Description
Overview:
Element is a $6.5bln market cap, $8bln EV producer of specialty chemicals. The company reports in two
main divisions. The company derives ~2/3 of profits from Electronics and ~1/3 in Industrials/Specialty.
In Electronics, the company is a global provider of Surface Mount Technologies (SMT), coatings, and
sintering/interconnect products for producing printed circuit boards (PCBs), smartphones, and
semiconductors. Within Industrials/Specialty, the company primarily supplies surface treatment (plating,
cleaning, water treatment) chemistries and graphics solutions materials (flexographic plates,
photopolymers).
The company’s financial metrics are attractive. EBITDA margins are in the low‐20s. And with a portion of
the company’s sales derived from passing through metals (gold, silver, copper, etc) at no margin, the
true “underlying” margin of the business is even higher. These attractive margins combined with low
capex needs (~2% of sales), mean the company converts well over half of its EBITDA into free cash flow.
The manufacture of electronics – whether for printed circuit boards (PCBs), smartphones, or
semiconductors – is highly chemical intensive. Products require significant use of surface cleaning
products, solders/pastes, laminates, and interconnect materials. Essentially each step in the below
schematic of PCB manufacturing requires chemicals.
Source: HeadPcb
Electronics‐related chemical producers are viewed as “scarce assets,” with attractive suppliers either
acquired (CMC Materials, JSR Corp), a piece of a larger conglomerate (DuPont, MKS Instruments, Merck
KgaA), or valued at high multiples by the market (Entegris 43x 2024 P/E, Tokyo Ohka Kogyo 28x 2024
P/E).
Why does the opportunity exist?
Element remains under the radar by investors partially due to its corporate history. ESI was initially
floated in 2013 as a SPAC by financier Martin Franklin (who remains Executive Chairman and whom we
first met in 1996 when he was rolling up eyeglasses businesses through his company Bollé). The current
Element was originally known as MacDermid and was acquired in October 2013, subsequently trading as
Platform Specialty Products. Following a poorly timed foray into the crop protection chemical industry
that nearly sent the business into distress, management became a pure play electronics/surface
materials producer in 2019 and has operated that way ever since. We believe the company’s history as a
nearly distressed chemicals conglomerate provides opportunity to investors today.
The current opportunity also exists because of a cyclical downturn in semiconductors and electronics.
Following a Covid‐related boom in semiconductor sales, the industry faced a destocking‐related
downturn in 2023. Industry shipment data points to as much as 20% reductions in YoY sales last year.
Source: SIA
Outside of semiconductors, the broader electronics industry faced a downturn as well. For smartphones
specifically (a large customer segment for ESI), industry shipments have been ex‐growth for several
years. Finally, concerns around general industrial end markets (Western Autos, construction) weighed
on organic growth and sentiment in ESI’s Industrial & Specialty business.
Source: IDC, Wolfe Research
There are clear signs that cyclical trends in electronics are improving. Semiconductor industry shipment
data has improved, and players across the value chain have talked about green shoots in demand. In
electronics more broadly, there are initial signals that the destock in areas such as industrial automation
may soon end, albeit at a lag to the overall semiconductor industry. And for handsets, one only needs to
see the recent move in Apple stock to understand the potential for AI to finally lead to a new global
handset cycle. On the auto side, EV/ADAS sentiment for Western OEM appears to have reset lower
while ESI builds up its presence with Chinese OEMs. Ultimately, ESI is an EV AND Hybrid winner, seeing a
1.5 – 2x content uplift versus ICE, which should be another driver of market outgrowth.
Valuation
Forward estimates for ESI are undemanding in our opinion. Consensus calls for 4% sales growth this year
and ~5% for the following two years. Prior to the industry downturn, ESI pointed to 4‐5% annual growth
in its end markets and an opportunity to outgrow its end markets by 1‐2%, translating into 5‐6% annual
sales growth. We believe both the industry growth and the outgrowth can exceed these levels for the
next two years, particularly as the industry exits a downturn and should there be any hint of an upcycle
in smartphones. Combined with strong incremental margins of 30‐40%, we believe the company should
grow EBITDA double digits per year. Prior to the industry downturn, the company issued 2026 guidance
of $2.50 EPS. This is now a stretch target given the industry downturn, but we believe even a modest
industry recovery can achieve EPS of $2+ in 2026, which could yield a $40 stock+ (current price $27).
While 20x EPS is a premium to its recent history, we see ESI’s increasing mix shift towards electronics
exposure as well as strong cash generation and organic deleveraging as key drivers for this rerating.
Kicker
There is an additional and timely source of optionality worth discussing, which is M&A. In late May,
DuPont (DD) announced it will split into three different companies – Water, “New DuPont,” and
Electronics. DuPont’s Electronics division is highly complementary to Element’s. Sales are ~$4bln (vs
~$2.5bln for ESI), with ~60% going into semiconductors and ~40% into interconnect applications.
DuPont’s electronics margins are even higher than Element’s at ~29%. We believe the breakup
announcement by DuPont may have really been an announcement that the company will entertain
merger offers. DuPont CEO Ed Breen is a serial dealmaker who engineered the DuPont merger with Dow
Chemical, and more recently spun out DuPont’s Nutrition & Biosciences division via a Reverse Morris
Trust (“RMT”) with International Flavors & Fragrances (IFF). Likewise, Element’s Executive Chairman
Martin Franklin has made a vast personal fortune rolling up complementary businesses. As a reminder,
an RMT allows a company to spin and merge a division with a smaller company in a tax‐free manner. In
the case of DuPont Electronics and Element, the two companies’ sizes would be ideal for an RMT.
Additionally, whereas a pure spinoff would create cost dis‐synergies, an RMT with Element would
generate substantial synergies. Finally, a merged DuPont/Element would create another “large‐cap”
electronics chemicals company in the space ($15bln+ market cap) that could effectively compete for
capital with the other pure play competitor, Entegris ($21bln market cap). We note that Breen had
previously tried to scale his E&I business with a failed attempted acquisition of Rogers Corp back in late
2021. We suspect that locking Ed Breen and Martin Franklin in a room for a few hours could lead to a
very value‐creating transaction. We have augmented our position with inexpensive out‐of‐the‐money
calls in case such a transaction comes to fruition.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
Improvement in electronics demand (smartphones etc)
Increased Penetration with Chinese EV OEMs
DD/ESI rumors
