Summary Thesis

Rockwood shares have been weighed down by a regulatory overhang as the Company seeks antitrust approval for 1) sale of its TiO2 business to Huntsman and 2) purchase of a JV stake in lithium producer, Talison.  I expect this overhang to abate by the end of Q3, uncovering a core business (without TiO2) with an underappreciated growth/margin profile and a net cash position that gives shareholder-friendly management maximum operating flexibility.  Layer on the optionality of electric vehicle demand ramping and ROC’s #1 lithium market share gives the Company a long runway of outsized earnings growth.

Business Description

Rockwood Holdings, Inc. is a specialty chemicals and advanced materials company focused on lithium (53% of EBITDA) and surface treatment (47% of EBITDA).  During 2013, the Company divested of its Ceramics, Clay Additives, and TiO2 businesses for $3.4bn in net cash. Pro forma for its recent JV transaction with Talison, ROC will be the market share leader in lithium for batteries (electronics, vehicles) as well as downstream applications such as synthetic rubber, pharmaceuticals, and solar panels.  In addition, its surface treatment business is second only to market-leader Henkel, selling mostly into EMEA (57% of division sales) and the North America (27%) with end market concentration in autos (27%), aerospace (15%), and general industrial (38%).

Recent History

A former portfolio company of KKR, Rockwood went public company in August 2005 at $20 per share. Following the company’s IPO and subsequent equity offerings in Nov. 2007, June 2008, Dec. 2010 and May 2011, KKR has fully exited its position. CEO Seifi Ghasemi owns $50mm worth of shares and has taken a self-proclaimed activist role since the Company’s January 2013 shareholder meeting.  The stock was up 43% in 2013 as management sold 60% of the Company’s EBITDA in divestitures of Ceramics, Clay Additives, and TiO2. More recently, the stock ran to an all-time high of $82 on TSLA gigafactory momentum, but has fallen back (now down 1.6% YTD) as the closings of its TiO2 sale to Huntsman and the Talison lithium JV deal were delayed from initial Q1 expectations.

Expanded Thesis

ROC is the best pure-play on the growing lithium battery market, the outsized growth of which hinges on the electric car market.  I believe the Talison JV lithium transaction and Huntsman TiO2 deal will receive anti-trust approval this summer.  Both regulatory processes have weighed on stock performance since approvals were pushed out in early-March until Q2/Q3. The Talison deal was approved in 2012 when ROC sought to purchase 100% of Talison.  Consequently, a 49% stake should clear regulatory hurdles.  Management announced German approval on its 1Q call last week and now awaits only Australian sign-off.  In addition, management is confident that the TiO2 deal will be approved despite 50+% PF share of the European market (already approved in the US).  In the event that the EU blocks the sale, ROC can also sell the division to acquisition-hungry Tronox or spin the assets to shareholders (Dupont plan).  Ultimately, post divestitures of TiO2 and funding of Talison, ROC will have $27 of its current $72 stock price in cash.  Near-term upside exists if strategic action continues through additional divestitures or sale of the Company (an LBO/MBO could garner a 30% premium and still hit 20+% IRRs, excluding the TSLA plant impact).  ROC can also use its cash to pay down debt, buy back shares ($500mm already announced), and grow earnings through acquisitions in Surface Treatment.  Post-2013 portfolio clean-up, ROC's remaining industry verticals are both high margin businesses (Surface Treatment 22% EBITDA Margin, Lithium 38%) with strong organic growth prospects (Surface Treatment high-single digits, Lithium mid-double digits) in relatively concentrated competitive industries.  Based on a sum-of-the-parts analysis of existing operations, ROC is a $105 stock without factoring in the TSLA gigafactory.  Then, considering the TSLA gigafactory, additional upside exists to $125 if ROC supplies 75% of lithium required. 

Lithium Overview

Expected Growth: mid-double digits

EBITDA Margin: 36-38%, expanding to 40%+

ROC is the low cost provider of lithium for batteries, synthetic rubber, pharmaceuticals, and solar panels.

• #1 global market share (33% standalone, 50+% PF for Talison JV deal)
• #2 largest brine-based production in Salar de Atacama, Chile (25 years supply) & Silver Peak, Nevada (21 years supply)
• Talison deal gives access to world’s largest spodumene mine in Perth, Australia and gives important second source of lithium to Chilean brine
• NC lithium hydroxide plant well-positioned to service US-based TSLA gigafactory

ROC holds #1 share of the market and will control 50%+ of capacity PF for the Talison deal.  The Company’s lithium goes into a diversified spectrum of end uses.

Outsized growth will hinge largely on the electric car market.

 TSLA- 100 lbs

Surface Treatment Overview

Expected Growth: high-single digits

EBITDA Margin: 22-23% expanding to 25%

Surface treatment business serves wide range of end markets (autos 28%, aerospace 15%, and general industrial 37%) and geographies (EMEA 57%, North America 27%, BRIC 10%).

• #2 market share (Henkel #1) in market with 4 major global players
• Robust FCF driven by limited ($25mm) maintenance capex needs

Recent Internal Activism

2013 Completed Company Initiatives

• Sell Advanced Ceramics business:Success, closed on 8/31/13 for EUR 1.49bn
• Sell Clay-based Additives business: Success, closed on 10/1/13 for $635mm
• Sell TiO2 business: Pending Q2/Q3 ‘14 EU regulatory approved, announce $1.325bn sales to HUN on 9/17/13
• Buyback $400mm stock: Success, repurchased 6.2mm shares for avg. of $64.17, announced add’l $500mm
• Repay $600mm Debt: Success, repaid $1.4bn of secured term debt
• Maintain 2.8%-3.2% tax-free dividend yield: Success, increased dividend quarterly dividend by 30% in 2013
• Accumulate cash for strategic action in 2014: Success, $1.5bn ($2.5bn PF for HUN) on the balance sheet

 2014 Initiatives

• $500mm buyback
• 2.8%-3.2% pre-tax dividend yield
• Close TiO2 sale to HUN: Q2/Q3
• Allocate excess cash for accretive investments (promised October/November deal or else return to shareholders)
• Announced purchase of 49% of Talison on 12/2, close in 1H
• Acquisition candidate must meet mgmt. criteria: 1) #1/#2 mkt. share 2) 25+% EBITDA Margins 3) Industry technology leader 4) Limited oil-based raw materials exposure

My price target is $103 (41% upside) based on 3-pronged probability tree with 3 case assumptions as follows:

Bull Case PT $125 based on 20x 2017 EPS of nearly $8.00 discounted back to YE 2015

• TSLA Gigafactory built in 2017 with ROC winning 75% share of lithium supplied      
• Strong Lithium Demand leads to significant pricing power (8.5% '15 Li Carbonate/Hydroxide Price Increase with rate stepping down annually by 1.0% through 2020) 
• High single-digit Surface Treatment Growth with EBITDA margin of 23.0% expanding to 25.0% by 2018           
• Target Leverage of 2.0x with FCF/Excess Cash allocated 50/50 btw Share Repo/Surface Treatment Acq (@11.0x)          

Base Case PT $104 (based on 20.0x 2017 EPS of ~$6.50 discounted back to YE 2015)

• TSLA Gigafactory delayed beyond projection period
• Strong Lithium Demand leads to attractive pricing power (4.0% '15 Li Carbonate/Hydroxide Price Increase annually through 2020)
• High single-digit Surface Treatment Growth with EBITDA margin of 23.0%  expanding to 25.0% by 2018
• Target Leverage of 2.0x with FCF/Excess Cash allocated 50/50 btw Share Repo/Surface Treatment Acq (@11.0x)

Bear Case PT $65 (based on 20x 2015 EPS of ~$3.30)

• TSLA Gigafactory delayed beyond projection period
• Muted Lithium Demand leads to limited pricing power (2.5% '15 Li Carbonate/Hydroxide Price Increase annually through 2020)
• High single-digit Surface Treatment Growth with EBITDA margin of 23.0% through 2018
• Target Leverage of 1.5x with FCF/Excess Cash allocated 50/50 btw Share Repo/Surface Treatment Acq (@11.0x)

Catalysts

• Talison deal receives Australian anti-trust approval and closes by the end of Q2.
• Huntsman deal closes by July 22 drop dead date.  Cash received and redeployed by October/November in an acquisition as signaled by management on Q1 call.  Without acquisition, large share repurchase announced by year end. 
• TSLA finds a partner for its gigafactory, generating a positive buzz around electric vehicles and solidifying 2017 timing for lithium demand ramp.
• Potential for LBO/MBO at any point given 1/3 of market cap held in cash on the balance sheet, underlevered balance sheet (3.5x), and ease of achieving 20% 5-year IRR even without the TSLA factory.