Description

 Last year I recommended Lanxess (LXS: GR) on the thesis that the split of Arlanxeo would unlock the value of “New Lanxess”, significantly delever the balance sheet and provide management a platform to grow. Since then the split of Arlanxeo occurred (the company received proceeds of €1.2bn), the company ended the year with €269mm of net financial debt and management announced the acquisition of a small biocides business from Chemours and the €2.4bn acquisition of Chemtura (expected to close by mid-year 2017). I believe the market has not accounted for the meaningful benefits Chemtura will bring to Lanxess (European investors are unfamiliar with the US-based company) which is why the opportunity presents itself today. I think pro forma “New Lanxess” is worth €75-85/share, or 20-40% upside to the closing price of €62 in 1.5 years.

Lanxess 2016:

In 2016 Lanxess reported revenue of €7,699mm, adjusted EBITDA of €995mm (+12.4% and margins +170bps y/y) and Adjusted EBITDA – CapX of €556mm +24%.  In separating out Arlanxeo adjusted EBITDA was €622mm, +26% and Adjusted EBITDA – CapX was €321mm, +57%.  Because Lanxess consolidates Arlanxeo for accounting purposes I’ll provide a quick update by segment to explain the performance:

Advanced Intermediates:  Total revenue declined by 4.6% but that was due to raw material deflation (-6.4%) and volumes were +1.9%. The Saltigo segment which provides customer chemicals to the ag/crop protection industry was weaker yet the additives businesses performed well and overall EBITDA margins grew 30bps to 18.8%. Overall EBITDA declined from €338mm to €328mm.

Performance Chemicals:  Total revenue increased by 2.7% led by volume growth of +3.8%, offset by raw material deflation. All businesses performed well with the standouts being material protection with the addition of the Chemours biocide business, strength in inorganic pigments given new capacity in China and offset somewhat by leather chemicals. EBITDA margins increased 200bps to 17.5% and EBITDA overall increased from €326mm to €374mm.

High Performance Materials: Total revenue declined 2.7% due to raw material deflation of 8%. Volumes were +5.6%. In this segment Lanxess continues to move downstream from the manufacture of caprolactam into the manufacturing of engineered plastics. Examples include the brake pad on the new Porsche 918. Margins increased 500bps to 15.1% and overall EBITDA increased to €159mm from €131mm.

Chemtura:

I believe this is the second step into the portfolio transformation (the first being the sale of 50% of Arlanxeo) of Lanxess and the one investors do not appreciate. On 9/26/16 Lanxess announced the all cash acquisition of Chemtura for $33.50 per share representing an enterprise value of €2.4bn.The acquisition represents a multiple of 9x EBITDA and 7x EBITDA post synergy (10x EBITDA – CapX). They are financing the deal with cash on hand, €500mm of 5 years notes yielding 25bps and €500mm of 10 year notes at 1%. The return on capital employed is attractive on a standalone basis. Furthermore the deal is highly strategic to the current Lanxess portfolio, whereby Lanxess strengthens their existing additive and flame retardants businesses.

Additives:

Combining the Lanxess “Rheine Chemie” additives business and Chemtura will create the second largest additive producer globally w/~€650m in annual sales. Additives is an attractive business growing 3-4% per year where the product is only a small part of the customer’s cost but one that differentiates the chemical. Additives serve to differentiate the end compound and where customers highly value the producer’s knowledge and technical service. The combined business will be backward integrated into the synthetic base oils and chemical intermediates. Lubrizol earned mid-20s margins when it was public and Chemtura standalone reported an 18% margin in their industrial performance products segment in 2016. I estimate Rheine Chemie will generate low 20s EBITDA margins.  

Flame Retardants:

Chemtura is one of 3 global producers of brominated flame retardants (2 other producers are ICL and Albemarle) with their assets in El Dorado, Arkansas. Lanxess, through the Rheine Chemie subsidiary produces phosphorous based retardants and these business are highly complementary. Combined the business should generate ~€900m in revenue and mid-teens margins. Flame retardants are used mainly in furniture, construction and electronics. Chemtura has developed a new line of environmentally friendly chemicals under the Emerald 3000 brand which has provided an uplift to growth and margins the last few years.

In addition to those businesses Lanxess is also acquiring the urethanes and organometallics portfolio from Chemtura. Urethanes are hot castable elastomers used to make pellets that go into molds. My checks indicate they have 40-50% market share in the mining and conveyor belt market and recently expanded in China. The business has suffered the past few years with weakness in the mining market but is a dominant player. Organometallics are essential catalysts used to initiate the polymerization of monomers into polymers.  I estimate these 2 businesses generate ~$200m in revenue and do 7% margins.

Management has initially targeted €100m in synergies.

Pro Forma New Lanxess:

Chemtura generated $311m in Adjusted EBITDA (€290m) and $223m (208m) in Adjusted EBITDA – CapX in 2016. Incorporating modest growth from Lanxess’ base business and the €100m in synergies I think the combined company ex-Arlanxeo can do €1.1bn in EBITDA and €750mm in EBITDA – Sustaining CapX in 2018 (first full year with Chemtura).

Note: Sustaining CapX I estimate at €250mm/yr though Lanxess will likely spend €400mm per year.

My target price of €75-80 values New Lanxess at 13-15x earnings and Arlanxeo at €15/share which is the price the business was valued at in 2015 when the joint venture was created.

I would also note that Lanxess has guided to 1Q 2017 EBITDA to be +20% y/y and for the full year to “be up modestly”  though the company has a history of guiding conservatively.

Catalyst

Closing of Chemtura

Continued strong performance in New Lanxess