Description
I recommend Lanxess for a near double to 30 by year-end. Stock is 30 by year-end as it looks toward 2006 numbers. Lanxess is the spin-off from Bayer AG. It trades under the symbol LXS GR in Germany. The company started trading on 2/1/05.
Business
After the spin-off takes effect, LANXESS AG, together with the companies being transferred to it, will be a legally and economically independent corporate group with a comprehensive product portfolio in the fields of polymers and basic, specialty and fine chemicals, and, as such, will be one of Europe’s leading providers of polymers and chemicals. The LANXESS Group, consisting of more than 50 operating companies, will produce polymers and chemicals worldwide at 50 locations in 18 countries.
As of June 30, 2004, the LANXESS Group will have approximately 20,000 employees worldwide after the spin-off takes effect, of which approximately 10,400 will be based in Germany. The business activities of the future LANXESS Group will be structured in 17 operational business units combined into the four segments Performance Chemicals, Chemical Intermediates, Engineering Plastics and Performance Rubber.
Segments and Activities:
Chemical Intermediates (‘03 Revs: 738 Million)
Basic chemicals as leading global commodity supplier, fine chemicals as raw materials and intermediates for pharmaceutical, agricultural and specialty chemicals, as well as inorganic pigments for coloring concrete, emulsion paints and other coatings
Performance Chemicals (‘03 Revenues : 1.0 Billion)
Material protection products, additives for the leather, textile and paper industries, ion exchange resins for water treatment, synthetic elastic fibers for fashion apparel, as well as additives for plastics, such as flame retardants and plasticizers. The Material Protection Products business unit offers a broad range of industrial biocides and material protection agents for applications in the areas of wood protection, disinfection, cosmetics, industrial preservatives and corrosion protection.
Engineering Plastics (‘03 Revs: 714M)
Thermoplastics for high-tech applications for the automotive, household goods, leisure and electronics industries
Performance Rubber (’03 Revs:705M)
Specialty rubbers and rubber chemicals for high-end rubber products, such as those used in automobiles, construction and footwear. #2 in the world.
Products and Competition (I have attached a follow-up post on the thread to detail its products and competition).
Reasons for the Spin-off
In the view of Bayer AG’s Board of Management, the current business activities within the Bayer Group’s portfolio show major differences in terms of profitability, technology, market position and market development. The businesses range from research-intensive growth businesses with innovative products to cost-driven businesses with standardized products in more mature markets.
The core businesses that will remain a part of the Bayer Group primarily involve innovative and technology-driven business activities, which promise dynamic growth in the future. The factors contributing to the success of these businesses are high research competence, technology leadership, the development and maintenance of intellectual property, and broad market access.
By contrast, the chemical and polymer activities combined within the LANXESS Subgroup primarily involve products that have reached a high level of maturity in the market. Compared with the new Bayer core business areas, these business areas have lower market entry barriers and lower growth rates. Generally lower margins require the creation of lean management structures with less complexity and a commitment to optimizing equipment and processes.
Selected Financials and Valuation
This is a solid, mature low to mid 20’s gross margin entrenched business with a very diversified product portfolio and a lot of room for operating margin improvement. From a porter analysis, this is a very mature industry structure and sales stability should be pretty high. A lot of patent protection, purchasing power, relationships with suppliers and customers discourage new entrants and prevent existing rivals from easily taking market share away from each other.
Selected Financials
(In Euros) 2002 2003 1st H'03 1st H'04 2006Est
Sales 6763 6315 3247 3283 7000
Gross Margin 21.8% 17% 19.3% 22.5%
R&D Percentage 14% 14% 14% 14%
EBITDA 547 180 221 262 700
Capex 487 312 126 104
Shares Outstanding : 73 Million
Debt: 1.5 Billion
Cash: .2 Billion
Net Debt : 1.3 Billion
Enterprise Value as of 2/6/05: 2.5Billion
Book Value per share: 19 Euros
Tangible Book Value per share : 17.7 Euros
Estimates for 2005 and 2006:
2005 2006
Sales 6.9B 7.0B (Revenue estimate from Lehman)
EBITDA(low) 485M 490M (7% - Their 2004 run rate)
EBITDA(base) 500M 600M (I used 8.5% base)
EBITDA(high) 690M 700M (10% - Management target)
Mtc Capex (250M) (250M) (estimated)
FCF (low) 235M 240M
FCF(base) 250M 350M
FCF(high) 440M 450M
Valuation:
EV/’04 Sales 0.31
EV/’05 E Sales 0.31
EV/’06 E Sales 0.30
EV/Trailing EBITDA 4.2x
Price/Tangible Book Value 0.84
Debt/Equity 1.15
EV/EBITDA Ranges for ’06 Estimates: (I estimate capex of 350 Million per year for ’05 and ’06. By then, about 200 Million of Debt will be paid down to 1.1B from 1.3B )
EBITDA Margin EBITDA Current EV/’06Est EBITDA
7% 490M 4.3
8% 560M 3.8
8.5 (Base) 600M 3.5
9% 630M 3.3
10% 700M 3.0
The range of possible stock price values assuming the Dec 31 ’05 stock price reflects the ’06 Estimates using the EV/Sales Ratio and net debt of 1.3B)
’06 Est Sales EV/Sales Stock Price by Dec 31 ‘05
7 B 0.4 23.3 / sh
7 B 0.45 28
7 B 0.5 33
7 B 0.55 37.7
EV/EBITDA – EBITDA Margin Matrix (The cells represent the equivalent Dec 31’05 stock price where the EBITDA Margin is achieved on the 7 Billion Sales and applying the Forward EV/EBITDA Multiple for ’06 Revenue estimates)
EV/EBITDA Multiple of 4.5x 5x 5.5x 6x
Margin EBITDA
10% 700M 28.1/sh 32.9 37.7 42.5
9% 630M 23.8 28.1 32.4 36.7
8% 560M 19.5 23/3 27.1 31
7% 490M 15.1 18.5 21.8 25.2
EBITDA Less Maintenance Capex (Free Cash Flow)
’06 EBITDA ’06 Capex FCF 10x 12x 12.5x
490 (250) 240 17.8/sh 24.4 26
600 (250) 350 32.9 42.5 45
700 (250) 450 46.6 58.9 62
Looking from scenarios applying various multiples, there seems to be not much downside below 15 a share. The central tendency is in the high 20’s Euros per share. That would be almost 100% gain from today’s closing price. 30 Euros is a reasonable valuation of about 10 x my baseline estimate of Free Cash Flow for 2006. since the market looks ahead 12 months, I think this price can be achieved by year end of 2005.
Management has a target of 10% EBITDA Margins for 2006, citing lots of room for operating improvement, pricing and cost-cutting. On 12/28, Management said it will cut 20 million euros in personnel costs for 2005. It will not raise salaries for management staff in Germany in 2005. It said it will forego market share to improve earnings, will trim business portfolio. The company is closing plants, and raising prices. In October 2004, it raised prices for rubber and inorganic pigments. With a stable revenue base of 7 billion, I have to agree that there is a lot of room for improvement for cost-cutting and operating expense improvement. Management also indicated they’d evaluate every product in the portfolio and would consider selling off the weaker product lines, business segments. Because this business should be a stable and mature business, I believe management's visibility is reliable.
COMPARABLE VALUATIONS
For the comps, I took some comparables in Germany, Switzerland and the U.S. Lanxess (LXS GR in the first row) trades ridiculously below its U.S. counterparts and substantially belowe its European counterparts. Below is the matrix
Symbol Market Cap EV/EBITDA EV/Sales P/B P/S
LXS GR 1.0B 4.5 0.37 0.78 0.15
BAS GR 29B 4.43 0.87 1.86 0.82
CZZ GR 2.6B nmf 0.80 1.27 0.82
KCH GR 0.95B nmf n/a 8.77 0.60
SDF GR 1.6B 5.84 0.64 2.81 0.68
SUC GR 0.358B 7.14 0.85 2.03 0.47
LONN SW 3.7B nmf 2.2 3.00 1.6
SYNN SW 14.5B nmf 1.8 1.95 1.57
CIBN SW 6.3B 7.7 1.1 2.47 2.28
CLN SW 5.8B nmf 0.72 1.95 0.43
GLK US 1.3B 10.4 0.99 1.55 0.82
ASH US 4.5B 6.3 0.66 1.59 0.48
SIAL US 4.4B 11.45 3.2 3.9 3.19
EMN US 4.2B nmf nmf 3.61 0.64
IFF US 3.9B 10.9 2.3 4.4 1.96
EC US 3.7B 10.12 0.99 2.71 0.89
LZ US 2.5B 11 1.56 1.75 0.70
CBT US 2.2B 7.6 2.2 1.91 1.09
CYT US 2.1B 8.4 1.26 2.29 1.20
VHI US 1.9B 15 1.88 2.02 1.42
HPC US 1.7B 8 1.48 nmf 0.84
ALB US 1.7B 8 1.88 2.24 0.98
CK US 1.4B 10 0.87 4.53 0.55
If Lanxess were to trade at comparable multiples, the stock could trade even higher than my optimistic range of values.
There are also a lot of behavioral finance contrarian indicators that bode positively
1. It is being dropped from the index on the first trading day (Feb 1). Index funds and quasi-indexers have to sell.
2. The ratio of Lanxess share for Bayer Shares is 1 for 10. A high ratio means more pressure to sell by institutional shareholders of Bayer.
3. All the analysts rate it a sell or underperform, except for Morgan Stanley who cited the petrochemical industry is poised for higher margins and adds room for better pricing and margins for Lanxess.
Lehman has a target Fair Value of the Equity of 6$, which is 1/3 of book value and about 35% of tangible book. Book value was subject to impairment test right before spin-off, so the appraisal should be contemporary. I do not agree with the low valuation by Lehman’s Report. They cited “underestimated NPV of Lanxess liabilities, uncertainty over fundamentals, future tax rates, restructuring programs, and disposals.” In their DCF for the equity value they used an 18% cost of capital.
4. It could get added to the Dax Mid 500 Index.
5. Upcoming listing in the ADR’s. Right now it is not even tradeable in the U.S. OTCBB.
Comments by bearish analysts and my thoughts:
1. Foreign exchange rate. I think the business is so well diversified they will cancel each other. The breakdown by geographic segment. For example, I think the asian currencies are relatively undervalued among the euro, dollar and asian currencies. If asian currencies appreciate, business in Asia can grow even more. Asia at this point is the fastest growing region. The filings said China is a big demand source. Another example is if you think dollar were to drop more against the euro, then just the fact that the stock is in Euros should offer some protection.
2002 2003 %chg 1st H ’03 1st H’04 %change
Europe 3606 3565 (1.1) 1839 1803 (2.0)
North America 1567 1346 (14.1) 697 711 2.0
Asia/Pacific 1019 887 (13.0) 436 488 11.9
Lat Amer/Afrca/ME 571 517 (9.5) 275 281 2.2
2. Raw material price risk. Company has been able to pass through a lot of the raw material price increases for the customers so far. It is not 100% pass through, but it is not zero, either.
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3. Lehman says industry conditions are challenging. The sentiment is mixed. Management seems to think industry conditions bode well until 2007. Morgan Stanley also things industry conditions bode well for pricing.
Risks and Issues
I could be off by a couple hundred million in some liabilities/pensions. I tried to be conservative with my assumptions.
It has debt of 1.5 Billion, backed by tangible book value(recently appraised) and high interest coverage.
My assumptions for capex could be off.
Wait to see what options/stock incentive package management gets.
Catalyst
Rising operating margins in a very stable, mature business
cost-cutting
price increases already happening with its products
Systematic mispricing of spin-offs