OLIN CORP OLN
September 07, 2015 - 11:09pm EST by
savvystockguy
2015 2016
Price: 19.04 EPS 2.22 3.04
Shares Out. (in M): 167 P/E 8.6 6.3
Market Cap (in $M): 3,183 P/FCF 5.8 4.6
Net Debt (in $M): 3,685 EBIT 723 934
TEV ($): 6,868 TEV/EBIT 9.5 7.4

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  • Chemicals
 

Description

Olin Corporation (OLN US)

Olin is currently made up of three businesses: chemicals manufacturing, chemicals distribution and small caliber ammunition manufacturing. Its two chemicals divisions manufacture and distribute chlorine and caustic soda (known as chlor-alkali) while its ammunition division manufactures small caliber ammunition for consumers, law enforcement and the department of defense.  Olin is, however, in the process of acquiring a significant portion of Dow Chemical’s chlor-alkali and downstream derivatives businesses, thereby becoming the largest chlor-alkali player in the world. The acquisition is on schedule to close within the next few weeks.  Pro forma for the acquisition, but before synergies, the new company will have the following business (2014):

-          Chlor-Alkali (64% of EBITDA) – 672 million

-          Global Epoxy (15% of EBITDA) – 157 million

-          Ammunition (14% of EBITDA) – 144 million

-          Chlorinated organics (5% of EBITDA) – 54 million

-          Chemicals distribution (2% of EBITDA) – 21 million

-          Corporate –(49 million)

Total EBITDA before synergies is therefore $1billion even.  Given the nature of this acquisition, where not only does the combined company have significantly more scale, but Olin achieves significantly more downstream integration, the transaction will create meaningful synergies.  Olin expects cost synergies of $200 million per year and potentially another $100 million per year in revenue synergies.  Given the size of the combined company and the nature of the business, the synergy targets strike us as being rather conservative.  We understand the company hired McKinsey consulting to give them an estimate of the cost synergies alone, and McKinsey’s estimate was at least $250 million, compared to the company’s estimate of $200 million.  As I am generally more skeptical of revenue synergies, I only give them credit for the $200 million of cost synergies in my estimate.  Before we assume any growth, 2014 PF EBITDA, including only the cost synergies we arrive at $1.200 Billion in EBITDA.  Given the cyclical nature of all of their businesses, it is important take a close look at where each one of the segments relative to its cyclical average. Here are my conclusions:

-          Chlor-Alkali: We have much more data for Olin’s Chlor-Alkali’s division that we do Dow’s, but given Dow’s greater downstream integration, Olin’s Chlor-Alkali business should be more cyclical. In 2014, EBITDA margins were 17.9%, vs. the average over the last 10 years of 27.1%. The 17.9% margin in 2014 is the lowest margin over the last 10 years, which margins peaking in 2005 at 43.0%. This is consistent with the management and industry commentary that we are at the trough of the Chlor-Alkali cycle.  The reason for the weak conditions in the chlor-alkali industry is that the biggest end users of chlorine is the vinyls market, which is primarily driven by constriction. It is no surprise that the higher margins were achieved in 2005 / 2006 when the US housing market was at its strongest.  Capacity utilization in chlor-alkali is in the low to mid 80% today consistent with little pricing power and trough margins.  This is due to the combination of weak housing demand as well as growth in supply over the last few years.  Fortunately, there is virtually no new capacity coming on, while demand should accelerate nicely as the US housing market recovers.  Olin has stated they believe that their own chlor-alkali business is likely to see a $200 million in increase in EBITDA as the industry recovers.   While Dow’s business is larger, its greater downstream integration makes the business less cyclical. Discussions with the company suggest there may be $100 million upside as the market recovers.

-          Global Epoxy:  As this business comes purely from the Dow side we have less historical data for this division, but analysis of the Epoxy businesses of Hunstman (within their Advanced Materials division) and Hexion suggests this business a. Is below average cycle (Hexion did 8.3% margins in 2014 compared to a 10 year average of 11.9) b. Dow’s Epoxy business’ margins are meaningfully below peers. We cannot find any structural reason as to why it should be lower margin that Hexion, so we suspect once it is run as a standalone business within OLN, that there is upside to margins regardless of the cycle. Dow’s conference calls from a few years back discuss this business having the potential to achieve 20% EBITDA margins, a far cry from the current fully adjusted 5% margin.  Epoxy is used for a number of end markets, but construction and infrastructure remains an important end market.  Given that Epoxy is a global market and the weakness in infrastructure in emerging markets, we are not assuming much of a cyclical recovery here, but believe the margin gap with Hexion can be closed, providing 50% upside to Global Epoxy EBITDA from current depressed levels (79 million of EBITDA upside from closing margin gap). Huntsman’s margin are significantly higher still, but their Advanced Materials division includes other businesses that could be even higher margin than Epoxy.

-          Ammunition (Winchester).  Sales of firearms and ammunition have seen significant growth over the last number of years in the US.  The reasons for this growth are growth in active sport shooting, increased demand for home protection and concerns about further regulatory changes.  While we have no specific reason to think fear around home security should decline or that the growth in sports shooting should reverse, we think fears around further regulatory changes may subside if there is a change in the White House.  This has to some extent already happened, as sales have been declining since the 2013 peak.  While recent government registration data for guns suggest a reversal of the declines, it is too early to tell what the true normalized levels for this business is.  In 2014, revenues for this business were about 40% higher than the 10 year average and almost 100% higher than the levels we saw under the Bush Administration.  The company has improved the profitability of this business independently of the growth in revenues over the last few years, so we assume the 144 million in adjusted EBITDA for 2014 is above normalized levels by 44 million. 

-          Chlorinated Organics. This is the business we have the least amount of detailed historical data on. It is clearly not at peak, given that EBITDA for this business was 160% higher in 2012 than it was in 2014. We use the average level of the last three years as average to come up with 16.7 million of upside to normalized levels. The chlorinated organics division produces chemicals for cleaning applications, construction, refrigeration and water treatment.

-          Chemicals distribution.  This business generally does not have much commodity pricing exposure as it largely a logistics business, but can still be impacted by pricing lags and inventory changes. The business has EBITDA of 21 million in 2014 compared to historical averages of 30 million, so we assume 9 million of EBITDA increase to normalized levels.

If we start with 2014 Pro Forma EBITDA of $1.200 Billion and make the following adjustment to get to normalized levels: +150 million in Chlor-alkali (assumes mid-point of cycle, not the full 300 million the company has highlighted as “recovered earnings), +79 million from Epoxy, -44 million from Ammunition, 16.7 million in chlorinated organics and +9 million in chemicals distribution. This add up to a total of 211 million on top of the 2014 figure for a total PF EBITDA of 1411. To be clear, this is to arrive at normalized, or through the cycle levels. As we are moving off of a trough in every business with the exception of the ammunition business, we expect EBITDA to go beyond average cycle and towards peak of the cycle over the next few years as housing in the US recovers from its abnormally low level of housing starts. Peak EBITDA is closer to $1.650 Billion.  In the company’s form S-4 filed you can find the individual projections of the two companies. Once you add in the synergies plus the benefit of the ethylene supply contract you will find a number just north of our peak estimate for 2017.  While earnings are likely to go above average cycle in the medium term, we will focus on the normalized earnings for the purposes of our valuation analysis.  After the investments make over the last number of years, capital expenditures are expected be lower on a recurring basis going forward.  In addition, we expect Olin to close down some of Dow’s older chlorine capacity which will bring down capital expenditures further. However, just using the company’s estimates of capital expenditures, they are expected to be $300 million per year for the foreseeable future.  Depreciation and amortization however, will be higher at 477 million per year, which means cash EPS will be higher than reported EPS by $1.06 per share. PF interest expense will be 153 million and there are 167 million shares outstanding PF for the deal. This means that using our normalized figure of $1.411 Billion of EBITDA, the business generates $4.09 in cash EPS, while reported EPS will be $3.04.  Because book EPS reflects abnormally high D&A relative to normalized capital expenditures, we focus primarily on the cash EPS figure.   While chemical multiples are currently depressed due to the fears around global growth, there are many strong arguments in favor of Olin deserving a higher multiple that your average specialty chemicals company: 1. Almost 20% of the business comes from ammunition and chemical distribution, where the peers trade between 17X and 20X EPS, 2. Olin is now the dominant market leader in chlor-alkali globally with an advantaged cost position due to its exclusively US manufacturing footprint and its advantaged access to low cost North American natural gas. Nevertheless. Let’s assume that the business receives a paltry 12x EPS multiple. Even using this multiple, the stock is worth $49 per share or 160% upside to its current price of $19. I suspect the stock will trade above fair value as the chlorine cycle recovers. As we move towards the peak, cash EPS will be well in excess of $5 per share, which at a 15x normal specialty chemicals multiple warrants a $75 share price.

The two obvious pushbacks are:

1.       If the stock is worth between $49 and $75, how can it trade at $19 today? It is really a combination of a few things:

a.       When the stock was announced in late March, the stock immediately popped from $27.19 to $32.41 as people realized the power of combining these assets. However, as fears around a Chinese slowdown intensified and multiples of chemical companies compressed, Olin’s multiple compressed with the rest of the group. Several high profile funds filed significant ownership in the mid to high 20s but this only made things worse as several months of weak hedgefund performance forced many of the holders to reduce or exit their position as the stocks fell, exacerbating the move down

b.      The merger arbitrage community have been putting an abnormally large amount of pressure on Olin stock as they have shorted Olin and bought DOW. Not only are there a number of large funds what like the DOW standalone story post deal, but there are also funds doing to pure arbitrage based on the uncertainty around the final ratio

c.       Olin is still a mid cap stock, so it does not yet have the size to gain the support of the larger asset managers of the sell side community. Once the deal closes and the large banks will have little choice but to cover it, we expect the deep dislocation in its stock price to be corrected. While the stock could be volatile for the next few weeks, given how tight the borrow has become in Olin, I suspect the shorting pressure from the arbs will be largely behind us. 

2.       Isn’t China slowing and doesn’t that mean that I can’t own anything in materials? Yes, China is slowing, but no, we don’t think it will impact Olin much if at all. Why? Because Chlorine is a national and not a global market. This is not true for Soda Ash, but Chlorine drives the cycle and if pricing for soda ash falls too far, producers will cut chlorine capacity further thereby stabilizing pricing for soda ash, and pushing price up for chlorine.  China has had overcapacity for soda ash and PVC for many years. For reference, their export capacity (on the coast in China) is running at 55% utilization. Needless to say the Chinese are not making any money on this, but they do provide a pricing umbrella for the US producers that use natural gas (ethane) instead of crude oil (naptha).  It is clearly true that the pricing umbrella has come down since the spread between natural gas and crude oil has come down. However, the cost curve has not flattened nearly as much as people think because the co-product prices in the naptha process have fallen so significantly. Please note that we are not assuming any recovery in crude oil prices, but there is clearly more upside fundamentally to crude oil prices over the next few years, despite the near term glut. If oil prices recover, the margin cost of soda ash and pvc will move higher which will increase the pricing umbrella for US producers like Olin. However, given the current spread, with brent crude oil at $47, there is plenty enough spread for utilization and pricing in the US to recover with US housing to get to normalized levels and beyond before Chinese products become competitive. Case in point, with crude oil where it is today, and with Chinese export capacity at 55%, the Chinese are far from being able to compete on cost relative to the US manufacturers like Olin.  The flip side to the current overcapacity in chlor-alkali is that there is basically no capacity coming on for the next number of years. Actually close to 3.5% of capacity will have to leave the industry by 2018 / 2019 due to regulatory reason in Europe (mercury based capacity).  In addition, we think it is likely that Olin takes out Dow’s old capacity in the US.  While sentiment around commodities and emerging markets could hardly be more bearish, there is a plausible scenario where, US housing recovers, European housing recovers, China doesn’t crash and burn but just grows as a slower rate from hare, India accelerates its infrastructure plans, while Brazil slowly recovers from its recession.  All of this happens while oil stabilizes and gradually grinds higher, while there is no new supply and a portion if the installed capacity in Europe is removed for regulatory reasons. If this scenario plays out, then Olin will be worth a lot more than what we have in our base case.

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

The closing of the deal at the end of this month.

Some other investors/analysts figuring out this story and publishing it in the next month of so.  (I am skeptical there are any sell-side analysts with the ability, but perhaps I will be surprised.)

    sort by    

    Description

    Olin Corporation (OLN US)

    Olin is currently made up of three businesses: chemicals manufacturing, chemicals distribution and small caliber ammunition manufacturing. Its two chemicals divisions manufacture and distribute chlorine and caustic soda (known as chlor-alkali) while its ammunition division manufactures small caliber ammunition for consumers, law enforcement and the department of defense.  Olin is, however, in the process of acquiring a significant portion of Dow Chemical’s chlor-alkali and downstream derivatives businesses, thereby becoming the largest chlor-alkali player in the world. The acquisition is on schedule to close within the next few weeks.  Pro forma for the acquisition, but before synergies, the new company will have the following business (2014):

    -          Chlor-Alkali (64% of EBITDA) – 672 million

    -          Global Epoxy (15% of EBITDA) – 157 million

    -          Ammunition (14% of EBITDA) – 144 million

    -          Chlorinated organics (5% of EBITDA) – 54 million

    -          Chemicals distribution (2% of EBITDA) – 21 million

    -          Corporate –(49 million)

    Total EBITDA before synergies is therefore $1billion even.  Given the nature of this acquisition, where not only does the combined company have significantly more scale, but Olin achieves significantly more downstream integration, the transaction will create meaningful synergies.  Olin expects cost synergies of $200 million per year and potentially another $100 million per year in revenue synergies.  Given the size of the combined company and the nature of the business, the synergy targets strike us as being rather conservative.  We understand the company hired McKinsey consulting to give them an estimate of the cost synergies alone, and McKinsey’s estimate was at least $250 million, compared to the company’s estimate of $200 million.  As I am generally more skeptical of revenue synergies, I only give them credit for the $200 million of cost synergies in my estimate.  Before we assume any growth, 2014 PF EBITDA, including only the cost synergies we arrive at $1.200 Billion in EBITDA.  Given the cyclical nature of all of their businesses, it is important take a close look at where each one of the segments relative to its cyclical average. Here are my conclusions:

    -          Chlor-Alkali: We have much more data for Olin’s Chlor-Alkali’s division that we do Dow’s, but given Dow’s greater downstream integration, Olin’s Chlor-Alkali business should be more cyclical. In 2014, EBITDA margins were 17.9%, vs. the average over the last 10 years of 27.1%. The 17.9% margin in 2014 is the lowest margin over the last 10 years, which margins peaking in 2005 at 43.0%. This is consistent with the management and industry commentary that we are at the trough of the Chlor-Alkali cycle.  The reason for the weak conditions in the chlor-alkali industry is that the biggest end users of chlorine is the vinyls market, which is primarily driven by constriction. It is no surprise that the higher margins were achieved in 2005 / 2006 when the US housing market was at its strongest.  Capacity utilization in chlor-alkali is in the low to mid 80% today consistent with little pricing power and trough margins.  This is due to the combination of weak housing demand as well as growth in supply over the last few years.  Fortunately, there is virtually no new capacity coming on, while demand should accelerate nicely as the US housing market recovers.  Olin has stated they believe that their own chlor-alkali business is likely to see a $200 million in increase in EBITDA as the industry recovers.   While Dow’s business is larger, its greater downstream integration makes the business less cyclical. Discussions with the company suggest there may be $100 million upside as the market recovers.

    -          Global Epoxy:  As this business comes purely from the Dow side we have less historical data for this division, but analysis of the Epoxy businesses of Hunstman (within their Advanced Materials division) and Hexion suggests this business a. Is below average cycle (Hexion did 8.3% margins in 2014 compared to a 10 year average of 11.9) b. Dow’s Epoxy business’ margins are meaningfully below peers. We cannot find any structural reason as to why it should be lower margin that Hexion, so we suspect once it is run as a standalone business within OLN, that there is upside to margins regardless of the cycle. Dow’s conference calls from a few years back discuss this business having the potential to achieve 20% EBITDA margins, a far cry from the current fully adjusted 5% margin.  Epoxy is used for a number of end markets, but construction and infrastructure remains an important end market.  Given that Epoxy is a global market and the weakness in infrastructure in emerging markets, we are not assuming much of a cyclical recovery here, but believe the margin gap with Hexion can be closed, providing 50% upside to Global Epoxy EBITDA from current depressed levels (79 million of EBITDA upside from closing margin gap). Huntsman’s margin are significantly higher still, but their Advanced Materials division includes other businesses that could be even higher margin than Epoxy.

    -          Ammunition (Winchester).  Sales of firearms and ammunition have seen significant growth over the last number of years in the US.  The reasons for this growth are growth in active sport shooting, increased demand for home protection and concerns about further regulatory changes.  While we have no specific reason to think fear around home security should decline or that the growth in sports shooting should reverse, we think fears around further regulatory changes may subside if there is a change in the White House.  This has to some extent already happened, as sales have been declining since the 2013 peak.  While recent government registration data for guns suggest a reversal of the declines, it is too early to tell what the true normalized levels for this business is.  In 2014, revenues for this business were about 40% higher than the 10 year average and almost 100% higher than the levels we saw under the Bush Administration.  The company has improved the profitability of this business independently of the growth in revenues over the last few years, so we assume the 144 million in adjusted EBITDA for 2014 is above normalized levels by 44 million. 

    -          Chlorinated Organics. This is the business we have the least amount of detailed historical data on. It is clearly not at peak, given that EBITDA for this business was 160% higher in 2012 than it was in 2014. We use the average level of the last three years as average to come up with 16.7 million of upside to normalized levels. The chlorinated organics division produces chemicals for cleaning applications, construction, refrigeration and water treatment.

    -          Chemicals distribution.  This business generally does not have much commodity pricing exposure as it largely a logistics business, but can still be impacted by pricing lags and inventory changes. The business has EBITDA of 21 million in 2014 compared to historical averages of 30 million, so we assume 9 million of EBITDA increase to normalized levels.

    If we start with 2014 Pro Forma EBITDA of $1.200 Billion and make the following adjustment to get to normalized levels: +150 million in Chlor-alkali (assumes mid-point of cycle, not the full 300 million the company has highlighted as “recovered earnings), +79 million from Epoxy, -44 million from Ammunition, 16.7 million in chlorinated organics and +9 million in chemicals distribution. This add up to a total of 211 million on top of the 2014 figure for a total PF EBITDA of 1411. To be clear, this is to arrive at normalized, or through the cycle levels. As we are moving off of a trough in every business with the exception of the ammunition business, we expect EBITDA to go beyond average cycle and towards peak of the cycle over the next few years as housing in the US recovers from its abnormally low level of housing starts. Peak EBITDA is closer to $1.650 Billion.  In the company’s form S-4 filed you can find the individual projections of the two companies. Once you add in the synergies plus the benefit of the ethylene supply contract you will find a number just north of our peak estimate for 2017.  While earnings are likely to go above average cycle in the medium term, we will focus on the normalized earnings for the purposes of our valuation analysis.  After the investments make over the last number of years, capital expenditures are expected be lower on a recurring basis going forward.  In addition, we expect Olin to close down some of Dow’s older chlorine capacity which will bring down capital expenditures further. However, just using the company’s estimates of capital expenditures, they are expected to be $300 million per year for the foreseeable future.  Depreciation and amortization however, will be higher at 477 million per year, which means cash EPS will be higher than reported EPS by $1.06 per share. PF interest expense will be 153 million and there are 167 million shares outstanding PF for the deal. This means that using our normalized figure of $1.411 Billion of EBITDA, the business generates $4.09 in cash EPS, while reported EPS will be $3.04.  Because book EPS reflects abnormally high D&A relative to normalized capital expenditures, we focus primarily on the cash EPS figure.   While chemical multiples are currently depressed due to the fears around global growth, there are many strong arguments in favor of Olin deserving a higher multiple that your average specialty chemicals company: 1. Almost 20% of the business comes from ammunition and chemical distribution, where the peers trade between 17X and 20X EPS, 2. Olin is now the dominant market leader in chlor-alkali globally with an advantaged cost position due to its exclusively US manufacturing footprint and its advantaged access to low cost North American natural gas. Nevertheless. Let’s assume that the business receives a paltry 12x EPS multiple. Even using this multiple, the stock is worth $49 per share or 160% upside to its current price of $19. I suspect the stock will trade above fair value as the chlorine cycle recovers. As we move towards the peak, cash EPS will be well in excess of $5 per share, which at a 15x normal specialty chemicals multiple warrants a $75 share price.

    The two obvious pushbacks are:

    1.       If the stock is worth between $49 and $75, how can it trade at $19 today? It is really a combination of a few things:

    a.       When the stock was announced in late March, the stock immediately popped from $27.19 to $32.41 as people realized the power of combining these assets. However, as fears around a Chinese slowdown intensified and multiples of chemical companies compressed, Olin’s multiple compressed with the rest of the group. Several high profile funds filed significant ownership in the mid to high 20s but this only made things worse as several months of weak hedgefund performance forced many of the holders to reduce or exit their position as the stocks fell, exacerbating the move down

    b.      The merger arbitrage community have been putting an abnormally large amount of pressure on Olin stock as they have shorted Olin and bought DOW. Not only are there a number of large funds what like the DOW standalone story post deal, but there are also funds doing to pure arbitrage based on the uncertainty around the final ratio

    c.       Olin is still a mid cap stock, so it does not yet have the size to gain the support of the larger asset managers of the sell side community. Once the deal closes and the large banks will have little choice but to cover it, we expect the deep dislocation in its stock price to be corrected. While the stock could be volatile for the next few weeks, given how tight the borrow has become in Olin, I suspect the shorting pressure from the arbs will be largely behind us. 

    2.       Isn’t China slowing and doesn’t that mean that I can’t own anything in materials? Yes, China is slowing, but no, we don’t think it will impact Olin much if at all. Why? Because Chlorine is a national and not a global market. This is not true for Soda Ash, but Chlorine drives the cycle and if pricing for soda ash falls too far, producers will cut chlorine capacity further thereby stabilizing pricing for soda ash, and pushing price up for chlorine.  China has had overcapacity for soda ash and PVC for many years. For reference, their export capacity (on the coast in China) is running at 55% utilization. Needless to say the Chinese are not making any money on this, but they do provide a pricing umbrella for the US producers that use natural gas (ethane) instead of crude oil (naptha).  It is clearly true that the pricing umbrella has come down since the spread between natural gas and crude oil has come down. However, the cost curve has not flattened nearly as much as people think because the co-product prices in the naptha process have fallen so significantly. Please note that we are not assuming any recovery in crude oil prices, but there is clearly more upside fundamentally to crude oil prices over the next few years, despite the near term glut. If oil prices recover, the margin cost of soda ash and pvc will move higher which will increase the pricing umbrella for US producers like Olin. However, given the current spread, with brent crude oil at $47, there is plenty enough spread for utilization and pricing in the US to recover with US housing to get to normalized levels and beyond before Chinese products become competitive. Case in point, with crude oil where it is today, and with Chinese export capacity at 55%, the Chinese are far from being able to compete on cost relative to the US manufacturers like Olin.  The flip side to the current overcapacity in chlor-alkali is that there is basically no capacity coming on for the next number of years. Actually close to 3.5% of capacity will have to leave the industry by 2018 / 2019 due to regulatory reason in Europe (mercury based capacity).  In addition, we think it is likely that Olin takes out Dow’s old capacity in the US.  While sentiment around commodities and emerging markets could hardly be more bearish, there is a plausible scenario where, US housing recovers, European housing recovers, China doesn’t crash and burn but just grows as a slower rate from hare, India accelerates its infrastructure plans, while Brazil slowly recovers from its recession.  All of this happens while oil stabilizes and gradually grinds higher, while there is no new supply and a portion if the installed capacity in Europe is removed for regulatory reasons. If this scenario plays out, then Olin will be worth a lot more than what we have in our base case.

    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

    The closing of the deal at the end of this month.

    Some other investors/analysts figuring out this story and publishing it in the next month of so.  (I am skeptical there are any sell-side analysts with the ability, but perhaps I will be surprised.)

    Messages


    SubjectWe agree. OLN compelling investment opportunity. Some more points
    Entry09/08/2015 10:01 AM
    Memberaviclara181

    We also believe OLN represents a compelling investment opportunity with tremendous upside and limited downside given the FCF generation.

    Some important points to highlight that we think are missing from this write-up

    1)     1) OLN management has been pretty clear they intend to reduce capacity.  Dow operates the lowest cost assets globally.  We believe that once the deal closes, OLN will move to rationalize their legacy assets, reducing supply and operate the Dow assets at a higher utilization.  OLN was not been explicit about capacity reductions when they announced the deal because of regulatory concerns.  Now that OLN has received all regulatory approvals, OLN has increased its disclosure.  Suntrust hosted investors at OLN’s headquarters in late August and published a note on August 31st that goes through the capacity reduction by facility.  Their analysis would suggest OLN could cut 6% of North American capacity.  We believe once the deal closes, further clarity on capacity reduction will be a catalyst to chlor-alkali pricing and the stock.

    2)      2) The presenter highlighted the European capacity reduction that is coming due to environmental regulations.  What is most important about that is it takes Europe from a net export position to becoming a net importer of chlor-alkali.

     

    3)      3) While we spend a lot of time discussion chlor-alkali supply demand and pricing, it’s also important to understand that the pro forma business will be less exposed to commodity prices.  Earnings therefore should be less volatile and warrant a higher multiple.  First, $1bn of sales or ~14% of pro forma revenues will be sales to Dow at a long-term cost plus contract.  Second, Dow asset does not sell chlorine into the merchant market.  All their chlorine production is consumed by their downstream business.  With regards to caustic, Dow assets sell ~40% of its caustic externally with the rest being consumed in downstream products.  Legacy OLN sells 2/3 of their caustic into the merchant market.


    SubjectRe: We agree. OLN compelling investment opportunity. Some more points
    Entry09/08/2015 10:47 AM
    Membersavvystockguy

    Thanks for the feedback, and yes, I agree.  I was trying to finish up this write-up, and forgot to include a few things, and I appreciate you highlighting some of them.  

    I also forgot to mention in the write-up that Olin also pays a 4.2% dividend yield that they have every intention on keeping. The company has been paying its dividend for 90% years through thick and thin so people should be pretty comfortable with this dividend.  So basically, you can buy a business at 4.6x Normalized Cash EPS, with a 4.2% dividend yield, at the trough of the cycle, with a leading a dominant position within the chlor-alkali industry.  It is quite amazing that the stock has traded this low in my view.

    Thanks again for the additional points.


    SubjectRe: Point72/EverPoint/Cubist
    Entry09/08/2015 11:54 AM
    Membersavvystockguy

    I think it is tough to say for sure, but it would seem that the fundamental side clearly filed a large long position prior to chemicals getting killed, and likely had to adjust sizing.  I wouldn't be surprised if they have some arb guys involved, but as this closes within the next few weeks, I suspect downside is very limited, and at current valuation, for anyone with a time horizon longer than a month or two, I think OLN under $20 is a gift, and never should have seen these levels.  I wrote-up Trinseo (TSE) a while back, and I believe this is akin to buying TSE when it was down around the $12-$13 level for no good reason.  This is a high conviction out-sized position for us.  


    SubjectRe: Point72/EverPoint/Cubist
    Entry09/08/2015 11:55 AM
    Memberaviclara181

    It appears Rubric is the majority of the holdings and that is the deep value generalist portfolio.

    http://www.bloomberg.com/news/articles/2014-12-19/point72-starts-multistrategy-unit-as-cohen-diversifies

     


    SubjectRe: Re: Point72/EverPoint/Cubist
    Entry09/08/2015 12:05 PM
    Membercuyler1903

    Got it, thanks.  Aviclara, to your point, it appears that Rubric has only been a buyer, and was active buyer in the 24-26 range in this filing.


    SubjectWe agree as well (dammit)
    Entry09/08/2015 04:35 PM
    Memberspike945

    We also like OLN a lot here. So much so that I had just finished a writeup on the name myself. That's what you get for waiting a day, I guess. Nice work.

    We have higher mid cycle numbers than you, and would also point out that for a cyclical company, OLN hasn't had a negative EPS every year since 2002. We really like the risk/reward from here.


    SubjectRe: We agree as well (dammit)
    Entry09/08/2015 07:59 PM
    Membersavvystockguy

    Thanks very much Spike945.  I have been wanting to write OLN for a while.  I wanted so badly to get this finished last week when it traded down to ~$18.50, but I just didn't have the time, and still had to rush it to get it out last night.  And then I figured, if this works the way we expect, anything under $20 is a gift anyway, so a buck here or there won't matter.  I appreciate your comment on the higher mid-cycle numbers - I have much higher "better case scenario" numbers, but went with the conservative base case, as I believe the investment case is sufficiently compelling that I don't even need to be a little bit aggressive.  Glad to know there is some validation for the idea here.  Thank you.


    SubjectRe: We agree as well (dammit)
    Entry09/08/2015 07:59 PM
    Membersavvystockguy

    Thanks very much Spike945.  I have been wanting to write OLN for a while.  I wanted so badly to get this finished last week when it traded down to ~$18.50, but I just didn't have the time, and still had to rush it to get it out last night.  And then I figured, if this works the way we expect, anything under $20 is a gift anyway, so a buck here or there won't matter.  I appreciate your comment on the higher mid-cycle numbers - I have much higher "better case scenario" numbers, but went with the conservative base case, as I believe the investment case is sufficiently compelling that I don't even need to be a little bit aggressive.  Glad to know there is some validation for the idea here.  Thank you.


    SubjectRe: We agree as well (dammit)
    Entry09/08/2015 07:59 PM
    Membersavvystockguy

    Thanks very much Spike945.  I have been wanting to write OLN for a while.  I wanted so badly to get this finished last week when it traded down to ~$18.50, but I just didn't have the time, and still had to rush it to get it out last night.  And then I figured, if this works the way we expect, anything under $20 is a gift anyway, so a buck here or there won't matter.  I appreciate your comment on the higher mid-cycle numbers - I have much higher "better case scenario" numbers, but went with the conservative base case, as I believe the investment case is sufficiently compelling that I don't even need to be a little bit aggressive.  Glad to know there is some validation for the idea here.  Thank you.


    Subjectquestions
    Entry09/09/2015 08:49 AM
    Memberaa123

    thanks for the interesting idea. could you please expand on your comments regarding the chlorine being a national market? where could I find info on supply and demand in that market? Also what's the breakdown between chlorine and soda ash in the 672 million EBITDA in that division?

    Also management was saying that 2014 would be the through. It appears that 2015 is worse. what happened versus their expectations? seems it's driven by soda ash but would love to hear your thoughts. 

    Thanks.

     


    SubjectAXLL, exchange offer
    Entry09/09/2015 01:07 PM
    Memberaltaloma

    Thanks for an interesting write-up. I have been following but not closely and agree OLN looks like good risk-reward here. A few questions:

    Do you think OLN would be interested in AXLL's chlorovinyls assets? Interim AXLL manangement seems to have suggested that they would entertain a sale of individual assets or the company as a whole. Have you spoken with management about this?

    I'm less familiar thus far with the structure, but how do you think about buying OLN through the DOW exchange offer? 

    Thanks again.

     


    SubjectRe: management track record?
    Entry09/09/2015 01:28 PM
    Membersavvystockguy

    hi. thanks for the interesting write up.  

    Olivia08 - You are welcome – I believe this is a great story, and the risk/reward is compelling.  You do make some excellent and valid points that I will attempt to address.

    what is management's track record in operations and capital allocation?  

    Per disciplined capital allocation, I would point to an incredibly consistent dividend payout (~90 years or 355 consecutive quarters), and also the fact that they have committed to using excess cash to deleverage the balance sheet in the coming years.  On the operations side, the company has a history of integrating acquired businesses and realizing cost savings in their core chlor alkali business – i.e. the acquisition of the Pioneer Companies in 2007 and the acquisition/integration of their SunBelt JV in 2011.

    this seems pretty important given the deal size and complexity here...  on the capital allocation front, its possible i am being unfair, but it doesnt look great.  the ka steel acquisition from a high level it looks like they spent $337mm in cash for what now produces $21mm of ebitda (per your estimate).  ebitda-capex for the past 2 fiscal years fell from $22.6mm to $14.2mm.  using your $21mm estimate would indicate about $19mm.  and then step it up to $30mm normalized and you get $28mm.  so they paid somewhere between 12 and 24x ebitda-capex?  

    Your point is an interesting one, but it is challenging to know if it is fair or unfair.  Unfortunately, we don’t really know, or have enough history for this business pre-crisis, and I cannot find any disclosure on this.  But as mentioned in the write-up, what we do have from disclosures and management commentary suggest that EBITDA averaged roughly $30m going back to 2008, and was probably higher pre-crisis.  So EBITDA has clearly been depressed the last few years due to pricing and inventory changes in the distribution channel.  I would also point to the fact that capex is very low considering the nature of the distribution business.  EBITDA less CAPEX is relatively high since CAPEX is so low for distribution. 

    Also you state they now have advantaged cost position due to access to cheap gas. Can you explain this comment as my understanding was that the chlor-alkali business is converting salt brine and electricity into chemicals.  

    The electricity component is natural gas based.  The vast majority of their cost comes from the electricity side, and for most of the USA players, this comes from natural gas.  Thus, they have the benefit of lower US natural gas prices. This impacts electricity which impacts their cost.

     

    i do understand they are then often combined with ethane based prodcuts to produce things like PVC.  so are you saying that this will drive volumes and utilization rates, so they indirectly benefit from domestic gas prices?  

    That is true.  But, that’s not really the way we are looking at it.  We are viewing this as stated above (electricity is the primary input benefit here via low cost natural gas).  Right now, Olin doesn’t manufacture any PVC, but sells chlorine to producers that combine chlorine and ethylene to make PVC.  Post the Dow deal however, OLN will be even more exposed to natural gas-based electricity in its chlor alkali business, and will also have the benefit of low cost ethane-based ethylene (via the supply agreement with Dow) to supply the acquired downstream businesses.

    Anyway - I hope this is helpful.  


    SubjectRe: questions
    Entry09/09/2015 01:33 PM
    Membersavvystockguy

    thanks for the interesting idea. could you please expand on your comments regarding the chlorine being a national market? where could I find info on supply and demand in that market?   

    aa123 - In terms of what is publicly available, there is limited supply/demand data, but several industry consultants publish ongoing pricing and supply and demand data.  IHS might be a good place to start.

    Also what's the breakdown between chlorine and soda ash in the 672 million EBITDA in that division?   

    For Chlorine, it’s very difficult to transport. Thus, you don’t see trade between countries with Chlorine. Because of the nature of the product, it is very difficult to transport. Even domestically, there are issues with moving it between regions, and globally, there is simply no real trade. Regarding the breakdown between chlorine and soda ash, I should have said “caustic soda” rather than “soda ash” – sorry, my mistake. But regarding the breakdown between chlorine and caustic soda - during the process, you get a fixed ratio, of roughly 1 to 1.1, chlorine to caustic soda, and the contribution to profitability depends on where we are in the cycle and on pricing of each product separately. Right now, caustic soda has been under pressure, because of weaknesses in emerging markets, and so overall, profitability has been negatively impacted because of this happening in caustic soda.

     

    Also management was saying that 2014 would be the through. It appears that 2015 is worse. what happened versus their expectations? seems it's driven by soda ash but would love to hear your thoughts. 

    Weakness on the caustic side has more than offset, stabilization and slight improvement in chlorine. Their commentary on the last call was that the business had hit trough then, and had pushed out their expectations from what they were looking at in 2014.  So, if you have any sort of stabilization in global market for caustic soda, or capacity rationalization for chlor-alkali in north America, then the business should improve significantly from there.  


    SubjectRe: AXLL, exchange offer
    Entry09/09/2015 01:48 PM
    Membersavvystockguy

    Thanks for an interesting write-up. I have been following but not closely and agree OLN looks like good risk-reward here. A few questions:

    Do you think OLN would be interested in AXLL's chlorovinyls assets? Interim AXLL manangement seems to have suggested that they would entertain a sale of individual assets or the company as a whole. Have you spoken with management about this?

    I don’t necessarily have a strong view on the possibility of OLN acquiring AXLL’s chlorovinyls assets, although odds are probably low on the back of the DOW deal and their subsequent need to integrate the new businesses and deleverage the balance sheet.  AXLL is in a somewhat difficult position because their PVC business is not integrated into ethylene, so whereas WLK has the benefit of ethylene AND chlorine integration into PVC, AXLL only has chlorine and is thus net short ethylene.

    We are mainly focused on the possibility of capacity rationalization in the North American industry which now seems likely – and our view is that OLN will likely shut some of DOW’s older, higher-cost chlor alkali capacity once the deal is done.  This should significantly help the North American industry in general.

    I'm less familiar thus far with the structure, but how do you think about buying OLN through the DOW exchange offer? 

     

    I haven’t spent a lot of time on the idea of buying OLN through the exchange offer, other than understanding the arbitrage dynamic which drove some selling pressure in OLN stock last week – some investors were selling OLN and buying DOW, but the upside to this trade is limited due to the upper limit set by the companies.  Otherwise, some OLN holders are apparently trying to capture some option premium by holding their long position and putting on a synthetic forward using options.  That said, we’re more focused on the longer-term fundamental setup, particularly as it relates to the newly combined businesses.


    SubjectDow biz EBITDA
    Entry09/14/2015 05:41 PM
    Memberzzz007

    Interesting idea.  I'm looking through the proxy and IR presentation and trying to nail down the EBITDA for the businesses being acquired from Dow.  Most of the recent IR presentations are similar, but to be specific I'm looking at the presentation from the KeyBanc conference on Sep 3.  On p. 10 of that presentation, they show "2014 pro forma EBITDA" for the Dow Chlorine Products businesses of $680mm.  That matches up pretty closely with the 2015E EBITDA for TDCC from the final proxy of $679mm.  Everything fine so far...it appears that EBITDA is roughly flat between 2014 and 2015.

    The problem I run into is when I try to get anything close to that number by looking at either the PF combined build-up in the proxy, or the standalone TDCC financials.  Those basically show me a business that was roughly between breakeven and money-losing on an operating (i.e. EBIT) basis for both 2013 and 2015, and generating somewhere between $100mm and $250mm of EBITDA.

    What am I missing?  Why are the two numbers ($680mm vs. $100-$250mm) so far apart?


    SubjectRe: accounting / environmental issues
    Entry09/16/2015 12:53 AM
    Membersavvystockguy

    We’re generally comfortable with the disclosure as they’ve continued to provide detail every year, but I’ll sleep on this, and if I see anything, or anything comes to mind, I will follow up.  But, as of now, I have no issues that come to mind.


    SubjectRe: Dow biz EBITDA
    Entry09/16/2015 12:57 AM
    Membersavvystockguy

    Chris815 - This is a great question and one we had to walk through with the company. There are a few items, the biggest being the net corporate allocation under Dow, over and above what OLN would allocate to that business.

    Here’s the detail if you start with the $235m for the DCP business under DOW and bridge to the “almost $1 billion” number they’ve given for pro forma EBITDA:

    • $133m for the pro-forma adjustments (ethylene agreement, arm’s length chlorine sales to Dow, etc.)
    • $250m for the additional corporate under Dow
    • 2014 EBITDA for the legacy OLN business

    I hope that helps.   Thanks for the feedback.

     


    SubjectRe: Risk of transaction not going through?
    Entry09/16/2015 01:08 AM
    Membersavvystockguy

    Thanks very much for the comment.  My initial reaction is that the likelihood of this transaction not closing at this point, is very low.  I think OLN's stock is ridiculously under-valued at this point, but after a long day, I would like to give this a more thoughtful reply after hopefully catching up on some sleep.  I am trying to pick my spots and select high-conviction ideas.  Thus, I believe OLN has been oversold for a variety of reasons, and believe the downside is very limited at this point, but at the trough of the cycle, I believe OLN is relatively safe at these levels.  That said, I am going to try and play my own devil's advocate and see if I can find some flaws and holes in my logic and thesis.  I would like to make a wise-acre comment about investos missing the boat, but this business can be humbling, and I will try to remain as objective as I can.  Truly - appreciate the feedback and questions.


    SubjectRe: Risk of transaction not going through?
    Entry09/16/2015 11:16 AM
    Membersavvystockguy

    After sleeping on this, I think it is very remote that this deal does not go through (low single-digit %).  Every hurdle has been met.  As to what the stock would do?  OLN closed at $27.19 the day prior to the deal being announced.  It spiked to $34.34 and closed at $31 after the deal was announced.  Now, it is below $19 per share.  At $18.75, it is down 31% from where it closed the day prior to the deal announcement.  Crude is lower, but I would still think it is worth significantly more than it is now.  

    Also - OLN Shareholder vote approved this yesterday, which pretty much makes this put in the "nearly inevitable" category.  

    Also - there were some very positive slides in the OLN presentation at the CS conference.  I think this is readily available from CS.

    I think  most of the pressure recently has just been arbs trying to squeeze what they can and also some tax-related selling in September.  But, housing data continues to improve (NAHB today) and there has been some commentary very recently about caustic soda inventories in the US finally normalizing - which if caustic prices stabilize or improve, this would probably drive a big swing in sentiment.  

    Hope that helps.

     


    SubjectRe: Re: Re: Risk of transaction not going through?
    Entry09/16/2015 01:04 PM
    Memberspike945

    The $250 million is NOT all SG&A.  This number includes savings from facility consolidation / capacity closures, etc.  It could actually end up being higher than $250mm.


    SubjectDow EBITDA Explanation
    Entry09/16/2015 04:16 PM
    Memberaviclara181

    We have spoken to the company many times regarding the bridge from the S4 EBITDA to the EBITDA shown in their presentations. 

    The number in the S4 for 2014 looks like $235.  The number in their corporate presentation is ~$680. 

    The largest piece of the delta is $250 of Dow allocated corporate expense.  These are expenses that go away day one when Olin takes ownership of the business.  Olin does not need to do anything to achieve these savings.  This is ENTIRELY SEPARATE from the $200mm of cost synergies.  Examples of expenses embedded in that $250 are things like Dow’s corporate jet.  Olin is not inheriting Dow’s corporate jets or the CEO’s vacation trips.  See link below.

    http://newsstore.fairfax.com.au/apps/viewDocument.ac;jsessionid=A1C9EE8423C5C55B7A0C9269F434909B?sy=afr&pb=all_ffx&dt=selectRange&dr=1month&so=relevance&sf=text&sf=headline&rc=10&rm=200&sp=brs&cls=472&clsPage=1&docID=AGE141219G37KR3BO5A9

    I think that link just goes to show there’s definitely tons of Dow expense they are punting to their segments on a reported basis, but are not real operating expenses of the entity.

    Next, there are pro forma adjustments that total $133.  See page 41 of the latest S4.  There are a few parts to that, which are explained on page 135.  I’ll ignore the step-up depreciation of $117 there because we’re talking about EBITDA.  The first bucket is the “Excluded assets / liabilities”.  The footnote explains,  “Relates to adjustments to sales related to operations and commercial arrangements that will not be transferred and commercial arrangements to be transferred in accordance with the Separation Agreement.”  Basically, there’s some business that Olin is not acquiring.  This business happens to have negative EBITDA contribution since the lost sales equals $88, but the COGS reduced by $123.  Next bucket is “Re-pricing of sales to TDCC” and the “Re-pricing of raw materials and services to /from DCP / TDCC”. Remember, pro forma for the transaction, Dow will be Olin’s largest customer representing $1bn of sales.  These sales will be sold on a cost plus basis.  In addition, Olin acquired long-term cost plus ethylene contract.  The EBITDA benefit from that is in this adjustment line.  Reduction in COGS of $46 and positive sales of $31.  There’s also an elimination of Dow’s sales to Olin, but that’s a wash because there’s $12mm of lost sales, but also $12mm of COGS that goes away.  Then there’s $16 of SG&A pro forma adjustments and the $4mm of transaction expenses.  Adding that all those together you get to $132, rounding difference to the $133 sum provided on page 41.

    So $235 segment ebitda + $250 of corp allocation that disappears and $133 pro forma adjustments and that gets me to $618. 

    Wait, there’s more.  If you look at the original Dow Olin merger presentation, the EBITDA listed is $640.  If you look at the most recent presentation, the number is $680.  How did historical 2014 EBITDA go up?  OLN is acquiring more EBITDA because of the “Tag Event”.  Dow had a 50/50 JV and this change of control gave the partner the right to put the assets to Dow.  On June 5th, the JV partner put the assets to Dow and Dow is selling that to OLN.  This increases the EBITDA OLN is acquiring and increases the shares being issued.  That’s why shares issued went from 80.6mm to 87.5mm.  How much EBITDA is this?  Based on the change in their presentation, it’s ~$40mm.  This can also be tied out against the valuation tables.  On page 164, they give you valuation multiples including the EBITDA from the tag and without.  So just backing into it, you’d get to $53-56mm of EBITDA.  So that also roughly ties.

    So $618 we went through plus $40 from tag event is $658mm.  Then there’s some other non-gaap adjustments that get you to the $680 provided in the slides, e.g. pension expense that has to be expensed for gaap but isn’t cash out for the company etc.

    Long answer to what seems like a simple question.  Hope this clears things up. 

     

          


    SubjectRe: Dow EBITDA Explanation
    Entry09/16/2015 04:20 PM
    Memberzzz007

    aviclara...very thorough and helpful.  Thanks.


    SubjectRe: Re: Dow EBITDA Explanation
    Entry09/16/2015 06:38 PM
    Memberruby831

    Shooter -

    The $250m you are referring to appears to be corporate allocation from Dow. If you look at the deal transcript from March you can see the DOW CFO charecterize DCP EBITDA at $600-650m, before any benefit from the JV.


    SubjectRe: Re: Re: Dow EBITDA Explanation
    Entry09/17/2015 06:57 AM
    Memberzzz007

    ruby,

    I don't think Shooter is disputing that Dow/Olin/the proxy are claiming that the $250mm is Dow corporation allocation - the docs seem to be pretty clear on that.  I think his issue is where that $250mm of expenses is appearing in the historical DCP financial statements.  The explanations of the sub-components of the "corporate allocation" sound like SG&A-type items, but DCP only reports $186mm of SG&A in 2014.  Therefore, it is mathematically impossible that there is $250mm of corporate SG&A allocation in the historical DCP statements even if Olin was arguing (impossibly) that they could operate the DCP business with absolutely no SG&A.  So, logically, a significant chunk of the $250mm add-back has to be up in COGS, but that doesn't make a lot of intuitive sense given that the description of the add-back items sound almost exclusively like SG&A-classified type stuff.  To his point, you have to take a significant leap of faith that Olin has done its homework in order to buy into the DCP-professed EBITDA number.  It would just be nice if the proxy language, audited financials, and mgmt guidance lined up in a logical way (w/respect to expense classification), which they don't seem to.

    zzz


    SubjectSkeptical
    Entry09/21/2015 07:12 PM
    Memberlatticework
    Savvy/Aviclara - A few questions: 
        
    1. Most sellside analysts thought these assets would sell for $3.5bn around this time last year, and this was prior to the USD strengthening and the oil move flattening the global caustic cost curve... OLN ended up paying >$5bn! Management made a fortune (CEO and CFO together >$20mm) given the Change of Control (in an RMT the "acquiror" is actually the target). Thoughts on management and any perverse incentives associated with the deal? I have met with Rupp a few times, I don't hold him or his team in particularly high regard.
     
    2. Even assuming the $250mm is correct (which, to Shooter's point, is tough to underwrite), I think there's downside risk to the $680mm of Dow EBITDA everyone is modeling. Epoxies benefited in 1H15 from outages in Europe and the timing of price/raws flow-throughs. We've begun to see spreads compress. Not to mention the industry's been structurally oversupplied for years and any Chinese slowdown would likely weigh further on global pricing. Also, caustic export pricing (meaningful piece of Dow's chlor-alkali business) has been under pressure (cost curve flattening) and I'm not sure I want to be exposed to EM alumina and pulp/paper demand drivers going forward. How do you think about downside to the $680mm when you mark to market?  
     
    3. How sustainable are ammunition margins? We have yet to see pricing normalize post-surge and retailers have been destocking.
     
    4. I hadn't seen the SunTrust note, thanks for flagging. If they do indeed close 6 points of capacity, pricing for chlorine and related derivatives should rip. How do you think about the dis-synergies though from capacity cuts? Part of OLN's strategy has been to integrate downstream into bleach, which has higher ECU margins. What happens to their logistics infrastructure around bleach?      

    SubjectColor on $250mm add-back
    Entry09/22/2015 10:48 AM
    Memberzzz007

    I've corresponded and spoken with the company a few times regarding the $250mm add-back.  Detail is sparse, in large part because of how the diligence process was run.  Apparently, Dow was very concerned about opening its books to a competitor.  A lot of lawyers inserted themselves between the two companies (Dow and Olin).  As a result, the financial diligence on DCP was in large part run by Olin's auditors, who themselves had to sign restrictive non-disclosure agreements.  Company maintains that its auditors are "very comfortable" with the $250mm in net add-backs.  The Company did receive from its auditors some detail on the categorization of these add-backs, but not at the level of detail you would typically expect if company management themselves had been driving the financial diligence (as opposed to the auditors).  One material COGS line item add-back is environmental liabilities, given that these are being retained by Dow.  However, I don't know (i.e. company didn't say) what this represents in aggregate of the $250mm, and beyond environmental liabilities I don't know what other specific line items are up in COGS.

    So, to earlier points that have been made, there is probably some reasonable level of skepticism in the marketplace regarding the true PF EBITDA for the new combined entity.  It would certainly be easier to feel comfort on the numbers if mgmt had been running the diligence process, as opposed to auditors who don't have as direct an economic stake in the outcome.


    SubjectRe: Skeptical
    Entry09/22/2015 11:54 AM
    Memberaviclara181

    1. Most sellside analysts thought these assets would sell for $3.5bn around this time last year, and this was prior to the USD strengthening and the oil move flattening the global caustic cost curve... OLN ended up paying >$5bn! Management made a fortune (CEO and CFO together >$20mm) given the Change of Control (in an RMT the "acquiror" is actually the target). Thoughts on management and any perverse incentives associated with the deal? I have met with Rupp a few times, I don't hold him or his team in particularly high regard.

    In the proxy, it indicates that OLN has been interested in the Dow assets since 2013.  Not sure management had any idea that they were going to engage in a transaction that would result in a CoC.  From talking to industry participants, we think it was clear OLN was the logical home for the Dow assets.  We’re not sure using $3.5bn estimate of sellside analysts is a useful data point for the value of these assets.  Is every stock worth the average sellside price target?  We jest, but the way we look at it is they are paying $5bn for a company generating $680 of EBITDA at trough, and we think the EBITDA is closer to trough pre synergies.  Including $200mm of synergies they are paying 5.7x EBITDA and the normalized capex of the business is $140 (using their guidance of $225-275 of pro forma capex less OLN capex of $110).  The business they are acquiring is a free cash flow machine. 

    In their creditor roadshow, they provide a free cash flow bridge. On 2014 EBITDA excluding synergies, the pro forma business would generate $427mm of FCF or $2.59 per share!   

    2. Even assuming the $250mm is correct (which, to Shooter's point, is tough to underwrite), I think there's downside risk to the $680mm of Dow EBITDA everyone is modeling. Epoxies benefited in 1H15 from outages in Europe and the timing of price/raws flow-throughs. We've begun to see spreads compress. Not to mention the industry's been structurally oversupplied for years and any Chinese slowdown would likely weigh further on global pricing. Also, caustic export pricing (meaningful piece of Dow's chlor-alkali business) has been under pressure (cost curve flattening) and I'm not sure I want to be exposed to EM alumina and pulp/paper demand drivers going forward. How do you think about downside to the $680mm when you mark to market?  

    On the $250mm of allocated Dow corporate, is not all SG&A. That being said, we don’t have the detailed breakout of what line items represent the $250mm.  That may be something OLN can provide more detail on going forward.  While we don’t have detail, we do know these are numbers that have been diligenced by the bankers (not just the M&A guys, but creditors because they are borrowing against it), two of the big 4 auditors (KPMG / E&Y) and the company.  We’re willing to underwrite the $250mm because the numbers seem reasonable.  It is universally understood that the Dow assets are the lowest cost in the world. So how do the margins stack up?  Let’s benchmark it against OLN.

    OLN’s 2014 revenues are $2,241.  Their Adjusted EBITDA reported was $344.  OLN did not back out restructuring charges of $16 from that number.  So adding that back, their consolidated EBITDA was $360.  Winchester revenue and EBITDA in 2014 were $738 and $144, respectively.  So the rest of OLN would be generating $216 of EBITDA on $1,503 of revenues or a 14.4% EBITDA margin.  Again, OLN’s position on the ECU cost curve is meaningfully higher than Dow.  Using $680 of EBITDA for Dow and $4,776 of revenues from the S-4 translates to at 14.2% EBITDA margin.  So effectively we’re underwriting the lowest cost chlor-alkali producer in the world has the same EBITDA margins as OLN legacy. We know that business mix isn’t entirely the same, but it just looks reasonable and would suggest the synergy opportunity is real.  Wouldn’t you think Dow assets should generate better margins than OLN?

    On the mark to market of EBITDA, a deep read of the s-4 would suggest that EBITDA is up in 2015. We met with Dow at the Credit Suisse conference on September 16, and they intimated as much.  There’s two parts to your mark to market question, caustic and epoxy.  On caustic, we think the market misunderstands the importance of caustic to Dow.  They consume caustic in downstream products, therefore have less exposure to commodity pricing. A new slide was put out from the Credit Suisse conference where OLN shows that legacy OLN had 40% exposure to merchant sales of chlorine and caustic.  Pro forma for the Dow deal, the number is 20%.  Pro forma sales are approximately $7bn.  The commodity price exposure would then be $1.4bn.  We don’t know the breakdown between caustic and chlorine.  Chlorine prices have gone up (first price increase happened in April and was the first one to occur in 4 years, which suggests to us market is getting healthier).  Let’s say caustic vs. chlorine split is 79% vs.21% because lots of chlorine is used in downstream products. Note that is just my estimate and we haven’t seen a good breakdown. The way we make that estimate is we know that Dow does not sell merchant chlorine.  So all merchant chlorine exposure must be from OLN.  If OLN merchant chlor-alkali sales was 40% of revenues, that would imply ~$900 of total revs.  Of that we’re saying 2/3 is caustic and 1/3 is chlorine.  How do we get that?

    OLN has 1.9mm tons of chlorine capacity and industry operating rates are low 80’s.  So using 82% operating rate implies 1.5mm tons of production of which we believe 85% is sold merchant so 1.3mm merchant sales at $234 average contract price in 2014 is $306.   

    $1.4bn of revs times 80% caustic is $980 of caustic revs.  Per IHS, average contract caustic in 2014 was $577 a ton. August pricing was $560.  So that’s down 5%.  5% on $1.1bn of revs is $57mm of EBITDA.  If I run that math on chlorine, chlorine prices are up from $234 on average to $275 or 17%.  17% on $0.3bn of revs is $51mm of EBITDA.  So back of the envelope math would suggest chlor-alkali EBITDA is basically stable.

    I think the market’s concern on caustic is also due to optics and seasonality.  The fall in caustic prices YTD is greater than difference between average for 2014 vs. current.  Caustic prices went down to start 2014 hitting $570 and then went up through the year and hit $610 by year end. Caustic is not as seasonal as chlorine because it’s less levered to construction / housing, which is more seasonal.  Spring time demand for chlorine / PVC results in higher operating rates, and higher supply of caustic which pressures prices.  Lower chlorine operating rates in the fall then brings down caustic supply and allows prices to go up. 

    On the epoxy side, let’s dig into what’s going on here.  We’re starting with 2014 EBITDA as the baseline.  What are we underwriting for epoxy in that number?  If you look at the s-4, the epoxy EBITDA went from $77 in 2012, to negative $38 in 2013 to positive $5mm in 2014. The actual ebitda is higher because this is the S-4 number that includes corp allocations and I would guess epoxy has a lot of allocation given it has a lot of revenues.  But we think this is indicative of the general trend in the business.  To your point, epoxy over the last years has been a challenged market given oversupply. However, we believe the market is improving.  We don’t believe there are any capacity additions and demand continues to grow.  I would point to the Nomura initiation on OLN on 7/23/15 for a good epoxy overview.  So embedded in our baseline EBITDA is already a depressed epoxy business that is a function of the market dynamics, but also mismanagement by Dow.  Our understanding is that Dow was focused on % margins vs. EBITDA dollars and gave up market share.  Dow is the lowest cost producer in epoxy, why should they give up share?  They are realizing that now.  So how has that business performed lately, 6 month 2014 EBITDA was $7 and 6 month 2015 EBITDA was $25 per the S-4.  When we spoke with Dow at the CS conference, they indicated momentum was good and that they are taking share again in epoxy.  OLN management believes there is opportunity to improve epoxy EBITDA through more focused execution.  This is NOT INCLUDED in their synergies.

    There’s a tremendous focus on what EBITDA is, but given where OLN’s share price is currently, we think that affords a margin of safety.  Let’s say core EBITDA is really $800 because market dynamics.  We think the cost synergies are very reasonable and attainable, so really the EBITDA is $1bn. At the current OLN quote of $17.63, the company would be trading at 6.7x EBITDA and would generate $2.70 of FCF per share.  

    One more thing to point out is the EBITDA of the new OLN is much less cyclical and commodity exposed.  They have a new slide that shows 40% of their EBITDA (assuming the ~$1bn baseline) is not cyclical / commodity exposed.  This is composed of several parts we can now identify. Winchester is $140-150 (I know that’s the next question that I’ll get into).  Then there’s the ethylene contract.  The ethylene contract supports the EDC business being purchased from Dow.  It seems as though the margins are in EDC are being made in ethylene, so if I assume downstream EDC margins are zero and apply current ethylene margins to that capacity, that would suggest another $100mm of EBITDA that is non-cyclical.  Note, the EDC is sold to third parties.  This is not related to the $1bn of sales OLN will make to Dow on a long-term cost+plus contract. On that contract, we don’t know the margins, but let’s say it’s 10%, that is another $100mm of EBITDA there that is not cyclical. The EBITDA composition of the new entity is more attractive and we think deserves valuation multiple re-rating

    3. How sustainable are ammunition margins? We have yet to see pricing normalize post-surge and retailers have been destocking.

    We have done a lot of work on this topic because we researched VSTO a while back.  For those of you who may not know, VSTO was a spin out of ATK and is one of the major ammo suppliers in the US along with Winchester.  The industry is an oligopoly would little impact from imports because Americans don’t want to buy Russian product.  There was a big bull / bear debate on VSTO when it spun because as you pointed out their ammo EBIT margins went from high singles to high teens.  People saw retail ammo prices surge and assumed those two were related and therefore, the ammo margins are unsustainable as retail ammo prices come back down. We’ve talked with VSTO in the past and they indicated the majority of their EBIT margin improvement came as a result of SKU reduction and capacity rationalization.  They did not meaningfully increase prices to their retailers (e.g. Walmart, which sells 1/3 of the ammo in the US).  They could not disclose to us what their price increases were, but it sounded modest.  We believe the same dynamic is happening at Winchester. The improvement in profitability is more a function of internal cost restructurings vs. price increases.  The companies who are benefitting from ammo price surge are the retailers, e.g. CAB, not the ammo manufacturers. If you go back through old OLN investor presentations / transcripts, you can see that the Centerfire relocation reduced costs by ~$40.  That alone is about 5% already of margin vs. what you would observe in historical financials before the cost reductions.

    4. I hadn't seen the SunTrust note, thanks for flagging. If they do indeed close 6 points of capacity, pricing for chlorine and related derivatives should rip. How do you think about the dis-synergies though from capacity cuts? Part of OLN's strategy has been to integrate downstream into bleach, which has higher ECU margins. What happens to their logistics infrastructure around bleach?  

    The capex and cost to achieve synergies revolves around infrastructure to resolve the logistics issues.  As a result, we don’t believe there are material dis-synergies. 

     

     


    SubjectBig Picture Value Creation
    Entry09/22/2015 12:22 PM
    Memberblaueskobalt

    Savvy & Avi,

    Really appreciate the idea and the in-depth discussion.

    Big picture question on value creation: back of the envelope, I see pre-deal EV of $2.5bn for Olin plus $5bn for the Dow business equals $7.5bn EV. Your $49-75 PT implies EV of $12-16bn, which is a >50% increase in value at the low end and >100% at the high end.  This is 26x pretax synergies at the midpoints. What factors enable this combination to create so much value? (The market currently seems to think this transaction is ~10% value destroying.)

    Thanks!


    SubjectRe: Big Picture Value Creation
    Entry09/22/2015 01:48 PM
    Memberaviclara181

    We can’t speak for Savvy’s math, but we’ll throw out some high level numbers.  $40 share price (up 125% from the current quote) would equate to $10.3bn enterprise value. Starting with the $7.5bn of enterprise value you stated, it was valuing the $1bn EBITDA at 7.5x.  Now there’s $200mm of cost synergies (again, there’s another $100 of revenue synergies we are not factoring in) at 7.5x is $1.5bn of value.  That gets you to $9bn enterprise value.  Where is additional value coming from asides from the synergies?  The result of this transaction is the creation of an industry leading producer with lowest cost to produce that will reduce capacity, improving industry supply demand, creating upward momentum on pricing. That would suggest EBITDA is closer to trough and we believe there’s value to the prospect of permanent capacity shutdowns. That is not built into the synergies because the synergies are cost benefit only, not factoring EBITDA improvement from better pricing.   Lastly, $1.2bn of EBITDA translates to ~$575mm of FCF, which accretes value every year.     


    SubjectHedge?
    Entry09/24/2015 07:30 AM
    MemberAtlanticD

    Savvy/Aviclara,

    Any thoughts on the best hedges for the macro and China risks here?

    Thanks


    SubjectRe: Skeptical
    Entry09/24/2015 09:59 AM
    Memberruby831

    Latticework -- just to your first question, the original idea was that the sale of the DOW assets would yield the buyer $500mm in EBITDA. Applying a 7x multiple would get to the $3.5bln value. The key is that the Dow assets were initially pruported to give $600-$650mm of EBITDA (since increased) which is why the purchase price is greater than $3.5bln (using the same rough multiple range). See quotes below for Dow's generic thoughts on the assets and then as it relates to the OLN deal:

     

    DOW Investor Day – Oct 2014:

     

    I'd like to pause for a moment and share a few updates on our chlorine carve-out. We're well down the road. Our offering is in the market today and management presentations are happening as we speak. We expect an indication of interest in early December. These assets will provide the right owner stable EBITDA of approximately $500 millionand a world-leading low cost platform from which to grow. We've carefully defined the scope of this planned divestiture to maximize and preserve integration benefits and ensure that we minimize stranded cost. In terms of progress, we've been engaging directly with buyers and we're pressing ahead with the target to have a binding agreement in the second quarter of 2015 that will close before the end of next year.

    -------------------------------------------------------------------------------------------------------------

    DOW/OLN Transaction Call – March 2015:

     

    <Q - David I. Begleiter>: Thank you. Andrew, first on the EBITDA. I think you initially referenced $0.5 billion of EBITDA from these assets, now we're up to about $625 million. Can you bridge that gap please?

     

    <A - Andrew N. Liveris (DOW CEO)>: Yeah. So the $500 million is the clean number and is now back-and-forth to Olin, the new Olin that lift that number to $640 million, that's the simple math. Howard, do you want to give any more details on that?

     <A - Howard I. Ungerleider (DOW CFO)>: Yeah, sure. David, good morning. There's two basically moving parts that bridge from the $500 million to the $600 million to $650 million. The first part is this back-and-forth of Dow selling products and services to new Olin, new Olin selling back, that's a net number, that's a bigger number. And then the second number is really around environmental remediation and pension and those two numbers net out between the bridge, between the $500 million and about the $600 million, $650 million.

     

     

     

     


    SubjectRe: EBITDA
    Entry09/24/2015 06:08 PM
    Membersnarfy

    Thanks for the color on the bond deal.  Why is it not going well?  Company-specific stuff or macro?


    SubjectRe: Re: Re: EBITDA
    Entry09/25/2015 11:08 AM
    Membersnarfy

    Good grief.  How can the price talk on the 8 year be at 9.75 - 10% when their existing 7 year bonds are trading at 5.8 - 5.9%?  Is the market simply that bad and they have no choice but to ram it home?


    SubjectRe: Re: Re: Re: Re: EBITDA
    Entry09/25/2015 11:29 AM
    Membersnarfy

    Where do you see that?  I see 3 trades on Trace this morning at >98 with a YTW of ~5.8%.  Schwab has a couple million face value offered at ~98.5 (obviously a retail markup is involved).  IB shows them at 97.8 x 98.50


    SubjectRe: Re: Re: Re: Re: Re: Re: EBITDA
    Entry09/25/2015 12:43 PM
    Membersnarfy

    You're right.  I see it now.  What a disaster.  I was modeling a 6% coupon.  This takes a real chunk out of my FCFE figures.  How are they making up for the downsized offering?  More equity?  Maybe the bonds are the opportunity here.


    SubjectRe: Re: Skeptical
    Entry09/27/2015 07:01 PM
    Memberlatticework

    Aviclara - thanks for your thoughtful reply.  A few follow-ups:

    1. Part of the synergies are shifting high-cost chlor-alkali production from OLN facilities to DOW's facilities in the Gulf Coast. As the lowest cost producer globally, why wasn't Dow already operating at 100% capacity? You mentioned interest in margins vs. EBITDA dollars in epoxies, not sure if this was the case as well chlor-alkali. And any sense for what the operating rates at the Dow facilities are today? Trying to calculate the back of the envelope savings.

    2. Conceptually, why would Mitsui exercise its put on the Freeport facility (the "Tag Event")? They are effectively relinquishing access to very cheap feedstock for a mediocre price, I can't understand the logic.

    3. Would you happen to know how the pricing terms are structured for the caustic sold to Dow? Is it indexed to a certain benchmark, and if so, do you know which one? Curious as there's been a bit of disconnect between domestic and export caustic pricing.

     


    SubjectRe: Re: Re: Skeptical
    Entry09/28/2015 12:27 PM
    Memberaviclara181

    1) The Dow assets are actually running at industry average levels of low 80’s.  Why aren’t they running full out?  We think this speaks to the industry structure.  The producers are rational and trying to maximize price to what the market will bear.  The producers are not trying to steal market share from one another.

    2) We have not spoken to Mitsui so can’t speak to their rationale.

    3) We don’t know what the pricing structure is exactly, but our understanding is that it’s not based on market prices.  The Company has communicated that the sales to Dow are on a cost plus basis, so not tied to market pricing

     

     

     


    SubjectRe: Re: Re: Re: Re: Re: Re: Re: EBITDA
    Entry09/28/2015 12:30 PM
    Memberaviclara181

    OLN filed an 8-K this morning with a merger update.  It contains pro-forma interest expense for the new capital structure at the new rates.


    SubjectRe: The longer view?
    Entry10/08/2015 08:02 PM
    Membermrmgr

    I am by no means an expert here, but isn't this primarily due to the Nat Gas / Crude Oil ratio? Basically, all the North American producers (whose cost base is driven by USGC nat gas prices) suddenly got a big advantage over peers who were forced to use more expensive forms of energy and who therefore provide a pricing umbrella for the North American producers.


    SubjectRe: The longer view?
    Entry10/09/2015 01:09 PM
    Membersavvystockguy

    The housing cycle was 03-06. In the 1999-2003 period both housing and industrial production were weak. Same as now. However, now the industry is much more consolidated which allows for higher margins. The two products are driven by different cycles. Chlorine is driven by housing, while soda ash is driven by industrial production (including EM). So in 2009, even though housing was weak, EM was very strong due to china's stimulus program etc. currently they are both weak as both global growth and housing are slow. Housing will improve for sure which will create a nice up-cycle on chlorine. That is our base case, upside in chlorine, but soda ash is still somewhat weak. If soda ash accelerates (there was just a price increase that went through) then we can get a super-cycle. The other component here is concentration of supply. With this merger, the industry is much more consolidated, and OLN is going to take some capacity out to further improve the supply / demand balance and strengthen pricing. This should be announced in the next couple of weeks.


    SubjectRe: Re: Re: The longer view?
    Entry10/09/2015 09:53 PM
    Membersavvystockguy

    Look at any chemical company - they all have cleanup cost and environmental liabilities that they accrue for in the p and l. This should not be an issue. 


    SubjectRe: The longer view?
    Entry10/12/2015 10:10 AM
    Memberaviclara181

    Ndn86, I think your comment illustrates the longer view that we are taking with OLN.  It’s important to understand that while the basic chemical itself is a commodity, the behavior of industry participants is more akin to an oligopoly.  There is very little import / export of chlor-alkali and domestic producers do not over-produce.  Case in point, DCP, the lowest cost producer runs at industry average operates rates.  So the determining factor of economic returns is really supply and demand.  Supply, or capacity, tends to move in a step change fashion while demand changes are gradual.  That is what creates chemicals cycles.  Chlor-alkali earned attractive economic returns earlier in the decade, which resulted in the addition of supply in the last few years.  That created over-supply as demand has grown, but not enough to keep operates rates elevated.  In the last few years, ~10% of net capacity was added to domestic capacity, but demand only grows a few percentage points per year.  We believe as demand catches up to supply, pricing should follow.  We already saw that happen this year with the chlorine side of ECUs as housing improved (chlorineàPVCàhousing).  Chlorine was not in deficit and pricing still went up meaningfully.  Operating rates are in the 80’s, but demand is healthy and no supply was added.  The issue is industrial demand does not grow as fast as housing recovers, which creates the pressure in caustic.  Even without industry consolidation, ECU pricing should have improved over time as no new capacity is being built.  The OLN Dow transaction accelerates this process as the new company will cut capacity.  All of these dynamics lend us to believe we are at the bottom or trough of the cycle and heading in the right direction (ECU prices going up) with no changes in cost to produce, therefore higher margins, more EBITDA dollars and better economic returns.  


    SubjectBroad based insider buying
    Entry11/09/2015 09:42 AM
    MemberWeighingMachine

    http://www.insider-monitor.com/reports/insider-buys-sortby-value-20151106.html


    SubjectUpdated perspective?
    Entry02/10/2016 10:32 PM
    Membermaggie1002

    Thanks in advance for any updated perspective pursuant to the investor day communicating almost a 20 percent equity FCF yield with an implied dividend yield of almost 6 percent.  


    SubjectContinued broad-based insider buying post investor day
    Entry02/19/2016 04:26 PM
    MemberWeighingMachine

    ~$1.7 mn this month

    http://www.insider-monitor.com/trading/cik74303.html


    SubjectRe: Author Exit Recommendation
    Entry12/14/2016 12:16 PM
    Memberruby831

    Hey savystockguy,

     

    Can you talk about your thoughts RE: exit here? Feels like a lot of one-off issues (too many) have plagued the company over the past 12mo. That said, caustic is moving in the right direction (supply situation hitting an inflection point) and lower production in China/Europe is a strong net positive. Also believe synergies will be coming in stronger in 2017/2018. Valuation isn't cheap on certain traditional metrics but still attractive at mid-cycle.

     

    Thoughts?

     

    Ruby


    SubjectRe: Re: Author Exit Recommendation
    Entry12/15/2016 11:47 AM
    Membersavvystockguy

    Ruby - your points are right on.  The stock has been great, and while it likely has more upside, I am in search of other value names, and simply wanted to communicate that I would not advocate starting a new position here. I agree with the positive points you highlight, and I would not necessarily encourage an existing owner to sell it.  But, I am finding other names and sectors I believe to be more attractive, and I have trimmed back my position so that it is pretty small at this point.  I am happy to take a long-term capital gain in the name along with some nice dividends in the process.  In light of that, I felt I should share that sentiment given this idea received a lot of message interaction.  I hope that helps.

    SSG

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