Description

If you missed the 50% run-up in Wacker after its April IPO, you missed nothing because it’s come right back to the IPO price. It ran up because this is a very attractive company, dramatically expanding its earning capacity and market share in (among other things) the high-growth Polysilicon segment (primary raw materials for both solar cells and semiconductors). We argue below that Wacker’s diversified mix of growth, specialty and traditional chemicals deserve a blended EBITDA multiple of about 9x on a mid-cycle number that will prove to be dramatically higher than historical due to current investments in capacity expansions. This justifies a 138 Euro fair value target (70% upside).

The reasons for the recent pullback are 1) recession fears and global risk reduction compounded by 2) management’s surprisingly conservative guidance in their first quarterly conference call. Although early sell-side estimates projected 750-800 Euro of 2006 EBITDA (ramping much higher in 2007), management suggested caution and established an FY2006 range of 640-680 Euro of EBITDA. This was a great surprise (and PR gaffe) given that many shareholders had had previous discussions with management about the strength of the cycle and their excitement about the high returns on current capital spending.

As a result, we believe there are terrific gains to be made over the next year as Wacker substantially over-delivers and becomes a more seasoned public company. Currently, with high capital spending for capacity expansions, the true future earnings power - which we estimate exceeds 900mm of mid-cycle EBITDA - is not easily apparent. We expect this will become better understood over the next year.

WACKER STATISTICS

Price 81 Euro
Shares 53 mm
Market cap 4300 mm
Net Debt 500 mm
PV Pension Liability 400
TEV 5200 mm

2005 EBITDA 608 mm 8.5x
2006E EBITDA 720 mm 7.2x [a 10% beat to mgmt’s midpoint]
2007E EBITDA 840 mm 6.2x

Our target mid-cycle
EBITDA after near- 900 mm 5.8x [We believe this mid-cycle
term capacity expansions earnings power will become more
apparent over the next year]

Normalized Capex 350mm [assumes 250mm maintenance and
100mm growth; after much higher
spending in 2005-7 timeframe]
Target Mid-cycle EBIT
EBITDA-Capex 550 mm [10.6% unlevered mid-cycle yield]


WACKER BUSINESS-BY-BUSINESS VALUATION

Traditional Chemicals (Silicones, Polymers, Fine Chemicals) – approx. 55% of sales; 39% of target mid-cycle EBITDA: These are the less sexy chemical business at Wacker. Great market share, oligopoly characteristics and margins much higher than average diversified chemical companies. A meaningful cycle recovery in nearly all lines should continue through 2007. We suggest a multiple somewhere closer to specialty chemical norms than commodity chemical . . . . 7.0x EBITDA

Siltronics – approx. 35% of sales; 44% of target mid-cycle EBITDA. Semiconductor inputs. The market is definitely overlooking how much stronger this business has become. Formerly highly cyclical and plagued with overcapacity, siltronics suppliers have become much fewer in number as next generation chips have been introduced. Wacker believes it is one of five major suppliers for 300mm chip-making which will ramp from 15% to 75% of the wafer market over the medium term. Some analysts don’t get it, but we submit that this business is worth . . . . 10x EBITDA.

Polysilicon – approx. 10% of sales; 17% of target mid-cycle EBITDA. The highest margin, highest growth business where Wacker has been shrewedly investing a lot in capacity expansions. Wacker produces more polysilicon and has greater planned capacity additions than MEMC Electronics (WFR), a semiconductor pure-play (both siltronics and polysilison) which trades at 5x sales and 14x ebitda . Management is aware that this unit can be a value-unlocking spinoff in the future. We’ll argue for . . . . 12x EBITDA.

SUMMARY VALUATION

Target Mid-cycle EBITDA
Business unit EBITDA Contribution Multiple Value
Traditional 350mm 7x 2450mm
Siltronics 400mm 10x 4000mm
Polysilicon 150mm 12x 1800mm
TOTALS 900mm blended 9.2x 8250mm
less net debt (500 mm)
less pension (400 mm)
Equity Value 7350mm

TARGET PRICE 138 Euro
Upside potential 70%

FINAL THOUGHT – SHAREHOLDER BASE DYNAMIC

Wacker IPO’d 29% of the company to pay down debt after the Wacker family’s opportunistic buyouts of stakes owned by Hoechst and Aventis. There are no concrete plans to increase the small (1.2B Euro) float. We view this as a positive in that we expect the float to get locked up in hands of investors who understand the earnings-power buildup and quality of management at Wacker. It is truly run by its owners very differently than stodgy public chemical companies with low management ownership. We believe management is doing the right thing re-investing the cash flow of this upcycle into less-cyclical, higher growth areas which is why we stress that the Company should be valued with reference to its near-future mid-cycle cash flow potential, rather than current year comparables analysis

Catalyst

New and unique public chemicals company finding its proper shareholder base; low-balled management guidance; chemical cycle upswing; heavy current capex disguises growing earnings power