|Shares Out. (in M):||247||P/E||0||0|
|Market Cap (in $M):||6,511||P/FCF||0||0|
|Net Debt (in $M):||2,954||EBIT||0||0|
We recommend purchasing shares of AXTA at today’s level of $26.32. Intrinsic value is $36, or 37% higher.
Axalta was purchased by Carlyle in Q1 2013 from DuPont. The stock went public at $19.50 a share in November 2014. Berkshire Hathaway (Combs and/or Weschler) purchased a stake from Carlye around $28 in the spring of 2015, and the stock broke $36 in June 2015. Berkshire is the largest holder with slightly under 10% ownership. The stock cracked to $20 in Q1 2016, and now trades around $26.
AXTA has been written up before on VIC. I refer you to those writeups for a good overview of the business. Since then, the company has executed well and continues to pay down debt.
Axalta is a leading global manufacturer, marketer, and distributor of high performance coating systems. The company generates 90% of its revenue in markets where it holds the #1 or #2 global market position, including a #1 position in its core automotive refinish end-market with approximately a 25% global share. The company has 2 reporting segments: Performance Coatings and Transportation Coatings. Each reporting segment has two sub-segments, and while we have revenue for all four sub-segments, we have EBITDA only for the reporting segments. This is a high quality business with strong returns on capital, low capital expenditures, and EBITDA margins around 23%.
Performance Coatings provides high-quality liquid and powder coatings solutions to a fragmented and local customer base. Axalta is one of only a few suppliers with the technology to provide precise color matching and highly durable coatings systems. The end-markets within this segment are refinish and industrial.
Based on 2015 sales, the segment breaks out as 71% refinish and 29% industrial. By geography, the breakout is 34% NA, 35% EMEA, 18% Asia Pacific, and 13% Latin America.
The refinish end-market is driven by the number of vehicle collisions and owners’ propensity to repair their vehicles. Refinish coatings are a small portion of the overall vehicle repair cost, but they are critical to the vehicle owner’s satisfaction given their impact on appearance. We spent a significant amount of time speaking to body shops and they are mostly focused on performance, reliability, and service. Unsurprisingly, Axalta and PPG both come away with strong recommendations here. We also learned that a significant amount of time and capital went into developing color match technology and the thousands of vehicle color formulations. Axalta’s color match technology provides Axalta-specific formulations that enable body shops to accurately match colors regardless of the vehicle’s brand, color, supplier, or age.
In the industrial end market, the company focuses on general industrial, electrical insulation, architectural, transportation, and oil & gas. Uses include the following:
General industrial: coatings HVAC, shelving, appliances, electrical storage components, as well as specialized coatings for the interiors of metal drums and packaging.
Electrical insulation: coatings to insulate copper wire used in motors and transformers and coatings to insulate sheets forming magnetic circuits of motors and transformers.
Architectural: exterior powder coatings typically used in the construction of commercial structures, residential windows and doors, as well as liquid interior and exterior house paint.
Transportation: coatings for vehicle components, chassis and wheels to protect against corrosion, provide increased durability and impart appropriate aesthetics.
Oil & gas: powder products to coat tanks, pipelines, valves and fittings protecting against chemicals, corrosion and extreme temperatures.
Transportation Coatings provides advanced coatings technologies to OEMs of light and commercial vehicles. These customers are becoming more global and require a high level of technical support coupled with cost-effective, environmentally-responsible coatings systems that can be applied with a high degree of precision, consistency, and speed.
2015 sales by end market in this segment break out as 77% light vehicle and 23% commercial vehicle. By geography, it is 39% NA, 28% EMEA, 17% Asia Pacific, and 16% Latin America.
Axalta has had two 2 cost saving programs underway: “Fit for Growth” and “Axalta Way.” Both will be completed by YE 2017. The Fit For Growth program is largely complete ($92 million out of $100 million in cumulative savings achieved by YE 2016). Fit For Growth has been focused primarily on Europe and involves right-sizing staffing levels, wage/benefit restructuring, rationalizing manufacturing and logistics, and investing in automation.
Axalta Way ($57 million out of $100 million in cumulative savings achieved by YE 2016) is implementing lean tools to enhance productivity and ROIC. Near-term opportunities include procurement and SG&A reduction.
Net leverage was 5.6x LTM EBITDA at the time of the LBO and is now 3.3x. The company’s target leverage ratio is 2.5-3.0x, which will be achieved in 2017. Given that over 50% of the company’s profits are from the stable refinish business, leverage is not a concern at all for us. Axalta has recently taken its average cost of debt down closer to 4% now versus 4.7% previously.
As mentioned earlier, the company first intends to pay down debt, and then focus on M&A. If attractive M&A opportunities are not present, the company has said it will repurchase shares if the shares are cheap. If the shares are not compelling, then Axalta will return capital via dividends. This year the company has done some tuck-in M&A. These acquired businesses include a refinish business in Southeast Asia, a light-vehicle business specializing in interior coatings based in North America, and 51% of a controlling interest in an industrial business specializing in coil and spray coatings.
Our estimate of 2016E EBITDA is $881 million which is net of stock compensation expense. The company expects to achieve another $52 million of run-rate synergies on top of this achieved by the end of 2017 which we give them credit for since the team has executed well on synergies to date. We use a maintenance capex number of $100 million which is much higher than management’s estimate. And then we hit them for $140 million of interest expense and a 25% tax rate to arrive at $520 million of FCF. Ex-cash, this translates into a 9% yield. This compares favorably to a stock market trading around 19x P/E. At $36, this would be slightly above a 6% yield, more in line with fair value. Keep in mind that while I am giving them credit for synergies, I am using 2016 #s, not 2017. The CEO Charlie Shaver will be giving 2017 guidance later this week and I expect it to be good. Charlie made public comments earlier this month and my guess is that he is going to guide to around 3-4% organic growth ex-currency for 2017 which is solid in this environment.
Our DCF also gets us to $36. It assumes a revenue CAGR slightly below 3% and an EBITDA CAGR slightly below 5%.
The company has significant long-term competitive advantages:
--Government regulations determine VOC limits. Axalta has completely compliant portfolios for both refinish and OEM.
--OEMs seek continuous productivity improvements. Axalta's technology enables OEMs to reduce capital, footprint, headcount, and energy.
--OEM vehicle light-weighting. Axalta has broad substrate coating applicability for next generation materials.
--Growth in MSOs (multi-system operators). Axalta's waterborne technology improves MSO productivity and the company's national coverage enables high service levels.
--More complex colors. Axalta has integrated itself with OEMs and is constantly growing its color library. Advanced color matching technologies are critical to body shop supplier selection.
Axalta market growth and drivers
The global coatings industry is forecasted to grow at a 4% CAGR for the next several years.
Drivers for refinish market: car parc, miles driven, and collision rates. The car parc is growing globally. Keep in mind that light vehicles per 1,000 people is 743 in the U.S., 263 in Central & Eastern Europe, 230 in Mexico, 129 in Brazil, 61 in China, and 19 in India. In emerging economies you have rapid growth of the middle class, increased vehicle penetration per capita, and elevated collision rates vs developed markets.
Drivers for light vehicle: emerging economies and middle classes; ongoing consumer strength in developed markets.
Commercial vehicle: Global consumer, infrastructure growth.
Industrial: Global GDP and industrial production.
The auto production cycle has peaked in NA and Europe. This is probably true for this part of the cycle, however the car parc will still grow in emerging markets, and heavy duty truck is already in a meaningful downturn. I have modeled a continued decline in the OEM and heavy duty truck markets, and this is offset by continued growth in refinish and industrial. So even with a downturn in the OEM and heavy-duty markets, I arrive at $36 for today’s value. In terms of cyclicality in refinish, sales were down 14% in 2009 which was much higher than in a normal recession, and one has to keep in mind that material costs were down as well. As vincent975 mentions in his writeup, there is a chart in the bond offering memo which shows this. The company goes a good job preserving margins given the variable cost nature of the business. I also think that current management would manage a downturn better than the previous DuPont management, which leads to the next point.
One of the questions cnm3d asked in the previous posting of AXTA was “why was AXTA sold to cheaply to DuPont?” While DuPont is not stupid, the DuPont employees which ran DuPont Performance Coatings were incredibly complacent and in most cases incompetent. It is clear that the coatings division never received nearly enough attention from management, and hence the complacency and low-hanging fruit which Carlyle focused on. And remember that this was always a small piece of DuPont, a $60+ billion market capitalization company.
Autonomous driving. This has been discussed on previous threads on multiple posts, so I am not going to rehash the discussion. I think it will take a long time (15 years) before a meaningful number of self-driving cars are on the road. The technology has to improve and become affordable, and then it has to work its way through the global car parc. And time will tell how it will work in terms of regulations. A meaningful number of autonomous cars will need to be on the road to bring down accident rates, and I think many people are going to still want to control their driving for many reasons, the most obvious of which is to exceed the speed limit. But it is undeniably a long term risk factor, and one can perhaps think of various hedges.
Currency. This is unfortunately a real headwind as 66% of Performance Coatings sales and 61% of Transportation Coatings sales are outside of North America.
Pricing. There is always a risk of pricing concessions/givebacks as commodity prices decline. Also, insurance companies limit the allowable cost of repairs charged by body shops. Our work has shown that insurance company limits have not impacted refinish pricing, especially since refinish is a small part of the overall repair. The refinish side does take more pricing than the OEM side since the body shop customer base is very fragmented. Axalta does an excellent job improving the productivity of body shops with its coating systems, and this creates meaningful value for the body shop.
Potential acquisition candidate
As I mentioned, this is a Berkshire Hathaway position initiated by Todd Combs or Ted Weschler. In 2015, the stock reached my estimate of today’s intrinsic value, so presumably Berkshire has more aggressive assumptions than I do. While speculative to guess, it would make sense for Berkshire to simply buy this today at $36+. The coatings market globally is very fragmented and Berkshire could meaningfully accelerate M&A in the refinish and industrial markets. The industrial coatings market is a terrific market and incredibly fragmented, and Charlie has mentioned his interest in making this segment much larger. And of course there are ample consolidation opportunities in their other markets.
There could be strategic purchasers down the road as well. While there may be antitrust issues to deal with, someone like PPG could be a natural buyer of AXTA. Prior to 2016, I would not have suggested Sherwin Williams as a potential buyer, but Sherwin is getting into industrial coatings with its purchase of Valspar, and Sherwin has no presence in auto refinish. Sherwin would need to digest its Valspar acquisition, but I think an acquisition by Sherwin would make sense. While Axalta does not have a big presence in architectural coatings like Valspar, Axalta has better technology than Valspar and it is much easier for Axalta to continue to make progress in industrial coatings than it is for Sherwin/Valspar to make headway in automotive.
You may have noted that Lou Simpson took a position in Axalta in Q3 2016 and shows up as one of the larger holders. Lou ran GEICO’s portfolio for Buffett and had a terrific long-term track record while part of Berkshire. The track record at his new shop, SQ Advisors, was marred by a large Valeant position which he sold out of this year. One would think buying VRX would be a younger man’s mistake, especially since Munger went on a anti-VRX rant at the 2015 BRK annual meeting, so it was interesting to see Lou get caught by it.
Meryl Witmer, who I think highly of, recommended Axalta at the beginning of the year.
The interview is somewhat misleading since the Barrons.com editor opens by saying “Wouldn’t it be nice to find a stock which is recession resistant?” Meryl mentions that the business is mainly driven by the refinish business, but keep in mind that ~45% of profits are from more cyclical, non-refinish segments. She is right that AXTA was neglected and milked for cash when part of DuPont. The stock was at $25 when she gave the interview in January 2016 and her target was $38, slightly above mine.
Continued debt paydown. Once AXTA reaches its target leverage level, it will consider share buybacks.
Continued accretive M&A.
Achieving all the planned synergies.
Acquisition by industry competitor or Berkshire Hathaway.
|Subject||Re: Re: Clarification|
|Entry||12/14/2016 09:53 AM|
I’ll defer to Wavelet, but imo the worldwide adoption of driverless vehicles will take a very long time to play out.
AXTA is a global business and most of the growth will come from developing countries. Off the top of my head, I think the U.S. has 700 or 800 vehicles per 1000 people while in places like China it might be 100. For the out years of the DCF cash flows will be more heavily weighted towards developing countries as their car parcs grow. People in developing countries first need to be able to afford any vehicle before they can afford a vehicle with the technology to be driverless. I don’t know what driverless vehicle hardware will cost (and of course there will be price deflation over time), but any serious solution will involve multiple cameras and perhaps radar and/or sonar as well plus a bunch of GPUs and more.
A good parallel to think about is the adoption of automatic transmissions in heavy vehicles. Allison Transmission sells an automatic transmission for trucks that is clearly superior to a manual, but penetration outside of North America is very low because the extra few grand is more than people are willing to pay (even when the TCO might be equivalent).
|Entry||12/14/2016 10:03 AM|
You mention autonomous cars as a risk, which is true - but isn't the greater risk the increasing penetration of ADAS like auto-braking and other crash avoidance? Unlike autonomy, this is happening right now and has an impact not only on the installed base, but also on the vehicles that installed base would have crashed into - so the impact on collisions should be ~2x the penetration change (at least in early days).
How might this affect AXTA's business? Have you attempted to quantify this?
|Entry||12/14/2016 09:01 PM|
Very good write up Wavelet. I've looked at it as well, deeply, and haven't bought the stock. Here's my take on it.
AXTA trades at 10x LTM EBITDA. The Refinish business (~50% of EBITDA) is probably a consistent ~5% EBITDA grower, driven by pricing.
Light Vehicle Coatings (~27% of EBITDA), as you mentioned, is facing topping cycles in the U.S. and Europe. The good news is auto cycles tend to flat-line near peak levels for a few years before turning down. So I expect this business to not grow, but not shrink either in the medium term. The thing is, what multiple are you going to put on peak earnings? The cycles will turn down eventually. This segment may be worth 6x current/peak EBITDA.
Industrial Coatings (17% of EBITDA) is facing a slowing macro economy, but AXTA is a small player who is gaining share. This segment probably has modest EBITDA growth.
Commercial Vehicle Coatings (9% of EBITDA) is declining as the U.S. heavy duty truck cycle has turned down. Fortunately, this is their smallest segment. But the top-line pressure you're seeing in this segment today will be seen in Light Vehicle Coatings, which is 3x bigger, at some point in the future...and Industrial Coatings as well.
Add FX pressure to the mix and AXTA likely has 0% to LSD EBITDA growth in the current environment. As you spelled out, their cost cutting programs still have a lot of fat to cut, so my guess is they can sustain MSD EBITDA growth through expense cuts.
The problem is this isn't high-quality growth. And it isn't sustainable. They probably have another 2-3 years of cost cuts to keep EBITDA growing at ~5% with no macro tailwinds, but beyond that it likely becomes an aggressive assumption to keep modeling that out.
A blended 10x EBITDA multiple seems fair to me. Refinish is worth more, but the cyclical businesses are worth less as we're at peak earnings for some of them.
So I basically see a stock at fair value given the current environment. It can rise in line with cost-cut-driven EBITDA growth of ~5%, but it would be hard to argue for multiple expansion.
Carlyle sold its position very quickly. From the IPO in November 2014 to their final secondary offering in July 2016 (where they sold a whopping 18% stake for $1.2 billion at $28.25) it seems like they wanted out of this investment rapidly. While I'm well aware that private equity firms don't hang on to public stakes for long, the speed with which Carlyle (likely the best PE investor in the industrial sector) exited is worth noting. There's nothing of concern at AXTA. Management is terrific and the businesses are #1 or #2 in most areas. I think Carlyle is concerned about where we are in the various cycles (i.e., the late innings).
Finally, I haven't read a solid bear case on AXTA anywhere. Since I always consider the "earthquake risk" to a stock, I'll spell out the bear base here. While it is a low-probability event, there is a scenario where the cyclical businesses turn down in tandem and the stock's multiple goes lower. The downturn in the cyclical businesses could mask the steady performance of Refinish, and you'd be able to buy Refinish at a very attractive implied multiple in this scenario.
Maybe I'm dead wrong here...and let me know if you think I am...but I see a stock with a 5% CAGR on the upside and far more downside risk if you get unlucky and more of its cyclical end markets do what Commerial Vehicle Coatings is doing now.
Personally, I'd rather keep this one on my screen and wait for a better price. My guess is Carlyle did not want to be exposed to the possibility of the scenario I laid out, as they made 4x their money on AXTA. So, I don't see a table pounding risk/reward.
Finally, you looked at FCF after maintenance capex, but AXTA is investing in growth and actual FCF is lower. You get to a 9% FCF yield after maintenance capex, and I'd argue that that's fair, as without growth capex they won't grow much. A 9% FCF yield for no/low growth with exposure to cyclical businesses near peaks seems fair to me.
|Entry||12/14/2016 09:14 PM|
Just read your write up again and am confused by something. You said, ex-cash the FCF yield is 9% (after maint. capex), but AXTA has a net debt position of just under $3 billion. How are you looking at FCF yield?
|Entry||12/15/2016 08:57 AM|
How far above normal do you (or anyone else) think light vehicle production is in the U.S. and Europe? I think US production is above normal but Europe is at replacement demand. On just released guidance, which seems to be based on 1-2% global auto production growth (where AXTA says ‘modest market outgrowth based on company specific opportunities’), the fcf yield using their guidance is 7.4% but >8% if you use maintenance capex and >9% if you back out a working capital use (imo closest to economic earnings). If the U.S. were the only region above normal, we would be talking about ~30% of the sales in Transportation Coatings, which itself is ~40% of total sales at slightly lower profitability. If only 12% of the total were above normal on an 9%+ FCF yield the stock is cheap, especially since some of this FCF can be reinvested at good returns.
|Subject||Re: Re: Re: Valuation|
|Entry||12/15/2016 12:48 PM|
Cool thanks for your views on production rates. I used a working capital outflow (which sounds like it won't happen) but I didn't include the cost saving cash outflow... so basically a wash. Do you have a view on what could ultimately be achieved with productivity enhancements beyond the current programs? They are talking about it more but it's tough to know what is possible. It's also tough to benchmark against PPG b/c their disclosures aren't great.
|Entry||09/27/2017 12:15 PM|
Wavelet, any updated thoughts here?
|Entry||11/30/2017 05:22 PM|
Anyone think it was a good idea for Axalta to walk away from a rumored $37/sh cash offer? The stock seems like it is still pricing in some chance of Akzo coming back, and commentary from Akzo today suggests it's a possibility, but it's hard to see something materializing unless Akzo was discouraged early in their process by Nippon Paint and would have had room to negotiate higher given more time. It also seems like BRK is off the table (they move quickly, so it would have already happened), Kansai is too small, and SHW is too levered (for now, but not in a year or two).
|Subject||AXTA was being used as a poison pill|
|Entry||11/30/2017 09:14 PM|
I had a feeling that the Akzo and Nippon deals would not go through, because neither company was truly serious about acquiring AXTA. They both had as their main intention to bulk up their market share in Refinish via AXTA, to become incapable of being acquired by PPG. PPG's CEO Michael McGarry seems to have high ambitions. Less than 2 years after becoming CEO, he tried to buy Akzo Nobel. He made 3 increasingly higher bids for Akzo, and finally walked away after being rebuffed by Akzo's board in each instance.
Under Dutch take over rules, PPG could not come back with another offer for Akzo for a 6 month period. That 6 month period ends on Dec. 1. So what does Akzo do during that 6 month period? It begins merger discussions with AXTA. Below are the global market shares in automotive refinish:
If Akzo merged with AXTA, it would have 36% share in Refinish. An acquisition attempt by PPG (20% share) would be dead in the water from a regulatory approval standpoint (56% total market share). This is why Akzo was interested in AXTA. Akzo wants to preserve jobs in the Netherlands, and it was estimated that if PPG bought Akzo, thousands of jobs in the Netherlands would have been lost. Akzo never had the intention of offering a big premium to AXTA. If you look at AXTA's press release confirming rumors that it was in discussions with Akzo, AXTA specifically refers to a "merger of equals." This is a bit ridiculous, because Akzo's paints and coatings revenues are 2x those of AXTA's. There was nothing equal about this potential deal, and a merger of equals typically entails no premium. My guess is AXTA CEO Charlie Shaver wanted the CEO role at the combined company if AXTA was going to get no premium, and Akzo was not willing to give that up.
Nippon jumped in and spoiled the Akzo/AXTA party because it knew that it would be the next logical target for PPG. And, since PPG stopped one step short of going hostile on Akzo, McGarry showed the paint world that he's playing by a different set of rules.
I scratch my head as to why McGarry went after Akzo in the first place. My only guess is Nippon turned him down in private talks, so he went after his second best idea. Akzo is the fixer upper at a discount, Nippon is the dream house at top dollar.
PPG's biggest hole in its global portfolio is in architectural paints in Asia. Asia represents 43% of the global end market for paint & coatings. With a lot of manufacturing having moved to Asia in recent decades and with China's construction boom continuing unabated, Asia is a huge end market in paint. PPG is ranked #8 is architectural paint in Asia, and it's revenues in this business have been declining, as it is losing share rapidly.
Nippon Paint (#1 in architectural paint in Asia) is eating everyone's lunch. While it is a Japanese company, Nippon branched out into China in the early 1990s. Having gotten there early, and having spent a lot on marketing, Nippon today has 31% market share in architectural paint in China. It gained 2 points of share in the last year, and targets getting to 40% share by 2020.
The Chinese architectural end market is 80% new builds and 20% repaint. In the U.S. and Europe, the numbers are reversed. Therefore, Nippon is sitting on a gold mine. As the Chinese market matures, the demand for repaint will rise exponentially. With its lock on this market (Nippon's "LiBang" paint brand in China is one of the strongest brands in the country, as Nippon has invested heavily in advertising over decades), Nippon will see a rising FCF stream over the next few decades. China represents about half of Nippon's revenues.
PPG is not ignorant of anything I've written here. It would love to acquire Nippon, even at a generous premium today, and gain access to the FCF gusher that Nippon has essentially locked in. But if you're Nippon, why would you give PPG the fruits of your decades of hard work in China? To ensure it keeps its independence, Nippon needed AXTA and its 25% market share in Refinish, because whoever has AXTA's 25% share, cannot be acquired by PPG. In fact, PPG told me that AXTA is the last paint company on its list regarding M&A, because the combined company's Refinish share stands no chance of gaining reg. approval, even with large divestitures.
I can promise you, you will not see rumors that AXTA has now begun talks with PPG.
Nippon is about the same size as AXTA, and AXTA is quite levered. Nippon wanted to do an all cash deal, meaning Nippon would have become a public LBO. It may have been worth it to ensure its independence, but the leverage on Nippon post deal would have been massive.
At the rumored $37/share that Nippon offered, AXTA would have been valued at 13.5x EBITDA. Valspar got 15x from SHW, and everyone thinks their business is the best. It seems AXTA wanted 15x ($43/share), but Nippon simply didn't have the risk tolerance to get that leveraged.
Moreover, the very long term risk with AXTA is that its Refinish business (50% of EBITDA)--while it is one of the best businesses in coatings today (AXTA raises prices in developed economies by ~2% annually)--faces the threat of accident avoidance technology and self-driving cars gaining share within the global car parc. In my estimate, we are 40 year away from seeing a meaningful reduction in accident rates in the U.S. and probably 80 years away from seeing an impact internationally. But if you're buying AXTA mainly as a poison pill to ensure your independence, you don't want to be the CEO who goes down in history as having paid top dollar for a runoff business.
So, that's my view...No one REALLY wanted to buy AXTA. They wanted to permanently seal off PPG. And with AXTA's large exposure to Refinish, and that business's increasingly uncertain future the further out you look, the talks remained just talks, it seems no one was willing to give Charlie Shaver the CEO role, or VAL's valuation.
The dream combination, in my view, is PPG/Nippon. That would truly create a formidable company with dominant global positions. Unfortunately, Nippon has too much pride to sell out. If you read the CEOs letters to shareholders in the ARs, he's very proud that Nippon is one of the few +100-year old Japanese companies who are global players today. Nippon created something great, and they want to enjoy their own party. I don't blame them. (Check out their paint commercials on Youtube. They have the best ads for paint that I've ever seen. The ads are geared for children, so that if a father mentions at the dinner table that he's going to be repainting the house, the kids ask enthusiastically "with Nippon paint?!" Truly brilliant. )
|Subject||Re: AXTA was being used as a poison pill|
|Entry||11/30/2017 10:11 PM|
Idk ... I get the idea of playing companies against each other in deals but to say both of these companies didn’t really want to buy Axalta seems like a stretch (if you said that Axalta didn’t really care about a merger with Akzo but they talked in order to smoke out other bidders I’d be more receptive).
Both Akzo and Nippon would know that if the terms were good enough for Axalta they would have a deal, and if not they would be back to being PPG targets. I (and most people) do agree that Akzo had additional motivations, but it does them no good to go through these negotiations and not even drag it out through December 1st (so it’s not even a stall tactic).
But yes, Akzo almost definitely didn’t happen because Charlie wanted control. I’m confident that Charlie would have done a merger of equals with control.
And look, if Nippon really really wanted to get it done, they could have issued equity. Instead, they remained disciplined.
|Subject||Re: AXTA was being used as a poison pill|
|Entry||12/01/2017 06:51 AM|
You seem to know this space intimately. How do you view Jotun in this context? Would they be attractive acquisition to PPG e.g.? This is a private company so maybe it's not for sale. It has a pretty stellar historical record and a great set of businesses.
|Subject||Re: Re: AXTA was being used as a poison pill|
|Entry||12/01/2017 11:08 AM|
Good question on Jotun. Jotun is 42% owned by Orkla (public company) and majority owned by a family. It does about USD $2 billion in revenues. PPG does just under $15 billion.
All of these guys talk to each other, and PPG has certainly talked to Jotun. The family would need to want to sell, and that can take years or decades, or it may never happen.
If you read the SHW/VAL "Background to the merger" section in the merger proxy, SHW had expressed an interest in acquiring VAL for over a decade, and basically told VAL "if you ever want to sell one day, give us a call." There is a "Company 1" referred to in this section, which VAL had simultaneous discussions with regarding a merger. It is believed that Company 1 is AXTA. That would have been more of a merger of equals (both companies do around $4 billion in revenues) and you probably had the same issue of who is going to run the combined company. Charlie Shaver is too young to just go away. And if you're a CEO of a major paint company, you want to stick around because the industry is going to get a lot more interesting (see below).
So while VAL was talking to AXTA, they called up their friends at SHW and said that they'd be interested in selling but that they are talking to others as well (there's a Company 2 mentioned, which I believe is PPG), and that if SHW wants to make an offer, that they must put their best offer on the table. That's why you saw the 15x EBITDA multiple. But, there's an interesting quality with mergers in this space. 45% of the merger synergies in the SHW/VAL deal came from purchasing synergies in raw materials. The total synergies were 9% of VAL's revenues, but again 45% came from raw materials savings. So you need to put the seemingly astronomical valuations in context. Post-synergies, VAL was acquired for 11x. This still looks rich, but here's why it may not be.
The industry is moving toward an oligopoly
Nippon's CEO wrote in a recent shareholder letter that while the industry has seen accelerating consolidation, it has not become an oligopoly yet. This is a key insight. All of the CEOs talk to each other. They know where this is going. And if you're a jockey on one of these horses, you'll want to stick around because it's about to become a great ride. Charlie Shaver is not dumb. His attitude is, "you either pay me a crazy price for me to go away, or I want the CEO role to enjoy the rest of the journey." If you're a CEO of a major paint company, you're going to look like a genius just by showing up to work over the next 15 years.
Post the SHW/VAL deal, the top 11 paint companies control 55% of the global market. The other 45% is held by +7,500 smaller companies which have an uncertain future. The top 11 will continue to consolidate. But they will also swallow up the best of the smaller ones in the 45%.
Historically, paint was solvent-based and therefore had high levels of volatile organic compounds (VOCs). Regulations in the U.S. and Western Europe have limited the amount of permissible VOCs in paint, and only water-based (or partially water-based) paint can achieve these lower levels. Such regulations are bound to spread to the rest of the world, with China, which suffers from high levels of industrial pollution, following closely behind developed economies. Water-based paint is a technological advancement that only the largest paint suppliers have achieved. Accordingly, more stringent regulations with respect to VOCs will have unfortunate consequences for smaller firms, the vast majority of which do not possess water-based technology. Some of these firms have strong brands and regional scale, and they will be prime M&A targets for the global majors who can introduce water-based technology into their products. In addition, water-based paint carries premium pricing, which has positive margin implications as regulations slowly force the adoption of this technology. So there are multiple forces ultimately leading to greater market shares and higher margins for the largest paint companies.
That's why 11x post-synergies is not expensive for VAL. And that's why Charlie Shaver is sitting back saying, "look guys, you either give me a crazy price or the CEO role at the combined company...or I'm just going to continue to sit on my butt and milk this great ride at AXTA."
Just my 2 cents...I doubt BRK is willing to pay what AXTA is worth to a strategic buyer. First, BRK will not get the 45% merger synergies from better raw materials. It won't even get much of the other 55%. In the VAL deal, the synergies accounted for 4x multiple points of EBITDA. BRK is simply not competitive here. In addition, Buffett paid 12x earnings for Benjamin Moore 17 years ago. He'll now have to may a higher multiple of EBITDA.
I think the Precision Castparts deal results in a lot of people seeing AXTA in the same light. But the very long term threats to the refinish business (50% of AXTA's EBITDA) from accident avoidance technology and self-driving cars are very real. Buffett think 100 years out. And GEICO faces this same risk. I doubt that he wants to double up on this unknown, especially when he has to pay a hefty price to take on this risk.
Fwiw, I think AXTA will remain independent and grow into the +$37 price they could have gotten. Given that volume growth has slowed for the entire industry, and the raw materials have squeezed margins, I think you'll see the refinish players, which benefit from the most consolidated end of the coatings business, start to ramp up price increases to make up for softness elsewhere. PPG recently stated that if body shop consolidation continued at a rapid pace for another 20 years, maybe they'd gain enough scale at that point to be able to push back on refinish price increases. They'd be dumb not to boost price increase on refinish while they can. And the softness in the rest of coatings gives them a reason to do it. I see AXTA becoming more of pricing power story than in the past.
|Subject||Akzo was concerned about AXTA's auto exposure|
|Entry||12/01/2017 12:45 PM|
“We had a very strong click with Axalta, but we were only ever interested in a merger. We were never prepared to pay a premium for a takeover, partly because of the outlook for the automotive industry,” Vanlancker told an Akzo Nobel shareholder meeting on Thursday.
Akzo Nobel also wanted to keep much of its current governance arrangements, including keeping the top job with Akzo Nobel CEO Thierry Vanlancker and maintaining the combined company Dutch with headquarters in Amsterdam, the sources said. It had offered Shaver the chairman role, the sources added.
He's probably referring both to AXTA's refinish business (50% of EBITDA) and the cyclical auto OEM business (27% of EBITDA). Nippon was smart not to go crazy on leverage given AXTA's exposures.
|Subject||Re: AXTA was being used as a poison pill|
|Entry||12/04/2017 09:15 PM|
Beethoven, thank you for a very informative analysis. If I may ask, what do you think of SK Kaken (4628 JP)? I bought it years ago after reading the VIC write-up but you seem to know paint space orders of magnitude better than I do.
|Subject||Re: Re: AXTA was being used as a poison pill|
|Entry||12/08/2017 11:51 AM|
Hi eigenvalue. Thanks for the compliment. I kind of nerded out on the paint industry, as my eyes got opened to the oligopoly that it is heading toward.
I actually know nothing about SK Kaken. Hadn't heard of it until you mentioned it. The only tiny bit of value I can add is that the paint world has bifurcated into two segments: the global majors (11 of them which hold 55% global share) and the rest (+7,500 smaller firms which collectively have 45% global share).
Deal multiples for the largest players have risen to the 14x-15x EBITDA range (because of the oligopoly that will be created once these guys merge). IMO, AXTA said no to Nippon's $37/share offer (13.5x), because they wanted close to the 15x ($43/share) that Valspar got.
Back to SK Kaken. The unfortunate thing for the +7,500 smaller companies is that deal multiples have stayed in the 9x-10x EBITDA range. These bolt-on deals are just not game changers. For example, earlier this year AXTA bought Valspar's wood coatings business (a required divestiture in the SHW/VAL deal) for 9.3x EBITDA.
Just curious, what is SK Kaken's valuation?
|Subject||Re: Re: Re: AXTA was being used as a poison pill|
|Entry||12/08/2017 04:09 PM|
Beethoven, thank you very much for the reply. There is a very good write-up, albeit dated on SK Kaken on VIC. It is my understanding that the company has roughly 50% of the architectural paint market in Japan and is expanding around Asia. Unless I am mistaken, they do have the technology for water based paint. SK Kaken is trading at EV/EBITDA = 6x.
|Subject||Re: Re: Re: Re: AXTA was being used as a poison pill|
|Entry||12/08/2017 06:25 PM|
Eigenvalue, thanks! I just read the write up and given the high quality of the business, it seems like SK could sell at the high end of valuations for smaller companies (so 10x EBITDA), and could possibly get a premium given their dominant market share, if the family wanted to sell. Even though the stock has done very well, it is still surprisingly cheap compared to public and private market values outside of Japan.
Looks like the Japan discount coffee1029 wrote about at the time is still in place at SK. I was nodding my head as I read the write up, agreeing with coffee1029 that Japanese companies have shockingly poor disclosure. Nippon Paint was the first Japanese company I researched and I felt I was trying to learn about a business on Mars. IMO, you shouldn't even be allowed to sell equity to the public with that level of disclosure, but maybe I'm just a spolied American. I realized that you need to read the 10K of an American peer to understand an industry. Then you can look at a foreign company. Even Akzo Nobel (Netherlands based) had surprisingly less disclosure than the American companies (but, nonetheless, way more than Nippon).
|Subject||Re: Re: Re: Re: Re: AXTA was being used as a poison pill|
|Entry||12/08/2017 06:49 PM|
Thank you. Yeah, the disclosure could use some improment.