Market awaits Akzo specialties decision as buyers gather

Source: ICIS News


LONDON (ICIS)--AkzoNobel is expected to post a slight increase in profits for 2017 as the market awaits a final decision on the fate of the paints and coatings producer’s specialty chemicals division.

AkzoNobel logoThe Netherlands-based firm is expected to generate a 1.5% year on year increase in 2017 operating profit to €1.53bn, excluding the €130m bill for the separation of the specialty chemicals unit and the dual-track process pursued for its sale or initial public offering (IPO) in April.

“The preliminary results were surprisingly positive, but this was driven solely from the specialty chemicals division, therefore the underlying results for remaining AkzoNobel are in our view a negative surprise,” said Baader Bank chemicals analyst Markus Mayer.

An intense 2017
The final results for the year, released on 8 March, will mark the close of one of the more tumultuous years in the company’s history, with a takeover approach by US rival PPG leading to the planned separation of the specialties business and the decimation of the company’s leadership board.

Former CEO Ton Buchner stepped down after successfully repelling PPG to be replaced as company head by Thierry Vanlancker, the former AkzoNobel specialty chemicals chief whose first job would be to groom his old business for sale or demerger.

CFO Maelys Castella also left her role to be replaced by former InterTrust CFO Maarten De Vries. Board chairman Antony Burgmans, one of the final players in the fight against PPG and activist shareholders led by Elliott Advisors, completed his departure on Monday, to be replaced by former AP Moller-Maers CEO Nils Andersen.

With a transformed management team and the prospect of moving forward as a pure-play paints and coatings player, AkzoNobel is faced with the challenge of hiving off a business worth a third of its revenue and adapting to an increasingly competitive environment with intensifying cost pressures.

Specialty chems carve-out
The specialty chemicals business has now been entirely separated, according to Akzo, with the decision to pursue a potential public listing as well as a sales process intended to derive the highest value for the business by demonstrating to prospective bidders that it has the power to take the business off the table if offers are not strong enough.

Whether due to that gambit or the fundamentals of the business, specialty chemicals is expected to raise at least €9.5bn, according to analysts, and has attracted several consortia of industrial investors and blue chip buy-out houses.

Up to four bidding groups proceeded to the second round of the sales process, with Bain Capital and Advent International in the running, and Germany-based chemicals producer LANXESS reported to be bidding alongside private equity firm Apollo.

US investor Carlyle has also been mooted as a potential buyer, as has HAL Investments, the only Dutch name that has appeared in the running thus far.

Most of the private equity firms involved have track records in the chemicals sector, and the unit would be attractive to a private equity owner, according to researcher Bernstein.

A buy-out of €10bn would represent a relatively affordable 10 times EBITDA and provide a 25% internal rate of return (IRR) over a three-year hold period, with scope for €200m of cost efficiencies and four internal divisions that could be sold off piecemeal.

In the event of a demerger rather than a sale, AkzoNobel shareholders will receive stock in the newly-listed spin-off on a one-to-one basis, and an additional €1bn dividend generated from Akzo’s capital reserves.

But the level of interest and the number of potential buyers in the frame means that a sale is currently regarded by the market as the default outcome.

“I am pretty sure it's going to go to either private equity buyer or a strategic buyer such as LANXESS partnered with private equity,” Mayer said. “This business has been highly cash-generative, and this is extremely interesting for PE players and has interesting consolidation story to it.”

The company may be a more natural target for private equity than for a strategic investor, with Bernstein stating that it cannot think of an industrial buyer for whom the company would be a good fit.

Post-demerger vulnerabilities
The divestment of the specialties unit was triggered as a means of offering enough value to shareholders that Akzo could justify remaining an independent company. A sale would guarantee a short-term cash injection, but will deprive the company of a reliable cash generator in the longer-term, according to Mayer.

“I think the divestment or spin off of the specialty chemicals business is a short-term value generator, but I think in the long-term it will destroy value,” he said.

“It is a great business, and is in particular extremely important for the cash generation of AkzoNobel to fund the growth of their paints and coatings division,” he added.

A specialties exit will likely come at a time when the remaining paints and coatings business is facing price pressure from higher raw material costs, as well as incursions from lower-cost producers.

In recent analyst notes, both Bernstein, Credit Suisse, and Baader Bank have noted AkzoNobel that AkzoNobel's paints and coatings business remains exposed to margin pressure.

The pressure will remain for AkzoNobel, which has a strong European presence and invests heavily in sustainability initiatives, to become cost-competitive with its US rivals, according to Moody’s analyst Francois Lauras.

“There have been pressures on margins coming from higher raw material costs, leading to a more difficult trading environment for some of the markets they serve, so that will continue to put pressure on Akzo to raise efficiency and to narrow the gap that we can see in terms of margins with some of their US peers,” he said.

The scramble to hive off specialties may have also taken the focus, both for the company and for the market, off reforms and restructuring measures

“When I speak with privately-owned chemical companies, some of which are producing for AkzoNobel, they still tell me that the left hand does not know what the right hand is doing, which is particularly true for paints but also to an extent for coatings,” Mayer said.

M&A: the targets and the targeted
The post-spin off AkzoNobel will be a more focused company but also a smaller company, 67% of the size of its former self. This may leave it open to fresh takeover bids, with the cool-off period for PPG after its initial approach concluding at the end of 2017, and key adversary Burgmans now departed.

The company had approached US-based coatings firm Axalta regarding a merger of equals last year, which fell apart when Japan-based rival Nippon Paints expressed interest in buying the business outright, potentially producing a higher premium for Axalta shareholders.

Valuations in the chemicals sector have been heating up over the last few years, and the deal fell apart after Nippon reportedly found the price tag for Axalta to be too high.

This potentially puts Axalta back in play, but AkzoNobel had been keen to avoid the valuation premiums likely if the terms shift from merger to acquisition. However, a successful purchase could insulate it against another PPG approach, and alternative acquisitions are scarce, according to Mayer.

“I think AkzoNobel will come back to Axalta, but I don't think with the price rumoured that there is a huge chance to generate value out of this deal. However, it might be one chance out of to acquire such an asset, and a deal would also be a poison pill against a takeover by PPG,” he said.

Credit Suisse estimates that an Axalta deal would still be a value generator for both parties, but that a renewed PPG bid equivalent to its 2017 offer for the remainder of the business still offers the best value to shareholders, with a projected valuation of around €90 apiece compared to current levels of €78.

However, the bank forecasts that Akzo’s desire to remain an independent Dutch company would spur it to pursue a takeover.

“Our base case scenario assumes there is a [two-thirds] probability Akzo attempt expansive M&A at a size that requires a shareholder vote,” analysts at the bank said in an investor note.

Focus article by Tom Brown

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