Description
Polynt represents a compelling investment opportunity with one-year upside of around 50% from the current price, significant downside protection and positive dynamics. Polynt is an Italian chemical company that was recently IPO’d out of Lonza, a Swiss life-science/chemical company. The IPO failed to generate significant investor interest seemingly due to the small size of the company and the fact that it did not have the margin/restructuring story of recent successful European chemical spin-offs (Lanxess/Arkema). Despite the poor investor reception, Lonza went ahead with the offering because it had already announced to the market that it would use the proceeds from the IPO towards a previously announced acquisition and was therefore largely price insensitive.
As a result, I believe that there is currently an opportunity to purchase shares in a stable, free cash flow generative business at a significantly depressed valuation with minimal leverage, a newly-incentivized management team and the potential for a takeout. Interestingly, it was recently reported in the local Italian press that the Chairman has indicated that the company would make a good takeout candidate in the coming months.
Business Description
Polynt is a niche producer of chemical intermediates, catalysts and compounds used in a wide variety of end markets. Based on management estimates, the company has #1 market positions for approximately 60% of its sales and #2 positions for the remaining 40%. The company currently operates five manufacturing facilities, four of which are located in Italy and one in Germany, with a sixth plant in Poland that is currently under construction. The following statistics provide general info on the company’s sales and end markets:
Sales Breakdown Geography End Markets
Specialties 60% Italy 40% Electronics 32%
Commodities 40% Rest of Europe 48% Construction 27%
America 6% Transportation 24%
EBIT Breakdown Asia 5% Household 8%
Specialties 67% Other 1% Sporting Goods 6%
Commodities 33% Food & Feed 3%
The following descriptions provide additional detail on the company’s four segments:
Resins and Compounds
% of 2005 Sales: 31%
Market Position: #1 in Southern Europe
Products: Thermal hardener resins used in compression and injection molding
End-Markets: Construction, transport and electrical
Competitors: Cray Valley, DSM, Menzolit
Maleic Anhydride, Derivatives and Catalysts
% of 2005 Sales: 31%
Market Position: #1 in Europe
Products: Additives for lubricants, copolymers for detergents, unsaturated polyester resins and alkyd resins, additives in electronic materials and in high-performance compounds
End-Markets: Food, agro-chemical and electrical
Competitors: Bartek, BASF, Dixie, DSM, Huntsman
Pthalic Anhydride and General Purpose Plasticizers
% of 2005 Sales: 24%
Market Position: #2 in Europe for Pthalic Anhydride
Products: Plasticizers to make PVC more flexible and robust (electrical cables, etc.) and for various types of resins
End-Markets: Electrical, transportation, construction, sporting goods, household
Competitors: BASF, Degussa, Exxon
Trimellitic Anhydride and Special Purpose Plasticizers
% of 2005 Sales: 14%
Market Position: #2 worldwide
Products: Special purpose plasticizers with resistance to high or low temperatures (cables, roofs, car interiors)
End-Markets: Electrical, transportation, construction
Competitors: BASF, Flint Hill Resources, Huntsman
Valuation / Base Case Returns
Current Stock Price 2.25 euros
Shares 103.2mm
Market Cap 232mm
Est. Net Debt @ 12/31/06 31mm
Enterprise Value 263mm
Current Multiples (see financial section for details):
EV / EBITDA:
2007E 4.8x
2008E 4.4x
EV / EBIT:
2007E 7.5x
2008E 6.7x
Cash P/E (Based on cash taxes):
2007E 10.7x
2008E 9.4x
Maintenance FCF Yield (EBITDA – Interest – Cash Taxes – Maintenance Capex):
2007E 13%
2008E 16%
Price / Tangible Book Value:
2006E 1.2x
Net Debt / EBITDA:
2006E 0.6x
I believe that Polynt represents a compelling absolute value opportunity with minimal downside at the current valuation of 4.8x 2007 EBITDA, a 2007 cash P/E of 10.7x and 1.2x tangible book value. On a steady state maintenance basis (as defined above), the company is generating a nearly unlevered FCF yield to equity of 13%. In addition, Polynt is valued at a significant discount to the European chemical comps which trade at approximately 6.0x 2007 EBITDA. If Polynt traded at the comp average as shown below, it would imply a current share price of 2.90 euros – nearly 30% above the current price:
2007E EBITDA 55mm
Comp Multiple 6.0x
Enterprise Value 330mm
Net Debt 31mm
Equity Value 299mm
Share Price 2.90 euros
Immediate Upside from Current Price 29%
If you roll the above valuation forward one year based on my estimate of 2008 EBITDA and free cash generation you arrive at a share price of 3.28 euros which is a 46% one-year return from the current price:
2008E EBITDA 60mm
Multiple 6.0x
Enterprise Value 360mm
Net Debt 21mm
Equity Value 339mm
Share Price 3.28 euros
One-Year Upside from Current Price 46%
It is also worth pointing out that Polynt is not burdened by pensions or restructuring provisions and has only 19 million euros (0.3x EBITDA) of provisions for employee benefits, litigation and environmental. This compares to the peer group which has a full multiple point of provisions on average (7.0x EBITDA including provisions in enterprise value / 6.0x EBITDA excluding provisions as shown above), so I believe that the 6.0x multiple I use above may prove conservative.
Acquisition Upside
With the low current leverage level, Polynt has significant future financial flexibility. Management has indicated that they believe that they will be able to find attractive acquisitions and that the company could easily debt finance 100+ million euros of acquisitions, which would be highly accretive to equity. I have outlined the potential impact to the company’s financials and valuation if it were able to debt finance 150mm euros of acquisitions (still less than 2x leverage) by the end of 2007 at a valuation of 5x EBITDA (post synergies):
2008 EBITDA: 90mm
2008 EBIT: 58mm
2007 Net Debt: 171mm
Interest Expense @ 7%: 12mm
Net Income (45% tax rate): 25mm
EPS: 0.24
Cash Net Income (35% tax rate): 30mm
Cash EPS: 0.29
Maintenance FCF: 47mm (15mm pro forma maintenance capex)
Assuming that the company were able to do the acquisitions described above, at the current price Polynt is trading at 7.8x 2008 pro forma cash EPS with a maintenance FCF yield of 20%! Applying a 6.0x EBITDA multiple to the pro forma company would result in the following value:
2008 EBITDA 90mm
Multiple 6.0x
Enterprise Value 540mm
Debt 171mm
Equity Value 369mm
Share Price 3.58
Upside from Current Price 59%
Even at the target value of 3.58/share, which is nearly 60% above current levels, the addition of prudent leverage creates an attractive valuation of 12.3x cash EPS and a 13% steady state FCF yield.
Additional Investment Positives / Upside Opportunities
IPO Dynamics. Polynt was a non-strategic asset for Lonza and was run as a cash cow to support its growing life science businesses (100mm euros of dividends to Lonza in the past three and a half years). As a stand-alone company, management believes that there are attractive opportunities to generate value through both organic growth and acquisitions. In addition, management is now incentivized through a long-term incentive plan based on total shareholder return.
Potential Takeout. As a result of the low leverage and attractive valuation, Polynt is a good takeout candidate from both a strategic and a private equity perspective. According to management, Lonza has attempted to sell the company in the past and there has been significant private equity interest at around 6x EBITDA, but at the time Lonza was unhappy with the valuation. There have even been reports in local press since the IPO that the chairman of Polynt believes that the company could be a takeover target in the near term. At the current valuation of 4.8x 2007 EBITDA, it’s easy to see how a private equity firm could probably finance nearly the entire purchase price.
Stable, Free Cash Flow Generating Business. Polynt has leading market positions in Europe (about 60% #1 and 40% #2) in stable, niche product lines. As a result, it has generated a consistent cash flow stream of approximately 40-60 million euros of EBITDA over the past 10 years (per Lonza’s historical filings) with expected maintenance capital expenditures of 10 million euros going forward.
Organic Growth / Expansion Opportunities. Management believes that the company should grow EBITDA organically at approximately 5% annually. In addition, the company believes that they have additional attractive investment opportunities of 10-15 million euros per year over the next several years to build plants in Eastern Europe and China that should boost EBITDA growth to approximately 10% annually.
Financial Summary
For reference I have provided my assumptions and estimates for the next couple of years of financials based on the company’s stated guidance and discussion with management:
Stated management guidance:
- 2006 sales and EBITDA of 500mm and 50mm, respectively
- 12/31/06 net debt of approximately 31mm based on 41mm at 9/30/06 and 10mm of fourth quarter cash flow
- 10% EBITDA growth for 2007
Other assumptions based on discussions with management:
- 5% organic EBITDA growth
- 10mm of maintenance capex + 15mm expansion capex = 25mm total capex
- Expansion capital expenditures (China/Eastern Europe projects) have returns of approximately 20% that boost overall EBITDA growth to approximately 10% over the next 3-5 years
- Book tax rate of 45% and cash tax rate of 35%
- Working capital constant as a % of sales
Income Statement
2005 2006 2007 2008
Sales 425 500 538 578
EBITDA 46 50 55 60
EBIT 28 31 35 39
Net Income 14 15 18 21
EPS 0.14 0.14 0.18 0.20
Cash EPS NA 0.18 0.21 0.24
Balance Sheet
2005 2006 2007 2008
Net Debt NM 31 21 7
Tangible Book Value / Sh. NM 1.88 2.06 2.26
Free Cash Flow
2007 2008
EBITDA 55 60
Interest (2) (1)
Cash Taxes (12) (13)
Working Capital (6) (7)
Capex (25) (25)
Free Cash Flow 10 14
Maintenance FCF 31 36
Risks / Negatives
General Economy / Macro Risk. As a chemical company, Polynt has the standard sensitivity to general economic activity in Europe.
Competitive Risks. The company has faced competitive pressures over the past couple of years in its trimellitic anhydride and special purpose plasticizer division. Specifically, there was increased supply in China coupled with the depreciation of the dollar which made both Chinese and U.S. imports more competitive in Europe. Sales of trimellitic anhydride decreased 66% in 2005 so most of the impact from this has come through the financials and management has indicated that this market has stabilized. While this type of competitive activity is always a risk generally, there is no indication that the company’s other product lines face similar imminent threats. In addition, the company’s market positions are generally strong with leading shares and world scale plants which should help to mitigate cost competition.
High Tax Rate / Deferred Tax Liability. Italy is a high tax rate country and as a result Polynt has a book tax rate in the mid-40s%. However, the company’s cash tax rate is lower and as a result it has generated a significant deferred tax liability. As long as the company continues to invest and grow as expected, the cash tax rate will remain below the book tax rate and the deferral will continue to be pushed out into the future. In addition, the company’s book tax rate is expected to move lower over time as it expands its business into lower tax regions (Eastern Europe and China).
Lonza Overhang. Lonza retained a stake of 31% of Polynt post the IPO. Given that Polynt is not a strategic investment for Lonza, it is likely that they will exit their remaining investment over the course of the next year or two. This actually could be helpful to the stock as it will increase liquidity dramatically.
Catalysts
- Potential takeout
- Accretive acquisitions
- Initiation of research coverage by Wall Street
- Removal of Lonza overhang
Catalyst
- Potential takeout
- Accretive acquisitions
- Initiation of research coverage by Wall Street
- Removal of Lonza overhang