Description

We recommend shorting the shares of Platform Specialty Products Corp. (PAH). Our short thesis rests on the obvious factors (at $ 8.79 / share, PAH is trading at 11.8x trailing EBITDA, its balance sheet remains significantly levered in relation to its fixed obligations) and less obvious factors (its strategy is ill conceived, its management is less than forthright with investors).  

Martin Franklin founded PAH on 4/23/2013 with the objective to acquire companies with an enterprise value of between $750 million and $2.5 billion.  PAH went public on 5/22/2013, selling  $881 million of shares. Since inception, PAH has acquired six chemical businesses at a cost of $9 billion; the businesses are categorized into two segments: Performance Solutions (plating chemicals) and Agricultural Solutions (agricultural chemicals). The company’s philosophy is to acquire “Asset-Lite, High-Touch” specialty chemical businesses, i.e., favoring employee intensity over capital intensity. The following table summarizes PAH’s current capital structure and valuation:

PAH’s share count (as of 11/1/2016) includes 48.8 million shares sold to the public (21% dilution) on 9/21/2016 for $8.25. The market capitalization calculation in the table above includes 5.5 million common shares issuable to Premira Advisers LLC, the private equity firm from which PAH acquired Arysta on 2/13/2015.  In accordance with an agreement struck with Premira on 9/9/2016, PAH will issue these shares to Premira before 12/15/2016. (more on this below, but note that in addition to issueing 5.5 million common shares, PAH will pay Premira $460 million cash by 12/15/2016).  

PAH’s Businesses

PAH spent $9 billion acquiring these six businesses since 10/31/2013; with a current enterprise value of $6.7 billion, perhaps PAH represents a bargain? We don’t think so. The earnings and EBIT and EBITDA data in the above table are constructed from the historical performance of each business immediately prior to its acquisition by PAH.  Where possible, we averaged the prior three years of performance.  By this methodology, PAH paid an average of 32x trailing EBIT, 20x trailing EBITDA and just shy of 6x tangible book value for these businesses. As value investors, these valuations strike us as very rich.  Furthermore, these valuations are considerably higher than the valuations PAH touts because they make numerous adjustments to their EBITDA calculations.  We make two inferences:

1. PAH paid very high prices for its collection of businesses (20x trailing EBITDA) – little wonder that PAH’s enterprise value is 25% below the combined cost of these acquisitions.

2. PAH management is less than clear in its disclosure of the prices it paid for its six businesses.

One interesting point that corroborates the second inference is PAH’s explanation of the CAS acquisition.  CAS stands for Chemtura AgroSolutions which is owned by Chemtura (CHMT on the NYSE).  While PAH characterizes CAS as an acquisition of a chemical business, what PAH actually purchased for $1.06 billion was four years of distribution rights for Chemtura’s AgroSolutions business.  To be clear, PAH did not purchase the plant and facilities to make the business’s products (they did buy current assets and liabilities).  To make matters worse, on 11/3/2018, their contract with Chemtura expires (Chemtura 2015 10-K, p. 65).  Chemtura characterizes their contract with PAH as “at cost” and recognized $35 million of EBITDA in this segment during 2015 from selling chemicals to PAH. Chemtura management estimates that their contract with PAH is $230 million below market ($57.5 million per year over four years). Two more inferences come to mind:

1. The historical EBITDA for the CAS business must be adjusted for the portion of EBITDA retained by Chemtura; we use Chemtura’s 2015 EBIT ($35 million) from this segment as a proxy for this adjustment. This depresses the EBIT (by $35 million annually) that PAH is likely to make from this business.

2. After 11/3/2018, PAH will need to pay a market rate for the chemicals sold by this part of their business.  Assuming Chemtura’s estimate of the contract economics are about right, PAH’s EBIT will decline by about $57.5 million per year when the below market contracts roll-off in 2018.

We don’t think the market understands that PAH’s acquisition of CAS could be more accurately characterized as a four-year distribution agreement than it as an acquisition of a business. More importantly than what we think, let’s take a look at what a sophisticated chemical industry investor, with intimate knowledge of a large portion of PAH’s business, thinks about PAH.  

The sophisticated investor we have in mind is Premira Advisers, a large European based private equity firm.  Premira acquired Arysta Life Sciences, a Japanese agricultural chemical company (insecticides, fungicides and herbicides), for $2.4 billion in March 2008.  After owning the business for six years and 11 months, Premira sold it to PAH for $3.5 billion. As part of the Arysta acquisition, PAH issued $600 million of preferred shares (Series B) to Premira Advisors.  These shares were convertible, at the discretion of Premira, into PAH common shares at $27.14 per share.  In the event that Premira elected not to convert the shares by 4/20/2017, PAH was obligated to make Premira whole for the difference between the converted value of the shares and $600 million. On 9/9/2016, PAH and Premira reached an agreement which accelerated the term of this deal from 4/20/2017 to 12/15/2016 in exchange for a $93 million reduction in the value. The following table summarizes the original deal and the re-negotiated deal:

Series B Convertible Preferred Share Extinguishment Terms

The essence of the renegotiated deal is that Premira reduced the settlement costs from $600 million to $507 million (15.5%) in exchange for accelerating the settlement by four months and increasing the ratio of cash /  PAH common shares received as part of the settlement. One may infer that the Premira partners responsible for the sale of the Arysta business to PAH are not especially confident in PAH’s prospects.  In fairness, it should be noted that PAH issued 48.8 million common shares a week after renegotiating the deal with Premira – perhaps the Premira partners are sleeping easier regarding their upcoming December 2016 payment (if not feeling a bit burned on the timing of PAH’s share offering).  

What may have lead the Premira partners to accept the $93 million hair cut?  Note that a substantial portion of PAH’s revenue is from developing markets (exactly how much is not disclosed).  Here is what PAH had to say about this in their 2015 10-K:

Our consolidated financial statements are reported in U.S. Dollars while a significant proportion of our assets, liabilities and earnings are denominated in non-U.S. Dollar currencies. As a result, we are exposed to foreign currency exchange rate fluctuations from translating certain of our foreign subsidiaries’ financial statements. (PAH 10-K, 3/11/2016, PDF p. 29).

At the time of the Arysta acquisition, 65% of Arysta’s revenue came from Latin America, Africa, Eastern Europe, China, and South Asia. Yet 80% of PAH’s considerable debt load is denominated in dollars (the balance in euros).  This leaves PAH vulnerable in the event the dollar appreciates substantially against the currencies of the countries in which it transacts business.  The following table summarizes PAH’s current debt structure:

PAH Debt Structure

Note that PAH’s annual interest costs run about $369 million.  When combined with minimum principal payments and operating lease payments, PAH has financial obligations north of $400 million per year.  The following table summarizes PAH’s financial obligations through 2021:

PAH Financial Obligations

While PAH management often refers to adjusted EBITDA figures that are well in excess of $400 million, if we strip-out one-time gains made during the 9 ME 9/30/2016 (e.g., the gain from the renegotiated Series B settlement with Premira Advisers), PAH produced $435 million of EBITDA during the first three quarters of 2016. A continued downturn in the agricultural chemicals market and/or a downturn in the plating chemicals market coupled with further appreciation of the dollar could result in PAH producing less real (i.e., none-adjusted) EBITDA than its financial obligations.  And while management describes its business as “Asset-Lite, High-Touch,” it spends $30 - $40 million of capex annually just to stay in business. Also, its below market distribution deal with Chemtura ends in 24 months, which will depress EBITDA by about $57 million annually. We conclude that, even allowing for the recent equity infusion, PAH is not exactly a well-capitalized business.

Finally, to the extent PAH is truly “Asset-Lite, High Touch,” the company is more dependent on its employees than a typical specialty chemical business – i.e., its employees are its most important asset.  While this sounds good in theory, in practice, it is not the best fit for a company organized  by a financial engineer with no background in the specialty chemical industry.  Not surprisingly, anecdotal data suggests there are employee satisfaction problems at PAH.  The following table is comprised of the comments posted by PAH employees to Glassdoor.com, a website which tracks employee satisfaction at companies.

PAH Employee Comments Posted to Glassdoor.com

Given the hurly-burly acquisition activity at PAH, it is not surprising that employee satisfaction is low.  In a business with very high barriers that doesn’t rely on “high-touch,” such comments could be dismissed as growing pains.  However, in a business that relies on high-touch, employee dissatisfaction is a recipe for disaster.  Accordingly, we recommend shorting this particular disaster.

Catalyst

time

further dollar appreciation