INSIGHT: AkzoNobel shifts to pure-play stance following specialties sale

LONDON (ICIS)–AkzoNobel has completed its transition to a pure-play paints and coatings company following the completion of the €10.1bn divestment of its specialty chemicals division to private equity firm the Carlyle Group and sovereign investor GIC.

The sale of the business represents the culmination of a lengthy takeover battle with US rival PPG backed by activist shareholder Elliott Management that led to the resignation of former AkzoNobel CEO Ton Buchner.

Focused on remaining an independent The Netherlands-headquartered business, AkzoNobel managed to quell shareholder pressure to agree to PPG’s approach by pledging to carve out its specialty chemicals business and return the vast majority of proceeds to its investors.

After grooming the business for sale via a dual-track sale and initial public offering (IPO) process, AkzoNobel agreed the sale with the US- and Singapore-based investors, despite other bidding parties understood to have a stronger Dutch contingent.

Representing around a third of AkzoNobel revenues, the specialties divestment leaves the coatings producer a more streamlined, focused entity with a value proposition that can be more easily explained to investors, but also deprives it of a reliable cash generator that moved in a different cycle to paints.

Paints and coatings operations were stung last year by €300m in raw materials costs, and CEO Thierry Vanlancker has estimated a €137m year-on-year increase in second-quarter feedstock expenses.

The specialties division posted firmer operating income for 2017, helping to offset a drop in paints and coatings earnings, but now that the sale is concluded AkzoNobel will be significantly more exposed to the ups and downs of the coatings sector.

AkzoNobel announced the completion of the sale on 1 October, stating earlier on Tuesday that it will return €5.5bn of the sales price to shareholders.

The windfall is slightly below the €6bn that chemical equity analysts at Bernstein had estimated would be returned to shareholders but is still in line with AkzoNobel’s initial promise.

The company expected to receive €8.9bn cash proceeds from the sale, falling to €7.5bn factoring in the deduction of separation costs and other administrative expenses.

Subject to vote at an extraordinary general meeting scheduled for 13 November, the funds will be disbursed through a €2bn capital repayment and share consolidation, a €1bn cash dividend, and a €2.5bn share buyback.

Representing a repurchase of more than 10% of the company’s €20.35bn market cap, the schedule for the share buyback runs through to mid-2020, which Bernstein cites as a realistic timeframe.

The mix of avenues for the shareholder distribution is reasonable, Bernstein added, noting that the capital repayment and share consolidation represents a tax-efficient distribution from equity that consolidates share numbers to nine for every 10 currently issued.

The shift to an exclusive focus on paints and coatings provides significant scope for cost-cutting, according to company management.

The specialties business is four similarly-sized businesses, functional, industrial, surface and pulp chemicals, which makes it attractive for a private equity investor by offering the chance to potentially sell the business off piecemeal, but adds business expense and corporate complexity.

“AkzoNobel has, like many northern European organisations, been very decentralised, where every business was almost a little company,” Vanlancker said earlier this year.

The company focused on increasing its return on sales margin from 10% to 15% by 2020, also known as earnings before interest and tax (EBIT) margin.

At its current rate of progress the company is unlikely to meet its 2020 target but investors are increasingly positive on the measures taken so far, according to Bernstein.

“Investors are more positive on the cost savings than we are,” the analyst said in a research note.

“[We are] incrementally positive that they can deliver on self-help, and are more constructive on the possibility for more through the 2020s which is not priced in. However, we remain slightly cautious given the sheer number of ongoing programs and the possibility (and track record) of leakage.”

The company may have picked an auspicious time for its breakaway from specialties.

AkzoNobel has guided that raw materials headwinds are likely to remain a factor through the rest of the year, but the feedstock price inflation that has dogged much of the industry through this year is expected to ease into 2019.

In light of such dramatic cost inflation over the last two years, the firm is expected to be one of the key European beneficiaries of lower costs.

Entering a more forgiving economic cycle at a time when the spotlight will be on the newly-streamlined company’s performance.

“Our recent conference confirmed the company’s progress with offsetting raw materials headwinds, and playing catch-up – we expect a €250m net pricing benefit in 2019,” Bernstein added.

However, the cushion provided by the specialty chemicals division is something the company is likely to feel the loss of in future

“I think the divestment … of the specialty chemicals business is a short-term value generator, but I think in the long-term it will destroy value,” said Baader Bank analyst Markus Mayer earlier this year.

The question remains whether the company will pursue any transformative acquisition opportunities following the divestment.

Vanlancker’s emphasis has been on potential bolt-on deals that strengthen existing portfolios or geographic footprints.

There has been little indication that AkzoNobel will return to the negotiating table with Axalta, the US firm it was in talks to buy last year, but the company remains unacquired.

With Bernstein failing to fully rule out the possibility of a buyer swooping in for AkzoNobel now that it is smaller and more focused, a decent-sized acquisition in a favourable geography could strengthen AkzoNobel’s operations and make it a little larger to swallow.

At present, valuations in the sector remain high, meaning that the risk of overpaying on assets that ultimately destroy value continues to be a factor.

But with the European economy slowly cooling, valuations both for AkzoNobel as a buyer and AkzoNobel as a target could look more reasonable next year.

Picture source: Stock Connection/REX/Shutterstock

By Tom Brown