Description

Thesis:

AkzoNobel is one of the top three paint/coatings in the world, an enviable position in an industry with very attractive characteristics. It has clearly been under managed; while its profitability has improved over the last several years EBIT margins remain 350 basis points below the peer group. PPG, also in the big 3, made three successive bids for the company last spring, finishing at €96.75 in April.  Though it walked away and its CEO has publicly stated that they are moving on, the logic of the deal remains compelling:  PPG would become the largest coatings company in the world and enjoy significant earnings accretion.  Akzo management obviously hears footsteps, as evidenced by inconclusive merger talks with Axalta in the fall; anti-trust concerns would almost certainly preclude PPG from acquiring an Akzo-Axalta combination.  

Furthermore, Elliott Associates is the largest Akzo shareholder with a 9.5% position, having started to accumulate the stock in late 2016, or before the first PPG bid, and increased its position throughout the spring and summer of 2017.  Press accounts suggest that the original Elliott thesis was that Akzo was cheap on a sum of the parts basis given its substantial specialty chemicals business (now being separated, as I will detail below).    Elliott, along with several other large holders, was enraged by Akzo’s refusal to negotiate with PPG and initiated legal action in the spring.  In August, Elliott and Akzo announced a standstill agreement (now expired). Elliott helped vet 3 new supervisory board members and also secured the retirement of the board chair in 4/18, at which time the chemical business will be spun out or sold.  I like being aligned with Elliott.

2017:  The Annus Horribilis 

Without detailing every twist and turn in a tumultuous year, here are some highlights from last year which underscore AkzoNobel’s vulnerability:

• 2/15  Disappointing Q4:15.  Stock at €62.

•  3/9  Bloomberg reports PPG and Akzo talking about a deal at €83; both stocks rise over 10%; Akzo states proposal “substantially undervalues AkzoNobel and is not in the interest of shareholders” and announces that it is looking at options for specialty chemicals.

• 3/22  Akzo rejects 2nd bid at €88.72.  Three large shareholders, including Elliott, call for engagement with PPG though say that the price should be higher.

•   4/5  PPG CEO Mike McGarry says that almost all of Akzo’s top 20 shareholders favor talks between the two companies and that, while there  would be need to be some divestitures to satisfy anti-trust regulators, a number of prospective buyers had already approached PPG.

• 4/19  Akzo announces a strong Q1 and guides core earnings for the full year to increase €100MM.  Additionally, it raises the dividend and announces a one-off special dividend for 11/17 tied to the planned separation of the specialty chemicals business.

• 4/24  PPG makes 3rd bid of €96.75 (inclusive of the €4/share special dividend), saying it was its last friendly offer.  It also made a series of pledges of a corporate commitment to the Netherlands.

• 4/25  Akzo rejects an Elliott led drive from six leading shareholders for an extraordinary general meeting aimed at removing the chairman and forcing the company to negotiate with PPG.

• 5/8  Akzo and PPG CEOs meet briefly followed by another Akzo rejection.  According to PPG there was no comparison of the Akzo standalone plan with the PPG offer and that Akzo said up front that “they did not have the intent nor the authority to negotiate.”

• 5/29  Dutch court rejects Elliott appeal for an extraordinary general 8/16meeting. 

• 6/1  PPG walks away; faces a 6 month cooling off period under Dutch law.

• 7/7  Elliott makes a new push for a special shareholder meeting to remove the chairman and announces it has raised its stake to 9.5%.

• 7/19  Akzo CEO Ton Buchner resigns immediately for health reasons.  Company names Thierry Vanlancker, who had only been hired as head of the Specialty Chemicals business months before, as his replacement.  

• 7/25  Akzo misses Q2 estimates but maintains full year estimates.  Announces special shareholder meeting on September 8.  

• 8/16  Elliott and Akzo reach a truce of at least 3 months.  Elliott pledges to support Vanlancker for CEO at shareholder meeting.  Akzo agrees to 3 new directors, importantly selected in consultation with Elliott.  In the FT, Lex argues:  “. . . new appointments . . . mean Akzo is more likely to succumb to any future approach.” 

• 9/8   Profit warning at special meeting.  Reaffirms commitment to 15% return on sales by 2020.  Also announces CFO taking a leave of absence for health reasons (she has not returned yet.)

• 10/18  Reports poor Q3 and says adjusted earnings will be flat with 2016.    Retains 2020 targets.

• 10/27  Akzo approaches Axalta about potential merger. 

•   11/22  Talks break down as Nippon Paint submits all cash offer for Axalta.

What do we know now?

Much of the shareholder base has lost confidence and is aggrieved that management refused to talk seriously to PPG.  The former CEO is gone and analysts are openly skeptical of the company’s aggressive financial targets that he put forth last spring.  The Chairman is leaving this spring.  PPG sees that the market reacted well to its series of bids for AkzoNobel. Elliott, arguably the most successful activist investor anywhere, is now the largest shareholder.  Multiple buyers are apparently interested in the specialty chemical business (more on this below). Its sale, scheduled by April, makes Akzo an even more alluring target for PPG.  The potential of Axalta to block a renewed PPG bid was almost certainly a factor--and perhaps the only factor--in AkzoNobel’s interest in a merger (see the VIC Axalta thread for interesting thoughts on this). 

 Akzo has 3 new outside directors:  Sue Clark (ex SAB Miller, which acquired Foster’s, bid for Heineken and ultimately was bought by Anheuser-Busch); Patrick Thomas (soon to retire CEO of Covestro, a Bayer spinoff); and Michiel Jaski (former CEO of OfficeFirst, acquired by Blackstone last year.)  All are experienced in major corporate transactions and it is doubtful that any have a particular commitment to an independent AkzoNobel.  

Specialty Chemicals:

This is a substantial business which generated €953MM in EBITDA in 2016 with attractive margins and industrial positioning.  The Akzo CEO is committed to its separation by April and his comments suggest that a sale of the unit in its entirety is the most likely path.  Press reports suggest that the there are several potential buyers, including CVC/KKR, Advent/Bain, Apollo/Lanxess, Carlyle and Blackstone and that a multiple in the 9-10 range is likely.  One thing that is not clear, and management has ducked the question at least twice in public fora, is the leakage from capital gains taxes.  Factoring in a little growth in profitability and a wild ass guess of €500MM in taxes, I will assume €9 billion in net proceeds to AkzoNobel.  

PPG:  A Compelling Acquisition:

Over the last decade, PPG has transformed itself to a virtual pure-play paints and coatings companies through a series of divestitures and 30 acquisitions. While the stock has significantly outperformed the market, it has underperformed its leading competitor, Sherwin Williams.  CEO Mike McGarry, who began his career at the company and rose through the ranks, is dynamic and aggressive.  Additionally, several PPG directors have direct experience heading companies that have been involved in transformative deals.  

Acquiring Akzo would give PPG added strength in Asia (especially the decorative market in China) and in several important product categories.  Allowing for some required divestitures, new PPG would have close to 20% of the worldwide paints/coating industry and be significantly larger than Sherwin Williams. (Also note that SHW levered up to buy Valspar a few months ago, so at least over the next 2-3 years it is unlikely that they could compete for Akzo.)

Beyond the industrial logic, cost savings are the real key to the deal.  Last spring PPG estimated $750MM in cost savings, or about 6% of Akzo coating sales.  Remember that PPG had no access to Akzo financials.  Additionally, SHW says it is on track to realize cost savings approximating 10% of Valspar sales.  In my model, I use $900MM (7.5-8% of Akko coating sales) to be realized by 2020, recognizing that there is a blurry line between synergies and the inherent potential in Akzo’s margin structure.  

Let’s assume that PPG comes back with a successful bid in the €95-100/share range, which would be a little higher than the final offer last spring adjusted for the special dividend paid in the fall.  I think that is probably necessary to be successful.  After the disposition of the specialty chemicals unit, AkzoNobel will have significant net cash.  If PPG levers up to the 4.0-4.5 range, which it was willing to do last spring, the deal would be mostly cash and some stock.  By my reckoning, the deal would be slightly accretive without any cost savings.  More importantly, however, it would be at least 25-30% accretive with the cost savings described above:  PPG EPS power would go from $6+ to $8+.  

I disagree with the consensus that apparently believes that PPG has lost interest.  And while AkzoNobel has a structure which under Dutch law makes a hostile takeover difficult if not impossible, I think it will prove hard for a Board, especially one with new directors and which will soon have a new Chair, to stand against the overwhelming majority of large shareholders, especially given the commitment to the Netherlands and Europe which PPG was willing to make last spring and I believe would again.

Risks:

1. PPG doesn’t come back.  This is a real risk, but I think there is some protection in the Elliott involvement and the latent margin potential in standalone AkzoNobel.
2. Worldwide recession.  It will happen sometime.  

Note:  I know this is a Dutch company, but there was no way of identifying it as such in VIC.  

Catalyst

1.  Sale of Specialty Chemicals in the spring

2.  Elliott keeps stirring the pot.

3.  PPG comes back.