Description

Business Description

• PAH is a roll-up specialty chemical company helmed by CEO Dan Leever (the CEO of the first acquired company, MacDermid, by what was then a SPAC) and Chairman Martin Franklin, the architect behind the highly successful Jarden Corp (JAH)
• The base business, MacDermid, is a producer of chemicals for plating and surface coatings, printed circuit boards and other electronic applications, water-based hydraulic control fluids and photopolymers; it enjoys #1 or #2 market share in most of its businesses which major end-markets of electronics, industrial, offshore drilling, graphic printing, and automotive
• Since the October 2013 announcement to acquire MacDermid, PAH has announced three further transactions, all in the agricultural chemical space
• The first deal was for Chemtura AgroSolutions (CAS) in April 2014 for approximately $990mm; CAS is a fast-growing provider of agrochemicals and seed treatment products with niche exposure to applications for tree nuts, fruits, vegetables, tea, rice, tobacco, etc with only a minority exposure to row crops such as corn and soy
• The company then announced in August a €300mm acquisition of Agriphar, which primarily serves the European markets with a wide range of herbicides, fungicides, and insecticides
• Finally, in their largest transaction, the company announced in October a deal to acquire Arysta LifeScience for approximately $3.51bn. The company was in the midst of preparing for its IPO at the time and is backed by Permira. The company offers market-leading insecticides, fungicides, herbicides, biostimulants and value-added nutrients. Its portfolio consists of both agrochemical and biosolutions products, which address the full spectrum of growers' protection and yield enhancement needs.
• Pro forma for all the transactions, AgroSolutions will account for 75% of revenues (54% Arysta, 15% CAS, 6% Agriphar) while MacDermid will account for 25% (19% Performance Materials, 6% Graphic Solutions). 47% of sales will be in the Americas, with 32% in EMEA and 21% in Asia

Thesis & Variant View

• Franklin has created tremendous value in the consumer products space by executing a highly similar strategy with JAH in the consumer products space, and now intends to do the same in the chemical space. When he started as CEO on 9/25/01, JAH traded at $1.08 (adjusted for splits), vs a close today of $45.25
• The company today has virtually no sellside coverage (apart from boutique CJS Securities) but now with critical mass, it is set to become a “normal” company and stock with appropriate institutional focus and coverage analysts
  • In recent meetings with the company, Franklin has stated they do not intend to offer any more equity to the market “in the $20s”
• While the equity is not absolute “cheap” on P/E or EV/EBITDA metrics, management’s focus on “asset-lite, high-touch” businesses has allowed them to acquire a number of assets at similar / average EBITDA multiples despite highly attractive FCF and ROIC attributes
  • This FCF (net income conversion of 105-114%) aspect of PAH will allow it to de-lever rapidly and continue acquiring complementary assets
  • On PF 2013 results, PAH has the highest ROIC within the chemicals group at 19.4% (second is ECL at 17.0% and the peer average is 10.3%)
  • In addition, mgmt. expects to be able to accelerate growth in its acquired business. For instance, CAS cash flow should be able to grow at three times MacDermid’s rate, per the CEO. The drivers to get there include “small investments” into R&D to drive active ingredients registrations (leading to 25% higher top-line growth, e.g. 5% vs 4%) and initiatives to get gross margins to 50-55% from 37%
• Mgmt has 7-year deals through 2020; 60% of their incentive pay is based on achieving an 8% EBITDA CAGR for MacDermid ($282mm in 2020 vs $180mm in 2013) and 40% is based on stock price achievement with the highest trigger being $26. Although this latter trigger has already been met, mgmt. owns a material amount of equity and their clear incentive is to get the share price higher (CFO owns 285k shares, CEO owns ~2mm). Each new acquisition gets its own incentive plan and we assume these will be based on EBITDA growth, but the board is apparently also discussing the usage of other metrics such as FCF
• The thesis is difficult to derail in the sense that if there are ever questions on the base business, one would still always pay a premium to peers with the assumption that the company will make another accretive acquisition in line with their strategy

Event Path

• Analyst initiations – I expect to see a couple at least of CS, Barclays, UBS, and DB initiate within a quarter (they are all off restriction by January)
• Normalized earnings results: the company has yet to close Arysta (expected Q1’15), but once it does, PAH will have a normal earnings release process and allow investors the ability to track the business more precisely
• Update on synergies: as with most management teams, I suspect the company has under-estimated its synergy potential. With the close of Arysta, it would not be surprising to see an increase in their synergy target or an accelerated timing. As it stands, the $65mm target is expected to be 25% achieved in 2015, 50% in 2016, and the remaining 25% in 2017. G&A represents $25mm, distribution $20mm, and other COGS $20mm. The company has not assumed any reductions in R&D or sales and marketing. We could see an adjusted target approaching $85mm
• Although this is probably a year out, management has said they are likely done acquiring in the ag space given the attractiveness of other verticals. I would imagine their next material non-ag deal would be greeted positively. Mgmt has specifically highlighted flavors and fragrances, niche coatings, and water treatment and cleaning solutions as target areas

Risks

• The company is now predominantly an ag chemicals company and despite a greater focus on niche products such as fruits and vegetables, there is close to a quarter exposed to soy and corn and our view is that crop chemical applications will be reduced YoY possibly resulting in pricing pressure
• The company has just combined 4 separate entities within 5 quarters: there is a possibility that the integration does not flow as smoothly as we currently underwrite. The synergy target of $65mm in our view is low but there may be challenges in retaining all of them or higher costs to achieve them
  • The company has tried to reduce integration risk by hiring JAH’s Chief Integration Officer out of retirement
• The stock inherently carries a premium as a “deal stock” – a long stretch with no deals and/or pressure to do a deal impacting target valuation would both be viewed as negative. I view the latter as unlikely but the former is possible as the company integrates what it has just acquired

Upside & Downside

• Please see projections below for FCF
• To get to the most attractive risk-adjusted upside on today’s estimates, some expectation regarding M&A is required – though at a current 5.8% FCF yield on 2015 projections, PAH is arguably priced cheaply for what the company is currently (ECL and SHW trade with a current 4.3% yield while PAH is also less expensive than FMC and DD at 5.0%). Using 2016 FCF as our driver, and a 4% yield (FCF will grow 19% in 2016 and 17% in 2017 per our model), PAH would be worth $42 in a year, factoring in no further deals. How one incorporates future M&A is one to debate, but we are implicitly underwriting management doing accretive transactions which will benefit the share price.
• To be fair, the downside in PAH depends on whether or not mgmt. retains credibility and the prospect for profitable M&A. The business itself could in a bear scenario see 2015 EBITDA decline 6.4% YoY on a sales decline of 2.0% and a 100bps decline in EBITDA margin to 21.1% (despite synergy capture) – this downside scenario is in line with what pro forma EBITDA did in 2009 across the companies which now make up PAH, per CEO Leever (he has stated EBITDA was down ~5% per their analysis). In this scenario, if you took away their valuation premium and applied a 6% FCF yield to the resulting $249mm FCF in 2015, the per share valuation would be $18.

Catalyst

• Analyst initiations – I expect to see a couple at least of CS, Barclays, UBS, and DB initiate within a quarter (they are all off restriction by January)
• Normalized earnings results: the company has yet to close Arysta (expected Q1’15), but once it does, PAH will have a normal earnings release process and allow investors the ability to track the business more precisely
• Update on synergies: as with most management teams, I suspect the company has under-estimated its synergy potential. With the close of Arysta, it would not be surprising to see an increase in their synergy target or an accelerated timing. As it stands, the $65mm target is expected to be 25% achieved in 2015, 50% in 2016, and the remaining 25% in 2017. G&A represents $25mm, distribution $20mm, and other COGS $20mm. The company has not assumed any reductions in R&D or sales and marketing. We could see an adjusted target approaching $85mm
• Although this is probably a year out, management has said they are likely done acquiring in the ag space given the attractiveness of other verticals. I would imagine their next material non-ag deal would be greeted positively. Mgmt has specifically highlighted flavors and fragrances, niche coatings, and water treatment and cleaning solutions as target areas