|Shares Out. (in M):||299||P/E||14.2||12.2|
|Market Cap (in $M):||2,541||P/FCF||11.2||10.3|
|Net Debt (in $M):||5,130||EBIT||720||750|
Platform Specialty Products was previously posted in December 2014 when the stock was at $23.68. Today the stock is around $8.50. In June 2015, the company did a share offering at $26.50 with Pershing Square, Blue Ridge, and others participating. More recently, the company issued shares at $8.25 in September 2016. We feel today’s fair value for the stock is $16-$17, basically double where the shares trade today. While this may seem odd given that shares were just issued at $8.25, these shares were issued in order to take care of a liability owed to Permira. Platform purchased Arysta, an agrochemical business, from Permira and Permira took back stock with the caveat that it would be made whole if Platform’s share price dropped. As Platform’s share price dropped, the liability owed to Permira grew – which put additional pressure on the stock. By issuing shares, the company finally addressed this variable liability. Platform was able to negotiate a reduction of $100 million in the face amount of the Permira liability, and the settlement of the liability allowed it to refinance $1.95 billion of term loans resulting in about $10 million of lower annual interest expense and maturities further out.
Platform is organized into two segments: Performance Solutions and Agricultural Solutions. The Performance Solutions segment focuses on the automotive, industrial, electronics, consumer, packaging, and offshore energy markets. Agricultural Solutions focuses on crop protection, seed treatment, plant nutrition, and biosolutions.
Note: regarding my multiples above. FCF is after-tax and after normalized working capital but uses my EBITDA numbers. My EBITDA takes adjusted EBITDA and includes the full benefit of synergies. So 2016 EBITDA is my estimate of adjusted 2016 EBITDA ($750 million) plus all future synergy capture ($70 million). 2016 EBIT shown above is my EBITDA number ($820 million = $750 million + $70 million) less maintenance capex of $100 million. This is similarly done for 2017. The vast majority of the synergies will have been achieved by the end of 2017; I adjust for synergies to get a sense of the full earnings power of the business. Since the synergies will be achieved (and likely exceeded) based on synergy capture to date, I am comfortable looking at the company this way. The EPS estimates above are consensus numbers and shown simply for illustration. Net debt above includes the liability to Permira.
Brief update since previous post
Hao77 gives a good overview of Platform in the December 2014 post. Much has happened since then:
(1) Strong USD has negatively impacted earnings.
(2) Former CEO Dan Leever left over disagreements with Chairman Martin Franklin on how to run the business. Dan ran MacDermid (as did Dan’s father), the initial chemical acquisition made by Martin. Dan was a good CEO of MacDermid, but integrating several companies at once required a different skill set.
(3) Platform made an acquisition of Alent and funded it primarily with debt since the company did not want to issue shares it felt were undervalued at the time. This high leverage led to further share declines. Cevian, a sophisticated European investor, had a large stake in Alent and was issued 18.4 million Platform shares as part of the purchase. Never having read The Art of the Deal, Cevian was not nearly as clever as Permira and has suffered along with Platform shareholders in the precipitous share decline.
(4) Rakesh Sachdev became the CEO in January 2015. Rakesh was the CEO of Sigma-Aldrich, a terrific specialty chemical company which he sold after running it for several years and improving growth. Platform’s stock almost hit $14 in December 2015 on the back of the announcement that Rakesh would be the new CEO. I have followed Rakesh for nearly a decade and think very highly of him. He knows how to increase customer intimacy and drive innovation and growth. Rakesh took this job shortly after selling Sigma-Aldrich to Merck KGaA, a German pharma/chemicals company.
(5) Platform acquired OM Group’s Electronic Chemicals and Photomasks business in 2015, and then bought the Malaysian assets of OM Group in Q1 2016.
(6) The stock closed 2015 at $12.83 and fell below $6 in Q1 2016 as it got crushed due to its high leverage and the fact that it is a hedge fund hotel.
(7) Platform hired a new head of ag, Diego Casanello. He is formerly of BASF and my reference checks are all very positive. He understands his products, markets, and customers. I have met Diego and spoken with him at length.
(8) Platform issued equity to address the Permira hangover; Martin Franklin was able to negotiate a reduction in the liability. But the share issuance at $8.25 has of course weighed on the stock. Martin bought 1 million shares in the offering and has an equity stake of $100 million in the company.
(9) The sell-side analysts who cover the stock have universally taken their target prices down from $30 all the way to around $10. They have lagged on the way down, and they will lag on the way up. The sell-side analysts have simply been chasing the stock price.
Performance Solutions (2015 pro forma sales $1.8 billion and adj EBITDA of $407 million)
Performance Solutions formulates and markets dynamic chemistries that are used in electronics, automotive production, other industrial applications, oil and gas production, and commercial packaging.
This segment has 5 sub-units:
· MacDermid Enthone Industrial Solutions
o Products: Corrosion resistance, decorative finishes, plating-on-plastic
o Customers: Automotive, construction, consumer electronics, aerospace, oil & gas
· MacDermid Enthone Electronic Solutions
o Products: Circuit board metallization, through-hole and in-hole plating
o Customers: Mobile devices, electronics, mobile infrastructure, servers and memory
· Alpha Assembly Solutions
o Products: Solder paste, solder spheres, pre-forms
o Customers: Consumer electronics, automotive, medical, aerospace
· MacDermid Graphic Solutions
o Products: Flexographic printing plates
o Customers: Consumer packaged goods, food, beverage
· MacDermid Offshore Solutions
o Products: Temperature and pressure resistant hydraulic fluids, blow-out prevention fluids
o Customers: Oil and gas production
MacDermid was the first acquisition made and served as the base platform for the entire company. The deal was announced in October 2013 and the purchase price was $1.8 billion, or 10x EBITDA. MacDermid’s CEO and private equity firms Court Square Partners and Western Presidio took MacDermid private in a 2007 buyout valued at $1.3 billion. 10x EBITDA was a very good purchase price for the asset considering the quality of the business, high returns, high margins, and low capital intensity. MacDermid has had stable gross margins for 40+ years, and I have spoken to former MacDermid employees who marveled at the stability and quality of the business. MacDermid focuses on dynamic chemistries which are essential to customers’ products and are a small portion of their costs. It has a leading market share in most of its businesses.
The Alent transaction was the second deal in this segment. Platform paid a large premium for the company, and the deal was done at 13x 2014 EBITDA. After synergies, the deal multiple was a little above 10x EBITDA. Platform paid a very full price for Alent and investors were skeptical that the team could achieve the targeted synergies. However, in light of the fact that Platform has done very well in achieving synergies in both segments, the Alent acquisition is justified. Moreover, the combination of MacDermid and Alent bolsters Platform’s market position and will lead to revenue synergies as well. I am very familiar with Alent and the previous CEO was complacent. Cevian correctly felt that much more could be done with Alent. The Alpha business within Alent focuses on electronic interconnect materials (electronics industry) while the Enthone business focuses on specialty electroplating chemicals (electronics, industrial, automotive). Like MacDermid, Alent has high margins, robust cash flow, and strong customer relationships.
The OM Group assets were also acquired in two transactions in October 2015 and January 2016. The OM assets are a nice complement to the Performance Solutions segment.
Long term growth drivers include a growing electronics market. The overall electronics market is estimated to grow sales by 3% over the next several years. Platform is well diversified across electronics end markets such as industrial, medical, aerospace, automotive, consumer, TV, computer/communications infrastructure, mobile phones, and PCs. While PCs are expected to continue to decline, the other end markets are expected to grow electronics content at a healthy clip (2-5% depending on the market). While there are concerns that automotive production has peaked in North America, automotive production is still robust and electronic content in autos continues to grow. Electronic content in vehicles has been growing at 5%+ and the circuitry in newer autos is much more complex than in older vehicles. Features such as collision avoidance, connected vehicles, sensors, cameras, safety systems, and autonomous features require much more content. Platform should outgrow its markets due to market share gains and its newly expanded product portfolio. Our work confirms management’s expectation of 3-4% growth in the segment long-term. While most of the revenues in this segment are correlated to customer production volumes, a portion of the products sold are inelastic to customer utilization rates and required just to run certain production lines.
Agricultural Solutions (2015 pro forma sales $1.8 billion and adj EBITDA of $382 million)
The focus of this segment is to increase crop yield and quality. The company offers diverse crop protection solutions against weeds, insects, and diseases in foliar and seed treatment applications. It also offers a wide variety of proven biosolutions, including biostimulants, innovative nutrition, and biocontrol products. The portfolio consists of herbicides, insecticides, fungicides, seed treatment, and the aforementioned biosolutions. The segment also offers non-crop products such as animal health products including honey bee protective miticides and certain veterinary vaccines.
The ag business is differentiated with its focus on specialty crops and niche geographies. This has helped insulate it relative to peers in the ag space. The company owns or licenses approximately 300 domestic and foreign patents, and has over 7,000 product registrations. The company in-licenses patents from other agrochemical and biosolutions companies and pursues other patents not related to the composition of matter, such as extensions, formulations, mixtures, and manufacturing processes.
Sales by crop: 30% fruits & vegetables, 32% main row crops, 38% other.
Sales by product: 20% fungicides, 32% herbicides, 31% insecticides, 4% biostimulants, 13% other.
Sales by geography: 14% Africa & Middle East, 13% Asia, 26% Europe, 34% Latin America, 14% North America.
The ag business has demographic trends in its favor: global population growth, declining arable land, increased crop intensity, and increased protein consumption due to gradual wealth increases. For these reasons, the crop protection market has grown at a 4% CAGR since 1980. However, weak commodity prices, high channel inventories, and currency headwinds have recently hurt farmer incomes and the ag sector generally. In addition to these trends, Arysta’s pipeline of planned launches should add significant sales.
During the September 2016 investor day, management guided to long term growth of 5% for the ag business. We agree with this assessment. In our view, the combination of regional products (in line with market growth), and then higher growth products (value-added products, biosolutions, and seed treatment) gets us to 5% growth. In the March 2015 investor day, management guided to 6-8% which was too high as a baseline in our opinion and probably assumed aggressive share gains.
The ag segment was assembled in 2014. In April 2014, Platform announced the acquisition of Chemtura Agrosolutions for 9.7x 2014 EBITDA or $1.0 billion. The Agriphar deal was announced in August and was for 9.2x 2014 EBITDA or 300 million EUR. Arysta was announced in October and was the largest ag transaction for Platform at $3.5 billion, or 11.7x EBITDA. The purchase prices were reasonable given that these multiples are before synergies, with the exception of (1) adverse currency movements which Platform could not have predicted and (2) aggressive inventory management in North America which caught Platform off-guard. In all fairness, the issue has been industry-wide as FMC and others have also had channel issues.
Investors unfamiliar with ag frequently fail to appreciate the competitive advantages of the ag segment. Platform is creating proprietary formulations based on the active ingredients they are licensing or have purchased from chemical companies which have expended significant capital and R&D into creating these active ingredients. So while Platform is generally not formulating the active ingredients, they are (1) listening to the farmers on the ground and understanding their needs, (2) creating formulations which address these changing needs through Platform’s own R&D which uses the active ingredients purchased or licensed from other chemical companies, and (3) going through the laborious, and technically and legally difficult process of getting Platform’s products registered in various countries. This is a complicated process akin to the registration process that large pharma companies undergo. In Europe, for example, it takes about 5 years to get a product registered, and there are EU and country approvals required. In Brazil, it can take up to 7 years. The U.S. and Africa take about 2-3 years.
There is a lot of product differentiation and a tremendous amount of customer intimacy here. Agrochemicals represent about 6% of a farmer’s cost but protect the entire crop investment. The money spent by a farmer on agrochemicals is about two-thirds the cost of the seeds and half the cost of the fertilizer.
FMC Corp trades at 12.8x 2016 EBITDA. I think it’s helpful to compare FMC to Platform’s ag business as FMC is perhaps the closest public comp on the ag side. Jgalt wrote a good post on FMC back in 2015. Now that FMC owns Cheminova, its ag business (the majority of FMC’s earnings) is comparable to Platform’s ag business. Cheminova significantly increased FMC’s operations in Europe and Asia and decreased the outsized reliance on Brazil. FMC now has an improved portfolio of fungicides, herbicides, and insecticides. And reliance on soybean and corn row crops has fallen from 35% to 25% of ag segment sales. Platform still has a more resilient ag business. Keep in mind that while crop protection is the bulk of FMC, it also has a high quality health & nutrition segment and a fast-growing lithium segment.
Despite a weak macro backdrop, Platform has put up decent numbers. The third quarter was particularly strong. These results measure organic growth and are presented on a constant currency basis.
In Q1, Performance Applications sales were down 2% and EBITDA was up 1% excluding incremental corporate costs. Agricultural Solutions was flat and EBITDA was up 7% excluding incremental corporate costs.
In Q2, Performance Applications was down 2% due to lower sales in oil & gas markets. EBITDA was up 8% excluding incremental corporate costs. Agricultural Solutions sales were up 3% due to significant growth in Latin America and Africa/Middle East, driven by both volume and price. However, EBITDA was down 11% excluding incremental corporate costs due to weakness in North America. North America has suffered from elevated channel inventory levels, and Platform decided at the end of last year to better manage its North American business by not pre-selling so much inventory. The inventory issues in North America are being resolved.
In Q3, Performance Applications was up 3% due to increased demand in the electronics business and strong growth in Asian automotive. EBITDA was up 9% excluding incremental corporate costs. Agricultural Solutions was up 4% due to growth in specialty crops in Europe, Asia, and North America, share gains in Europe, and volume/price gains in Asia. Management noted on the Q3 call that North America is starting to show signs of improvement. Agricultural Solutions EBITDA was up 18% excluding corporate costs.
Q3 was encouraging as North America is starting to improve, and both segments appear to be benefitting from share gains and the continued business integration.
Valuation and price target
We have valued Platform in several ways. Using a DCF assuming 3-4% top-line growth and EBITDA margins expanding to 24%, we arrive at a fair value of $17. EBITDA margins will be slightly under 21% for 2016, but if you give Platform credit for synergies (which will be achieved over the next 2-3 years), then EBITDA margins are slightly below 23% based on 2016 numbers. So my revenue and margin assumptions are not aggressive. We are modeling more conservatively than management’s long term guidance of mid-single digit % revenue increases and high-single digit % EBITDA increases. Although I gave Platform full credit for future synergies in my multiple table at the top of the writeup, the DCF properly phases in the synergies over time and takes into account the costs to achieve the synergies, etc.
If you take 2017 EBITDA and add the remaining synergy benefit, Platform is trading around 10.3x EBITDA less capex. Given the caliber of the business, this is too cheap.
The trading comparables are around 12x EBITDA. At 12x 2016E EBITDA plus synergies, the stock is worth $16. Platform shows us a list of comparables on slide 5 of its September 2016 investor day deck. I do not use 14-15x EBITDA as suggested by their choice of Ecolab which I think is too aggressive. Perhaps over time the team can evolve towards something like Ecolab, but we need to value the company based on what it is today.
The M&A comparables (pg 5 investor day deck) also point to a share price of at least $16. Some of the comps are more appropriate than others. For example, the Sherwin Williams/Valspar comp is not a great comp since it is an entirely different business and Sherwin Williams can extract a tremendous amount of synergies out of Valspar. But the FMC/Cheminova comp at 12x EBITDA is appropriate on the ag side. This is not on the slide, but Carlyle is purchasing Atotech from Total SA. Atotech is a very good comp for the Performance Solutions business. Atotech is being purchased for 12x EBITDA as well.
So based on a DCF, trading comparables, and M&A, intrinsic value is $16-$17. We tend to rely mostly on our DCF valuation. Taxes will also be trending down over the next several years as Platform works to improve its tax structuring. This is a minor point but it has real valuation implications. For an international business, its tax rate is too high at 35%. Sanjiv, the CFO, feels the tax rate can be well below 30% over time. FMC, for example, is currently at 25% and feels it can get down closer to 20%.
Net leverage defined as net debt divided by 2016 EBITDA (plus synergies) is 6.3x. The company is aiming to bring net leverage down to a target of 4.5x EBITDA by the end of 2019. In our model, this happens in 2020. Management wants to be able to issue equity and debt when doing M&A, and this cannot be done if the equity is penalized for high leverage.
With a levered equity, understanding the downside is key. From a cash flow perspective, the leverage is very manageable. The recent equity issuance reduced leverage by approximately $400 million. The EBITDA guidance for 2016 as of Q3 2016 is $750 to $765 million, a slight improvement from previous guidance. Capital expenditures are expected to be around $100 million, and cash interest will be around $340 million. So the company is highly cash generative. The company’s cost base is highly variable, and I would expect Platform to weather a downturn reasonably well. Platform’s most expensive debt is a 10.375% coupon on $500 million of bonds with a 7.7% yield-to-worst currently (they trade at 108). They are callable at 105.2 in May 2018 and at 102.3 in May 2019. In May 2020, they are callable at par. Given the high call premium, the bonds are probably not refinanced until 2019. It is interesting that all tranches of Platform’s bonds are up nicely YTD while the stock is down 34%.
I think Platform will reach intrinsic value and then compound well beyond today’s intrinsic value, but the path between today and $16+ could continue to be painful and volatile. While we have followed Platform since 2014, we recently took a position and so have been spared some of the emotional pain and believe we are looking at the story objectively. One must have the stomach for an investment like this, and I recommend sizing it with room to add and capping the sizing at cost. But this is not a flyer or option - this is a high quality, superior ROIC (>20%), highly cash generative business with scale and leadership in its markets and operated by a talented management team.
1. Leverage is the most obvious risk and this was addressed above. I believe the leverage is very manageable and time is on our side as Platform generates more cash and pays down debt.
2. Currency has already hurt the company and is a risk. Perhaps Trump does result is an even stronger dollar. The risk is more translational as Platform’s costs and revenues are well matched. As mentioned before, Platform’s cost structure is highly variable. There are also some mitigating factors. For example, as BRL weakened vis-à-vis the dollar, Platform got pricing since farmers tend to sell their crops in USD. One should note that there is a mismatch between earnings and debt - about 25% of the debt is in Euros with the rest in dollars. About 30% of revenues are USD, 25% EUR, 12% BRL, 10% CNY, and 5% JPY.
3. Aggressive accounting. A few people have claimed that Jarden was an accounting sham and no value was created. Jarden was aggressively managed and perpetually used a high share price with a baked-in M&A premium to facilitate deals – but Jarden created significant value over ~15 years. Many critics said that Martin was selling to Newell since Martin knew Jarden’s profitability was unsustainable and/or not real. It is interesting to note that Martin still has a huge stake (half of his after-tax proceeds I believe) in Newell Brands. I have not studied Newell, but I am familiar with Martin’s investments and if you talk to retailers, they will tell you that during the 2008-2009 period, Jarden grew organically and took share from competitors as retailers rationalized their supplier base and were impressed with Jarden’s constant innovation and execution of new product introductions. The company’s organic growth was real and Martin understands the concept of competitive advantage and moats very well. Martin bought 1.05 million shares in the recent $8.25/share offering, and has around a $100 million stake in Platform. The majority of this stake is from the economics of the original SPAC/carry, but it is a large stake nonetheless and Martin and Berggruen will not receive any more carry until the shares have nearly tripled from here. Rakesh ran Sigma-Aldrich in a very honest and transparent way, and he is doing the same with Platform. Rakesh did not come to Platform to make this levered asset a success via accounting games. All of the adjustments are transparent and you can adjust accordingly. And most of the investors in Platform are incredibly sophisticated (Pershing, Wellington, Permira, Corvex, Cevian, Cap Group, Bares, Blue Ridge) and little is gained via aggressive accounting. Over time, the adjustments will come down as management wraps up the integration of the businesses. They have executed as promised on the synergies to date. The 2H of 2016 is demonstrating the cash generative nature of the business. The ag business has a large working capital ramp in Q1 and Q2, and in 2H there is a large working capital release, particularly in Q4. Management has said that they expect the Q4 working capital release to exceed $100 million. Although it is a Pershing Square position and many hedge funds have gotten crushed in the name, comparisons to Valeant show a misunderstanding of the business.
4. LatAm credit. Thus far, the team in South America has managed credit very well. This is important given the working capital cycle on the ag side. The ag businesses have been managing credit successfully for decades. On the Q3 call, the company mentioned that collection trends were positive.
5. Owning a levered name at this point in the market cycle. I agree this is not the best time to own a levered name. Regardless of your views on global economic growth and Trump, global and U.S. leverage are going higher not lower. This is a name that your investors may dislike due to the extreme volatility. But as I said, fair value today is $16-$17, and buying this today at $8.50 creates a much larger margin of safety than paying $26.50 in the offering 16 months ago. I expect Platform to gain market share (as they have done this year), pay down debt, and continue to show its resilience in a weak economic environment. The world will continue to eat and buy electronics, and electronic content per item will continue to grow. Companies like dealing with fewer, more innovative suppliers, and Platform now has one of the largest and comprehensive offerings relative to peers in both segments. Suppose that intrinsic value truly is $16-$17 as we say. Then raising $1 billion in equity at $8/share takes the intrinsic value to $12.77 (50% upside). Raising $2 billion in equity at $6/share takes the intrinsic value to $10 per share (19% upside). This is simply done for illustrative purposes and of course assumes we are correct on our estimate of fair value for the enterprise. We strongly believe that PAH will not issue dilutive equity, and that the recent offering was done to address the one-off Permira liability. Given that we believe the capital structure is improving, there is no reason that Platform’s future is not as bright as those of other high quality specialty chemical assets. If Platform were to sell itself (probably done in two pieces), it would achieve around $16-$17. The company has optionality and various levers to pull over the next few years. Martin’s preference for leverage is 4.5x. I prefer 3x. I assume Rakesh would prefer lower leverage than Martin given that Sigma-Aldrich had low leverage.
6. Board composition. The board is too finance-heavy. Pershing is on the board given that they are the largest investor. Martin is a strong Chairman and Ian is involved. Martin is more well known to investors than Ian, but Ian is also good at overseeing integrations and understands how to meld businesses together. Nicholas is Martin’s SPAC partner and on the board. I have great faith in Rakesh. But I would prefer to see the board augmented with some specialty chemical expertise. If the board cannot be augmented, then some of the board members should be replaced by industry veterans from the chemical industry. It is amusing that Stanley O'Neal is on the compensation committee. You will remember that he had a severance package of $160 million when the board of Merrill Lynch replaced him. If you were a Bernie supporter, this reason alone eliminates the possibility of you placing Platform in your fantasy stock portfolio. Platform’s competitors have boards with extensive chemical experience, and Rakesh benefitted from a board with stronger chemical experience when he ran Sigma-Aldrich.
Platform is a high-quality asset that is poised for long-term success. The capital structure is manageable and will improve over time. A strong team led by one of the best executives in the specialty chemical space has finally been assembled and is executing. We have slowly worked on Platform for over a year now. Many things kept us on the sidelines: leverage, skepticism about synergy realization, the share price (when it was in the $20s), the CEO (we didn’t like that Dan Leever was overly promotional and on Cramer’s show claiming it could be a $200 stock), our concern that the ag business would have trouble navigating a difficult environment, the resignation of Wayne Hewitt (former ag head who apparently did not get along well with Dan), the fact that this is a hedge fund brothel, and the board composition. With the exception of the board and shareholder composition, each of these issues has either been resolved or is in the process of being resolved. It is still a hedge fund hotel, but the stock has gotten crushed. Once the company’s share price trades in line with intrinsic value, the company may issue equity or execute an acquisition with equity in order to more quickly reach its targeted leverage ratio. The specialty chemical space is still very fragmented, and value can be created by an intelligent consolidator. In mid-2015, the stock was priced for perfection and the markets were giving Platform credit for executing flawlessly. Now we have a better team, more clarity on the business quality and direction, and a much cheaper stock price.
Continued execution of the remaining synergies, most of which will be from the Performance Solutions business due to the late 2015 acquisition of Alent.
Share gains in both segments as the commercial integrations progress.
Rebound in the ag business.
Continued execution demonstrates to investors that this is a high quality business. As concerns subside, this will get revalued in line with peers.
Stanley O'Neal is booted from the board resulting in immediate multiple expansion of 1x EBITDA, or nearly $3 per share.
Chipotle purchases Platform in order to have complete access to its portfolio of fungicides.