Description
- · The sale of the Ag division in late ‘18/early ’19 will allow the company to delever down to 2.2X
- · Pro forma, the company is trading at a 7.3% 2019 FCF yield, a yield reserved for over-leveraged or commodity focused peers
- · A $750mm share buyback authorization will allow the company to buy back 61mm shares, increasing the 2019 FCF yield to 8.2%
- · The shareholder base is highly sophisticated, and 61mm shares repurchased would represent over 1/5 of shares outstanding, and over 1/3 of the float (shares outstanding less the shares owned by long term, sophisticated holders)
A Financial Drama
Platform Specialty Products (PAH) has been written up on VIC four times, with the two most recent submissions being short pitches. The company was created during the ‘platform company’ craze to execute a specialty chemical rollup, with capital allocation directed by Martin Franklin of Jarden rollup fame.
The big idea was that companies with an asset-light and high-touch business model could be managed similarly, and therefore achieve high synergies. The company had the backing of Bill Ackman, who took part in an equity raise in the $25s. Ackman was a genius, platform companies were hot, and we were all going to make 45X our money in 14 years.
Unfortunately, the Ackman cycle was just peaking and soon took a sharp turn down. Valeant imploded, Ackman was a fool, and platform became a dirty word. (S)Platform fell from $28.00 and splatted on the concrete in the $5s.
Of course, there’s more to the implosion of PAH’s share price than that.
PAH diversified into high-tough asset-lite agriculture at the peak of the cycle, and the Brazilian Real depreciated ~25% in 2016 (~1/3 of Ag segment’s revenue). PAH acquired the Arysta ag business from Permira and paid them in convertible preferred stock with a make-whole provision. As PAH’s price declined, the make-whole liability grew. The company was forced into issuing shares at $8.25. Ouch. One would think that a company whose existence is predicated on its acquisitional prowess would have the wherewithal to organize its subsidiaries and capital structure for tax efficiency. Yet missteps have caused PAH, a company with a weighted average statutory rate of 26% and D&A that’s multiples of its capex, to pay a 40% cash tax rate.
A Transformational Divestiture
On July 20th, PAH announced the sale of its Agriculture Solutions segment to UPL Corp for $4.2B, an Indian chemical company. The financing is committed, and the transaction is expected to close in late ‘18/early ’19. There is a hell or high-water clause, and a break up fee of $168mm. If the transaction doesn’t go through for some reason, PAH will likely IPO the Ag division instead.
Typically, only acquisitions are called transformational. Yet PAH’s announced sale of its agriculture division to UPL will cure the company of its many real and perceived ills.
Crushing Debt
PAH is saddled with crushing debt, levered over 6X trailing adjusted EBITDA.
As explained below, the FCF has been paltry, which exacerbated the leverage problem. With $4.2B of cash from the Arysta sale, PAH will be levered only 2.2X 2018 pro forma adjusted EBITDA.
Low FCF Conversion
Despite high EBITDA margins and low capex as a percentage of sales, PAH really hasn’t delivered much free cash flow. In 2017, strictly defined free cash flow (cash from operations minus capex minus investments in registrations for the ag segment) was a paltry $100mm. Pretty bad for a company that supposedly did $821mm of adjusted EBITDA. So where did all of the cash go?
86% of the difference between Adjusted EBITDA and Strict FCF went to interest, taxes, capex, registrations, and working capital. The remaining 14% went to ‘Other Assets and Liabilities’ and ‘Other Charges’. Adjusted EBITDA already include addbacks for real cash expenses like restructuring. Nothing pops out as unusual. It’s a levered company paying too high of a tax rate.
The debt paydown with cash from the divestiture will reduce cash interest from $323mm to $65mm, and cash taxes from $145mm to $74mm. Strictly Defined FCF as a percentage of adjusted EBITDA will expand from the ~15% range to the ~50% range.
Complexity
Platform Specialty Products is complex. Lots of acquisitions, different geographies, different currencies, different industries, a complex capital structure with (formerly) two kinds of preferred stock. The Arysta divestiture will go a long way in helping to simplify the story. PAH will be a specialty chemical company. It will be renamed Element Solutions and forever rid itself of the Platform stigma. It will no longer need to factor receivables related to the seasonal working capital cycle, there will be less impact from weather, it will have lower FX exposure, and it will have lower capital intensity (granted, the difference between 2% of sales and 3% of sales isn’t that material).
Valuation
At $12.20/share, PAH is trading for a 7.3% 2019 free cash flow yield. The new PAH will have a ~4% long term top line growth rate, and an EBITDA growth rate higher than that as the highest growth segments have the highest margin. On an absolute valuation basis, I use a 9% total return hurdle rate. This implies a 5% FCF yield (5% yield + 4% growth = 9%) for a fair value of around ~$18/share. A look at comparable companies also leads to the conclusion that this is undervalued. In the specialty chemical space, 7%+ FCF yields are reserved for companies with significant commodity exposure or high (5X+) leverage. PAH won’t fall into either of those categories.
PAH also has a $750mm share repurchase authorization, contingent on the sale of Arysta. If the price per share doesn’t rise, the company will be able to repurchase 61 million shares and maintain a leverage ratio just above the top of their target range of 3.0x-3.5x. This would boost the 2019 FCF yield to 8.2%.
My FCF estimates in the tables below are lower than the company’s stated potential ‘cash flow generation of up to $300m’. That would be an 8.1% yield before any share repurchases.
PAH’s shareholder base is sophisticated. I assume that Pershing Square, Bares Capital, Glenview, Berggruen, Elliott, Mariposa, Miller Value, and Tepper aren’t going to be selling around current prices. If we take their shares as locked up, a $750mm share repurchase program would be over 1/3 of the float, and over 20% of total shares outstanding.
Risks
- · The Arysta transaction may not close.
o As described above, the only thing standing in the way are regulatory approvals. If the companies don’t get approval, PAH will likely IPO Arysta. This isn’t the preferred scenario, but it’s not exactly the end of the world either.
- · PAH may just forever trade in line with the lower quality specialty chemical companies on a FCF yield basis.
o If so, the share repurchases will go a long way. And despite whatever people think about Ackman and Franklin personally, no one can deny that they are smart guys. I can think of worse people to oversee capital allocation on an asset yielding over 8%.
o Macro issues could upset the applecart, as could unforeseen problems with the business.
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
UPL-Arysta transaction closes in late '18/early '19.