Description

FMC is a specialty chemical company, primarily selling crop protection products into the agriculture industry. Under the leadership of activist CEO Pierre Brondeau since 2010, the company has transformed itself into a top 5 global player by both divesting non-core businesses and by acquiring assets to strengthen its competitive position (i.e., entered new geographies and added additional product lines). FMC’s final step in becoming a pure-play global leader in crop protection is now underway with the recent partial IPO and future spinoff of Livent (“LTHM”), the company’s lithium operations. However, despite this business transformation and having reported earnings over the past year above expectations, the stock has declined 10% year-to-date. Our view is that both pro forma FMC and LTHM will continue to grow their earnings meaningfully over the next 2 years and that separating the two will allow investors to better appreciate the quality of each business. Thus, we believe both companies will trade at higher multiples on higher than expected earnings, yielding a combined value of ~$130 per FMC share over the next 12 months.

Business Transformation – Part I

FMC is in the crop protection business, selling herbicides, pesticides, insecticides and fungicides to farmers and distributors in Latin America, the United States, Europe and Asia. Despite the strategic rationale and financial benefits created by the transformation of the company under Brondeau, it has been a bumpy road for the stock, especially given the poor timing of the $1.8 billion Cheminova deal in 2015. The deal made sense strategically as adding Cheminova brought FMC direct market access to farmers in Europe, Latin America, India and Australia. Also, there appeared to be strong financial rationale, given that Cheminova was previously managed by a Danish university research foundation. Historically, profitability was a challenge at Cheminova, with single-digit EBITDA margins in 7 out of the 10 years leading up to the deal (2005-2014), as compared to FMC – a 20%+ EBITDA margin business at the time.

“It [Cheminova] broadens and strengthens our existing market access, enhances our portfolio of products and brings significant technology and innovation capabilities.” – FMC CEO Pierre Brondeau

Unfortunately for FMC, financial results in the ensuing periods were muddied by the saturation of ag chemical inventories in the U.S. and Brazil, as well as foreign currency headwinds. In response to the industry downturn, the company limited its sales into over-stuffed channels, and specifically lowered inventories in Brazil. Whereas competitors have continued to struggle, FMC’s Brazil business grew revenue by 15% in 2017 despite a ~10% contraction in that market. The strength in the company’s ag business has accelerated in 2018, with pro forma revenue growth in every region, including 18% in Latin America in the first half of the year.

Business Transformation – Part II

“This is a pivotal transaction for FMC, as it transforms the company into a Tier 1 innovation-based crop protection company, the fifth largest in the world by revenue once all the current consolidation is complete.” – FMC CEO Pierre Brondeau

In 2017, FMC found itself in the middle of the Dow Chemical (“DOW”) and EI du Pont de Nemours (“DD”) $120 billion merger. As regulatory scrutiny ensued, it became clear that the new DowDuPont Inc. (“DWDP”) would have to divest a portion of its crop protection business to address European Commission anti-trust concerns. With limited buyers, both large enough to absorb $1.5 billion in revenue yet small enough that anti-trust issues would not reappear, FMC became a logical acquirer. With DWDP clearly motivated to get a deal done, FMC took advantage of its considerable negotiating leverage by obtaining this highly valuable ag chemical business via an asset swap for effectively 5.5x 2018 EBITDA.

“Together, the performance of our Agricultural Solutions business will be transformed in terms of our margin expectations, driven by a different mix and enhanced geographic exposure.” – FMC CEO Pierre Brondeau

DWDP’s “forced sale” to FMC marked a major inflection point for the company and has driven pro forma earnings well in excess of both management’s guidance and analysts’ expectations.

Livent (“LTHM”)

With manufacturing facilities in the U.S., South America, Europe and Asia, Livent produces lithium to power batteries used in electric vehicles, smartphones, power tools, pacemakers and other products. While demand for lithium in general is expected to grow by 4x-5x between 2017 and 2025, the burgeoning electric vehicle market will drive even faster growth for lithium hydroxide producers specifically. LTHM and competitor Albemarle (“ALB”) operate in a duopoly supplying lithium hydroxides that are approved for commercial use in lithium ion batteries for electric vehicles. Demand for lithium hydroxide is expected to ramp from 55,000 tons in 2017 to 400,000 in 2025.

“We participate very little in the lithium carbonate spot market, but I can tell you for our sales between Q1 and Q2 sequentially, pricing is up for hydroxide and carbonate. So we are seeing sequential up pricing as well as very strong year-on-year pricing.” – FMC CEO Pierre Brondeau

As discussed in our Q1 2018 letter to investors, FMC’s stock fell sharply following the announcement that lithium carbonate producer Sociedad Quimica y Minera de Chile SA (“SQM”) had received regulatory approval to quadruple its production capacity by 2025. However, we believe the market erroneously lumps the lithium hydroxide and commodity carbonate markets together. In reality, we think the two operate independently, and we expect LTHM will continue to benefit from healthy supply/demand fundamentals in hydroxides over the next decade. Long term take-or-pay supply contracts for lithium hydroxide have already been signed by LTHM with its battery producing customers, providing visible and growing free cash flows driven by accelerating volume and price growth.

Following its recent partial IPO, LTHM is trading at just 10.4x projected 2019 EBITDA – a far cry from lithium valuations of above 20x EBITDA in the public markets prior to the aforementioned SQM capacity announcement. We expect that the deal roadshow and spinoff of LTHM in Q1 2019 will further highlight these nuances in the lithium industry and exhibit the underlying value of LTHM.

Valuation

“So I think we're undervalued… We believe that [the market] today does not recognize the value of those two businesses... So the key driver is giving to our shareholders the real value for the Lithium business and for the Ag business for that matter… we are here to realize the value for our shareholders.” – FMC CEO Pierre Brondeau

As a combined entity, FMC is trading at a meaningful discount to the value of its underlying businesses. Through the Corsair lens, we see a global leader in crop protection, only 2x leverage and a shareholder friendly management team, trading for 11.5x its earnings power while giving no credit to its specialty lithium operations. We see 2020 EBITDA and earnings growing to almost $1.4 billion and $7.25 per share, respectively, excluding LTHM. At 12x EBITDA or 15x Adj EPS, pro forma FMC alone could be worth $100-$110 per share in a year. We also believe that LTHM, having contractual tailwinds in both volume and pricing for the next several years and no debt on its balance sheet, could add another $25 per share of value to FMC shareholders at a 14x EBITDA multiple. With robust FCF generation and a value creating CEO, we would not be surprised to see FMC initiate a stock repurchase program as well, adding to the potential upside for shareholders in the years to come.

Catalyst

- FMC full spinoff of LTHM

- FMC potential buyback announcement post spinoff of LTHM

- FMC earnings releases displaying the accretion from the DWDP asset swap

- LTHM earnings releases proving the stable and accelerating growth in lithium hydroxide volume/pricing

- multiple re-rating for both stocks