Market outlook: Covestro’s share buyback leaves room for M&A

Source: ECN


German polycarbonate (PC), polyurethane (PU) and Coatings, Adhesives, Specialties (CAS) specialist, Covestro, still hopes to use some of its €5bn in forecast cashflow over the next five years to fund mergers and acquisitions (M&A), despite returning €1.5bn to shareholders through a share buyback.

The company – which was split from parent Bayer just over a year ago – plans to grow in all three of its main segments with a special emphasis on CAS where global market share is lower. The buyback, announced during third quarter financial results published on 24 October, will purchase up to 10% of the outstanding share capital.

Although a lack of M&A opportunities at the right price led to this decision, Covestro said in the same announcement that it will still seek bolt-on acquisitions.

Speaking before the Q3 results were published, chairman and CEO, Patrick Thomas, said: “There is some stuff we can put into PU and PC but because we’re number one in both there is a limit to what we can acquire. We’d love to increase the scale of CAS because it is very resilient and gives good returns: we have a long list of businesses we’d like to put in there but some of them are private and not for sale, and some are not at the right price, so we keep working systematically through that.”

The CEO added: “We are hugely cash-generative and have promised to deliver €5bn of free operating cashflow over the next five years. That would logically be used for inorganic growth and we have a load of ideas for how to do that. This money is post-capex so after all our usual expansion programmes.”

Acquisitions which fit well are either further geographical expansion where that makes sense or bolt ins of technology.

Covestro has almost 30% market share for PC and in PU it is a clear number one so it would be difficult to add a major competitor, says Thomas. “It’s the same for MDI and TDI. We’d like to grow our polyols business further although we are global number two. There are interesting trends here with the use of CO2 plus polyester polyols (rather than polyether).”

The company’s three arms share a common chlorine chain feedstock which gives economies of scale and means it does not make sense to add a further division or change the company fundamentally, says Thomas.

“We’re not really interested in creating a fourth leg to Covestro. One of the great strengths of our business is that it all runs off the same intermediate backbone – one of the largest chlorine-based backbones anyone operates anywhere in the world.”

He believes this is one of Covestro’s great strengths: if you look at the margins the company can generate on PU or PC compared to competitors it’s because everything is plugged into the same backbone.

“Sometimes people ask us why don’t we sell our CAS business. We say ‘no’ because the only reason it’s attractive and delivers 22% earnings before interest, tax, depreciation and amortization (EBITDA) [margin] is because it’s plugged into one of the biggest PU and PC backbones using the same infrastructure and feedstock.”

Thomas said that out of around 12m tonnes/year of total production, 4.5m tonnes is produced by the three core divisions with the rest being chlorine intermediates. When Bayer spun off Covestro predecessor, Bayer MaterialScience, it was created to be a logical portfolio of businesses

“The whole thing fits together logically and the capital market understands that. Acquisitions must be value-creative – return on capital employed (ROCE) above our own a basic starting point. We don’t want to be value-
dilutive in our portfolio.”


If no M&A activity takes place by 2021, Covestro is likely to continue the programme of share buybacks or consider a special dividend.

“If you look at our stock – that sets a hurdle for M&A. It’s got to do better than investing in our own company,” said Thomas.

Thomas gave the example of a thermoplastic composites acquisition – German group Thermoplast Composite in 2015 – which gave access to new carbon fibre/PC composite technology. The technology is designed for the automotive segment but Covestro has taken it to electronics. A range of laptops are now being produced with that material. Thomas – who is also acting chief financial officer – said he imposes very tight discipline on any M&A opportunity. “It really has to deliver a proper value-creation story otherwise we shouldn’t do it.”

He adds: “In my personal view several companies have done crazy deals at crazy multiples at a time where money is very cheap. I guess they’ll live to regret it.”


According to Markus Steilemann, Chief Commercial Officer, and CEO-in-waiting until October 2018 when Thomas retires, Covestro is focusing on big long-term trends such as electrical mobility where it sees huge demand growth opportunities. He says that by 2050 people will most likely no longer own cars but will want to have access to mobility through a combination of transport modes including electric vehicles which are driven autonomously.

“Instead of having a driver plus passengers we move to a more social environment more like a living room and this is how cars may be designed in the future. Comfort and communication – it’s more about the social environment than the vehicle itself.”

He says this will drive use of the company’s lightweight materials. The need for better energy efficiency means the battery weight will become even more important. Batteries need to be cooled to operate in a certain temperature range and Covestro’s materials can be used for that.

For battery safety, Covestro already produces a lightweight PC honeycomb structure for the BMW i3 which gives impact protection. In public transportation, the company is collaborating with manufacturers on heating and 
cooling systems made from PC for individual modules for battery packages. PU can be used in cars for insulation and noise reduction.

Steilemann recently had a conversation with a leading European, German-based car designer about autonomous vehicles. The car company is thinking about an entirely different comfort system with different seating, relaxing areas and entertainment areas.

“Our materials can be used for these systems. It may be a very scary thought but you may not need windows to see outside because automatic driving is going on. You just sit there as if it was your living room.”


Covestro is focused on growth in electric vehicles and energy-efficient technologies


Steilemann says around 30-35% of the food produced in the field never makes it to the table. In developing countries that can go up to 50%. Part of the reason is a lack of efficient storage and processing facilities in the field. Covestro is thinking about cooling facilities where fresh food can be protected and stored, at least for the first night or two.

One Covestro project enables people to use solar dryers containing PC which allow food to be taken off the field, protected from light, dried and cooled to ensure natural preservation.

Thomas points out that these technologies help farmers avoid waste and boost their economic activity cycle, bringing wealth to people at the lower end of the income pyramid.

At the broadest level in innovation the company tries to ensure that research and development (R&D) follows the three pillars of sustainable development: People, Planet, Profit. By 2025 Covestro expects 80% of its R&D expenditure to be on achieving the United Nations sustainable development goals. “That’s how we orientate our company because that is a multi-trillion opportunity for business,” says Thomas.


The overall growth strategy, says Steilemann, is driven by the fact that demand is driving product substitution and this allows sales growth above GDP. “Our materials are either lighter, stronger, more environmentally-friendly, deliver significant energy reductions or improved carbon footprint. All of these things drive growth.”

He says that growth rates of 4-5% are expected for PU and PC, 3-4% for TDI. Coatings should grow at 3%+ in the future. “Overall our entire portfolio is growing at about 4-5%, well above GDP, and this mix should not significantly change.”

In PU, where Covestro is a global leader in terms of market share, Steilemann says the industry has a very attractive growth outlook driven by megatrends such as lightweight materials and energy efficiancy.

“Look at temperature controlled goods – this is growing at 9%/year - and the global shipping container business which is growing at 3%. This gives you an idea why PU has so much potential – it is focussed on stronger and faster-growing niches.”

He highlights energy-efficient buildings (new and existing), pointing out that heating and cooling consumes roughly 40% of all global energy. “PU is one of the most effective insulation materials and is growing faster (5%) than the general insulation market (3%).”

In PC, Covestro has successfully increased the range of applications following the boom and bust of the optical storage market (previously 1/3 of demand). The company is moving into new, lightweight materials with different surface properties in terms of scratch resistance, gloss and structure.

Interactive car interiors are a key growth driver, with PC-based films for displays and integrated systems.

Steilemann said the coatings division has more than 2,300 products for more than 4,300 customers. “We have managed to grow our markets and application ranges plus move to more resilient and high-margin businesses.”


Thomas says Covestro has developed a technology to make aniline out of waste sugar products. Waste is converted to acid biologically and then catalysts used to create aniline. He estimates that by the middle of the next decade it could be commercialised. “You can imagine all the world’s aniline being make using that route,” he says.

Covestro is one of the world’s largest producers and consumers of aniline, using 1m tonnes/year of aniline out of global production of 4m tonnes/year. It is a feedstock for methyl di-p phenylene isocyanate (MDI).

Covestro was the first company to develop technology which uses CO2 for production of polyols. “We’ve always said that where it has a huge sustainability benefit we will licence it and this is available for licensing.”