purchase based on expected future earnings.

Indeed, Wall Street is so far viewing it as such, with both companies’ stock prices rising on the announcement of the deal on 17 September – Huntsman more so with a 1.9% gain versus Rockwood’s 0.9% rise – and to a greater magnitude than the overall market.

UBS analyst John Roberts said the deal doesn’t come as a surprise, given the speculation in the press and “Huntsman’s long history of bottom of the cycle deals”.

Jefferies analyst Laurence Alexander said the deal “appears incrementally positive” for Huntsman, with targeted earnings per share accretion of $0.60/share in 2016 “higher than we expected”.

From a strategic standpoint, Rockwood completes its transformation into a high margin specialty chemical business – one that could be ripe for a sale.

After the planned sale of its TiO2 and performance additives business to Huntsman for $1.325bn (including $225m in pension liabilities), the planned sale of its clay additives business to Germany’s ALTANA for $635m and the recently completed sale of its advanced ceramics business to European private equity firm Cinven for $1.75bn, Rockwood will be down to two core businesses – lithium and surface treatment.

On a trailing 12-month basis to Q2 2013, Rockwood’s lithium and surface treatment businesses had very high EBITDA margins of 38.6% and 21.9%, respectively.

Overall, this Rockwood core had $344m in EBITDA on $1.2bn in sales over the period, for an overall EBITDA margin of 28.5%.

Rockwood will also be cash rich with an estimated net cash position of $2.7bn after paying down $911m in debt, according to the company.

“While the sale will be dilutive to revenue and earnings per share, we believe Rockwood’s days are now numbered, as the streamlined company with only lithium and surface treatment businesses should be highly attractive to potential acquirers,” said Michael Harrison, analyst at First Analysis Securities.

“We expect Rockwood to pursue bolt-on acquisitions, pay down debt, and return a substantial amount of proceeds to shareholders through share repurchases and dividends,” he added.

Assuming Rockwood’s estimated net cash position following the close of its deals, Harrison arrives at a valuation range of $71 to $84 for Rockwood versus its current price of over $67.

For Huntsman, the company plans to combine its own TiO2 business with that of Rockwood, along with Rockwood’s other colour pigments business. Then within two years of the close of the deal, expected in the first half of 2014, it would seek an initial public offering (IPO) of that new pigment business.

So for Huntsman, the end game is to acquire, combine, achieve synergies and then divest the pigment operations so that investors can focus on the core Huntsman businesses of polyurethanes and performance products.

“This transaction, in our view, is classic Huntsman: a fixer-upper of a quasi-commodity with a tolerance for higher leverage near-term in exchange for value creation over 2-3 years,” said Alexander.

($1 = €0.75)

By: Joseph Chang
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