Description

Investment Overview:

JSR is a long. The Company was historically a rubber producer but over the past 3 decades they have expanded into specialty chemicals for semiconductors as well as life sciences which are both structurally better businesses than rubber. Pre-COVID elastomers represented ~40% of revenue and was their largest segment (but contributed mid teens to EBITDA). Because of the top-line contribution of elastomers (combinted with the fact that's where the Company's legacy was) it has generally been considered a commodity chemical company when it is really anything but. In May they announced the sale of their Rubber business which should catalyze a reconsideration of what the Company actually does.

Company Background:

JSR was founded in 1957 and started life focused on rubber compounds (JSR=Japan Synthetic Rubber). Over the ensuing decades, they have branched out into photoresist chemicals for semiconductor manufacturing as well as life sciences (CDMO and CRO). Unusually for a Japanese co, the CEO here is an American. I’d also note ValueAct has a 9% position here and they have run a similar playbook at Olympus (to great success).

Situation background:

·         In March 2020, the Company announced they had begun to pursue “restructuring alternatives” for their elastomer business. A few months later this changed to evaluating “all options” and it became clear the elastomer business was in play.

·         In May 2021 they announced the sale of much of their elastomer business to Eneos for 115Bn JPY.

o   The assets sold here include the legacy synthetic rubber business (inc their JVs for SSBR in Thailand and Hungary) as well as their 50% stake in Kumho Polychem.

§  Rubber end markets had turned around since they announced the alternatives process and I would argue this price was too low, but that’s irrelevant now and the value here is it cleans up the story for the stock.

·         What is left is a Company that is a market leader in niches with strong pricing power and secular growth.

·         ~63% of EBITDA from Digital Solutions.

o   The largest contributor here is Semiconductor Materials. These are chemicals which are effectively painted onto wafers prior to lithographic etching. Anybody who hasn’t been hiding under a rock knows that chip manufacturing has been experiencing massive tailwinds that aren’t expected to abate any time soon.

§  Photoresist chems are an oligopoly with only 4 players of scale.

·         JSR has 33% of the market, Shin Etsu has 24% and TOK has ~19%. The balance is shared among some smaller chem cos that are more focused away from leading edge nodes.

o    Semi chems are a tiny fraction of overall production cost of a chip but can have a huge impact on yield. There is also a major technological change going on in how chips are produced with the introduction of EUV which is a significantly more complex manufacturing process than the standard lithography of past 2 decades. JSR has already done the capex to get ready for this so should also see capex ramp back down

§  ASPs on standard photoresist chems are ~$2K/gal. For EUV it can be $10-$20K. There will be a mix shift uplift from EUVL uptake.

§  Given the low contribution to overall chip production cost, this isn’t something fabs are inclined to focus on pricing. In 2019 TSMC bought a bad batch of photoresist chem and they had to chunk a $500MM line because of the contamination.

§  Once a chip/fab is specc’d with a photoresist chem, they’re on that line for the life of the chip.

§  No great comps, but companies like Cabot, Entegris, Shin Etsu trade at low teens EBITDA multiples with slower growth.  

o    ~1./3 of this segment is from Display Materials which are films for LCD monitors (for phones and screens). This segment is likely ex-growth but the Company is focused on using CF from this business to fund the higher growth Semi Chem and Life Sciences businesses.

·         ~24% of EBITDA from Life Sciences

o    Outsourced provider of contract manufacturing (~50% of segment) and R&D for clinical stage pharma and biotech cos. This segment has primarily been assembled through M&A but they have a nice niche here.

§  Space not nearly as consolidated as semi chems but they’re the 4^th largest clinical stage biologics CDMO

o    They carved out a niche focused on large molecule/biologics which is <10% of current scrips but ~70% of current R&D spending.

o    For both CDMO and CRO, they focus on clinical stage companies and provide a higher touch service for companies who lack their own scale for managing some of the R&D and back office complexities of research and manufacturing.

§  They aren’t serving Pfizer-they’re serving more clinical stage companies and they will do things like develop cell lines which is the first biologic template of a drug which is then used to “grow” subsequent batches. 

o    While margins go from ~high teens EBITDA margins going to low 20s as they continue to scale. 

o    Based on most recent medium term plan, they’re looking to do 20Bn JPY in EBIT from this segment 3 years out-that’s almost as much as consolidated EBIT this year (+80% CAGR)

o    Comps for the CDMO business like CTLT and Lonza trade ~7x revenue while comps on CRO side lik IQV, CRL, PPD etc trade ~3-4x.

·         ~13% of EBITDA from Plastics

o   This segment manufactures a range of synthetic plastics. End market ~2/3 auto where they are used mostly on interior parts.

o   This segment could also theoretically be a disposal candidate.

·         As mentioned, the Company is run by an American who seems to “get it”. He was proactive about drastic restructurings in the legacy polymer business which I think indicates he’s not the typical Japanese CEO.

o   The Company has also been a consistent (if modest) repurchaser of their own shares and have bought back ~56Bn JPY in shares over the past 8 years.  

Valuation:

Catalyst

Sale of elastomer business will allow investors to realize underlying business quality