Norsk Hydro (stub) NHY W
January 29, 2007 - 8:36am EST by
2007 2008
Price: 8.90 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 11,449 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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The trade is to “create” the stub equity of the third largest integrated aluminum company in the world (after Alcoa and Alcan) before it becomes separately tradeable.  This aluminum company (“Hydro”) is currently part of a larger entity (“Norsk Hydro”) that is predominantly an oil and gas company.  Norsk Hydro has always traded at a large discount to the sum of the value of the parts (kind of a holding company discount), but now there’s a catalyst to unlock that value.  On December 18, 2006, Norsk Hydro and Statoil, both of Norway, announced a merger of the oil and gas activities of Norsk Hydro into Statoil.  Upon completion of this transaction in Q3 07, NHY shareholders will get .8622 shares of STO, plus will keep a share in the new "stub" aluminum company. 


The merger needs approval of the shareholders of both NHY and STO as well as regulatory approval.  No regulatory issues are expected and there should be no issue with the vote.  The Norwegian government owns 71% of Statoil and about 44% of Norsk Hydro, so government support for the deal is there. 


I am not concerned about the oil and gas business and this write up doesn’t focus on the oil & gas business; it is the aluminum company that is of interest.  In order to “create” the aluminum company today, it is necessary to sell short .8622 shares of STO for each share of NHY you are long.  The NHY financial data is reported in Norwegian kroner (“NOK”) so this is the currency in which I conduct my analysis.  Norsk Hydro trades in Norway (Bloomberg ticker: NHY NO) and on the NYSE as ADRs (NHY), and Statoil also trades in Norway (STL NO) and on the NYSE as ADRs (STO).  In USD terms, the stub is created by subtracting .8622 x STO price from NHY price.  Again, in practical terms, this is accomplished by shorting .8622 STO per NHY.  When the deal is completed, NHY holders will get the new stub aluminum share plus .8622 shares of STO (so you cover your short with this). 


As I said earlier, post merger, Hydro will be the world’s 3rd largest integrated aluminum producer.  It will also be Norway’s 2nd largest power producer (much of it hydropower used by Hydro’s own aluminum business).  It also has a polymer business which it is in the process of selling.  Hydro has 27,000 employees, of which 7,000 are in Norway, and has operations in 30 countries.  Hydro’s primary aluminum production in 2005 was 1.826mm tonnes (expected to grown to 2mm tonnes in 2010) versus 3.79mm tonnes at Alcoa and 3.32mm tonnes at Alcan.  Hydro produced 953K tonnes of rolled aluminum and 614K of extruded aluminum on 2005.  2005 return on capital was almost identical to that of Alcoa (around 8%) and well ahead of Alcan’s (about 2%). 2006 RoC is expected to be ~18% for Hydro, 15% for AA, and 10% for AL. 


According to Hydro, China is driving the demand for primary aluminum, with Chinese demand for global production expected to grow from 22% in 2005 to 35% in 2020.  Over that time total global demand is expected to rise from about 34 million tonnes to about 60 million tonnes. 


Hydro’s power generation business is the 2nd largest hydroelectric power producer in Norway, with average annual production of 9TWh, or approximately 7.5% of Norway’s total hydroelectric power.  The power business had revenues of NOK 8.24 billion and adj. EBITDA of NOK 1.14 billion in the first 9 months of 2006.  Annualizing the first 9 months 2006 EBITDA gets NOK 1.5bn of EBITDA, and applying the 2006 EV/EBITDA multiple at which Hafslund ASA trades (11.9x), gives a value for Hydro’s power generation business of NOK 18 billion.  At a company presentation, the CEO of Hydro told me they would explore ways to unlock some of the value of the power business, though a sale isn't really in the cards (I doubt the Norwegian government would allow it).


Hydro’s Polymers business is Europe’s 4th largest PVC producer with production facilities in Scandinavia and the UK, and 1,200 employees.  For the first 9 months of 2006, Hydro Polymers had revenues of over NOK 5 billion and adj. EBITDA of 794 million.  Annualizing the first 9 mos. EBITDA gets 2006 run rate EBITDA of NOK 1.06 billion.  Using a 6.9x multiple (European chemical sectors EV/ 2006E EBITDA average) gives a value of NOK 7.3 billion for the Polymers business.  Hydro is pursuing a dual track sale/IPO of this business and expects this to be completed in the second half of 2007.  At a recent analyst presentation, the CEO of Hydro said no significant tax impact (cap gains) is expected from the disposal of this business.


In valuing the core aluminum business, I look at the best comps, Alcoa and Alcan.  Novelis is a downstream aluminum company, and trades at very high multiples due to a few factors: its year over year results have declined, (so denominator in EV/EBITDA and other calculations has shrunk), it is a takeover target (of an Indian aluminum company; announced last week) and it is a pure play and leader in downstream aluninum.  So it is not really a good comp, though it is worth noting it trades at 11.7x 2007E EBITDA and 8x 2008E EBITDA.  According to Bloomberg data, Alcoa trades at 5.8x 2007E EBITDA and 5.7x 5008E EBITDA, while Alcan trades at 5.6x 2007E EBITDA and 5.1x 2008E EBITDA.  I conservatively take the multiples of the lower of the two (Alcan) and apply to Hydro’s core aluminum business 2007E EBITDA of 11.7bn and 2008E EBITDA of 11.6bn, and get a range of NOK 59bn to NOK 65bn.  The Hydro EBITDA estimates I use come from JP Morgan Cazenove, though some analysts have higher estimates.


Hydro is on the process of divesting its auto castings and other assets which will bring in NOK 4.3 bn in 2007.  This pretty much offsets the NOK 4bn of debt on Hydro’s balance sheet expected at year end.


Summing it all up:

NOK billions

Power Business                        18

Polymer Business                     7.3

Aluminum Business                   59 – 65

Auto Castings                           4.3


TOTAL ASSET VALUE         91.6bn (taking mid-point of aluminum range)



Net Debt:                                 4


NAV                                        87.6bn

Shares outstanding (in billions) 1.286455

NAV per share (in NOK)         68


STO Price (Jan 26 close)          $26.15

Exchange Ratio                         .8622

STO per share of NHY            $22.55

NHY Price (Jan 26 close)         $31.45

NHY, ex-STO implicit  $8.90

NOK FX Rate                         6.326

NOK equivalent price               56.3


So you can create the NHY stub for NOK 56.3, and it should be worth NOK 68 out of the box, for NOK 11.7, or 20.8% of upside.  The deal should close in Q3 07, so no more than 8 months away.  So that 20.8% of upside is 31% annualized. 


Merger of NHY's oil and gas business with that of STO, to be completed in Q3 07. NHY holders will get .8622 STO shares, plus share in new "stub" aliminum company, the world's 3rd largest.
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