LyondellBasell/Braskem makes strategic sense but complexities abound

An acquisition by LyondellBasell of Brazil-based polymers giant Braskem would make an excellent strategic fit, and would also be financially feasible with LyondellBasell’s strong and flexible balance sheet.

However, it may be interesting to see how Brazil’s government would view a foreign takeover of its national polymers champion – the country’s sole producer of polyethylene (PE) and polypropylene (PP).

The Wall Street Journal on 30 October reported that LyondellBasell made a takeover approach to Braskem and that talks are at an early stage. LyondellBasell declined to comment on market speculation. While any deal is speculative at best at this stage, investors gave their initial stamp of approval at the prospect.

INITIAL STOCK SURGE

Shares of Braskem surged 11% on the report – understandable for the speculated acquisition target. But the supposed acquirer LyondellBasell also bounded 7% higher, confirming the high level of strategic rationale for the combination.

“An approach to Braskem appears logical, creating an opportunity to cement a leadership position in both North America and South America in the polypropylene chain,” said Laurence Alexander, analyst with Jefferies. “Braskem has attractive market positions in Mexico, and feedstock sourcing that would help diversify LyondellBasell’s position.”

Wells Fargo analyst Frank Mitsch said while he was not surprised by the news given the strategic fit, he did note the timing of the report, coming “the first workday after the Huntsman-Clariant deal was called off.” There had been market chatter about a potential merger between LyondellBasell and Huntsman, he added.

COMPLEXITIES ABOUND

Yet an acquisition of Brazil’s sole polyolefins producer and the premier chemical company in Latin America could be far more complex than your run-of-the-mill multi-billion dollar cross-border deal.

Braskem has two major shareholders – one being Brazil’s state-controlled oil and gas company Petrobras, with a 36.1% equity share and 41% voting stake in Braskem.

Petrobras is the sole supplier of naphtha feedstock in Brazil, critical to Braskem’s petrochemical production. Braskem also relies on ethane and propane feedstock from Petrobras for its ethane cracker in Duque de Caxias, Brazil.

Braskem’s other shareholder is Brazil’s construction and industrial conglomerate Odebrecht, at the heart of the country’s widespread Lava Jato corruption scandal. Odebrecht has a 38.3% equity share in Braskem, and more importantly a controlling 50.1% voting stake.

ODEBRECHT SEEKS ALTERNATIVES

Odebrecht holds the obvious key to any deal. After the US market close on 30 October following the Wall Street Journal report, it stated: “Odebrecht continues to work on alternatives to add value to Braskem and all of its shareholders, and reaffirms its intention of keeping Braskem as part of the group’s investments.”

The next day on 31 October, shares of Braskem closed 1.8% lower while LyondellBasell fell 2.4%. That day, Braskem also said it “was not approached by LyondellBasell with any proposal for acquisition of its shares”, in a filing with the US Securities and Exchange Commission (SEC).

LyondellBasell may have approached Odebrecht rather than Braskem itself – a rational scenario as it would have to deal with the controlling shareholder. Note that Odebrecht did not deny an approach by LyondellBasell.

Braskem in its filing added that “the suitability and timeliness of disposing of Braskem’s shares is a decision that rests solely with its shareholders”.

While some could read Odebrecht’s “intention of keeping Braskem as part of the group’s investment” as quashing any deal, the statement leaves plenty of wiggle room. Odebrecht could still keep a stake in Braskem even with a LyondellBasell takeover.

Odebrecht has clearly been seeking “alternatives” for its Braskem investment, having agreed in December 2016 to pay a $3.5bn fine to settle charges with authorities in the US, Brazil and Switzerland for its role in the Lava Jato bribery scandal.

PETROBRAS SILENT

Petrobras, which has been silent thus far on the LyondellBasell talk, announced its intention to divest its stake in Braskem in 2016, as part of a plan to reduce its massive debt load.

However, on 19 October, Brazil’s government removed Braskem from Petrobras’ divestment program in a decree in the country’s official gazette Diario Oficial da Uniao. The decree was signed off by Brazil’s president Michel Temer.

Yet could Odebrecht and Petrobras swap their significant stakes in the national petrochemical and polymers champion, for smaller ones in a much larger and stronger global leader with competitive production assets in the US, Mexico, Brazil, Europe, the Middle East and Asia?

INVESTMENT CONSIDERATIONS

Odebrecht, industry observers may recall, had explored the construction of a new worldscale ethane cracker in Wood County, West Virginia, US with Braskem, but withdrew the plans in 2016, citing economic factors.

The project, called Ascent, would have been on the scale of Braskem Idesa in Mexico. The joint venture, which is 75% owned by Braskem, consists of a 1.05m tonne/year ethane cracker, with three downstream PE units. LyondellBasell has so far eschewed any new US cracker project, instead focusing on expansions of existing crackers, plus its new 500,000 tonne/year Hyperzone high density PE (HDPE) project in La Porte, Texas, planned for start-up in mid-2019.

However, in the event of a tie-up with Braskem, it’s not a great stretch to think the Odebrecht/Braskem Ascent project could be revived at some stage.

But more immediate, and on the PP side, Braskem is the only player to have made a final investment decision (FID) to build a PP project in the US – the 450,000 tonne/year plant is scheduled for start-up in Q1 2020.

LyondellBasell has been one of a handful of players exploring a new PP project in the US, and CEO Bob Patel noted it could make an FID for such a project, along with a propane dehydrogenation (PDH) plant to supply feedstock by the end of 2018.

MARKET SHARES

LyondellBasell is a global powerhouse in PP and PE, being the third largest overall player – it is #2 in PP and #6 in PE worldwide, as well as #1 in PP compounds, based on 2016 capacities, according to the company. The majority of polyolefins production is in the US and Europe. Braskem owns the Brazilian market in both PE and PP, and also has a significant presence in PP production in the US, with facilities acquired from Sunoco in 2010 for $350m and from Dow Chemical in 2011 in a $323m deal. It also picked up PP plants in Europe with the Dow deal.

“Although the companies are #1 and #2 in North American PP markets, they also overlap in such other products as PE, ethylene, propylene, etc, and would give LyondellBasell better access to Latin American markets,” said Wells Fargo’s Mitsch.

The analyst estimates LyondellBasell’s capacities at 16.5bn lb/year (7.5m tonnes/year) of ethylene, 11.4bn lb/year (5.2m tonnes/year) of PE, 9bn lb/year (4.1m tonnes/year) of propylene, and 11.8bn lb/year (5.4m tonnes/year) of PP.

This compares to Braskem’s capacities of 3.9m tonnes/year of ethylene, 1.5m tonnes/year of propylene, 4.05m tonnes/year of PE and 3.8m tonnes/year of PP, he noted.

FINANCIAL FLEXIBILITY

LyondellBasell, having been relatively conservative in its capital spending and M&A approach while enjoying strong cash flows, has built up a fortress balance sheet, giving it plenty of wherewithal to acquire Braskem.

As of the end of Q2 2017, LyondellBasell had $1.3bn in cash and equivalents, and $8.9bn in debt. Its leverage ratio as measured by debt/EBITDA (earnings before interest, tax, depreciation and amortisation) is very modest at just 1.3x. The company also sports a BBB+ investment grade credit rating from S&P. Its equity market capitalisation is about $41bn.

Braskem has an equity market capitalisation of about $13bn, along with cash and marketable securities of Brazilian reais (R) 8.4bn ($2.6bn), and R23.6bn ($7.2bn) in debt. Total net debt is around R15.2bn, or $4.7bn. This excludes the R10.2bn ($3.1bn) of Braskem Idesa joint venture debt.

But Braskem’s cash balance could double by the end of 2017 to around $5bn on strong PE and PP earnings, based on consensus estimates for net debt, Alexander of Jefferies pointed out.

LyondellBasell highlighted M&A as a potential growth driver for the first time at its Investor Day in New York in April 2017.

“We all remember back at its April Investor Day (which we dubbed the ‘Let’s Introduce the Concept of M&A’ Investor Day) when LyondellBasell highlighted that it may lever up to the $4-18bn debt capacity range but would remain ‘patient and disciplined’ if an opportunity arises,” noted Wells Fargo’s Mitsch.

During that Investor Day, LyondellBasell estimated it could raise up to $18bn in 10-year debt at an interest rate of around 4.3%, while maintaining an investment grade credit rating at BBB. An investment grade credit rating is defined as BBB- or better.

That $18bn would be just enough to absorb Braskem at today’s equity prices, although it would likely need to pay a further premium to get a deal done.

Prior to the Wall Street Journal report, Braskem was trading at an EV/EBITDA (enterprise value/cash flow) multiple of just 4.8x based on consensus 2018 forecasts – a discount to LyondellBasell’s 7.1x multiple and the peer group multiple of about 7.6x, according to Hassan Ahmed, analyst at Alembic Global Advisors.

With its discounted valuation and product overlap with LyondellBasell, Braskem is the only target that fits the former’s acquisition criteria, Ahmed noted.

There’s no question the strategic fit of a LyondellBasell/Braskem combination would be compelling. But the complexities of this potential deal are unique with the target’s status as a national champion, and one of the two major shareholders being a government-controlled entity.

Additional reporting by Simon West