13. Project Larch II Flashcards
Walk me through Project Larch II.
I am part of a four person deal team that is currently advising a $6 billion specialty chemical company on its potential $400+ million acquisition of the polypropylene licensing and catalyst business of a chemical conglomerate
The seller has chosen to actively market this business for divestment as they continue to selectively prune assets that are no longer a strategic or financial fit. We view the polypropylene licensing and catalyst business as an attractive complement to our client’s catalyst technologies business with tremendous potential for a synergistic combination. Our client is attracted by its leading market positions, global reach and potential for growth.
We have been asked to assess the attractiveness of this strategic acquisition opportunity, lead the due diligence efforts and construct a comprehensive valuation analysis. As the only analyst on the team, I have analyzed trading multiples and precedent transactions, built a preliminary accretion / dilution analysis and started constructing a plant-by-plant valuation model.
We have assessed the competitive landscape and determined that only a few other legitimate competitors exist. We have made a preliminary recommendation that we believe will position our client as a front-runner in the bid process ($500 million all-cash bid).
Walk me through the industry research that you did.
I put together a market study that analyzed the polypropylene supply / demand outlook
a. Analyzed global PP demand and capacity growth
- Historical PP demand growth of 4.5% and capacity growth of 6%
- CMAI projects demand growth for PP at an annual run-rate of ~5% through 2018 while capacity growth is expected to decline to growth of 2-3% annually
- Growth will be fastest in China, Central/Eastern Europe as developing countries shift from a largely agrarian to an industrial economy bringing growth opportunities for PP to substitute for paper, metal, wood, glass and natural fibers
- In China and SE Asia, consumption growth of PP is significant because of its importance in film in the packaging of textiles and general consumer goods and the high usage of polyolefin fibers in production of agricultural bags and twine
- PP consumption continues to grow 1.3-1.7 times GDP even in industrialized regions such as N.A., Western Europe and Japan
- Substitution for other polymers has been the significant driving force for this extraordinary growth, which in turn has been supported by continued investment in process and catalyst technology
b. Analyzed North American polymer pricing trends
- Since the trough in 2008, the recovery in PP prices has outpaced other polymers because of its high correlation to oil prices (~$2,000 / MT)
- PP and PE prices price in line
- PVC is the cheapest (~$1,000 / MT)
c. Analyzed polymer pricing ratios
- The ratio of PP to other polymer prices has increased significantly overhistorical averages
- PVC includes relatively price-stable salt and PE is mostly made from natural gas ingredients
- Since 2007-2008, massive capacity additions have forced older units to be rationalized, while the steep crude oil price increase has created some fundamental shifts in the light olefin markets, creating a long-term increase in the propylene to ethylene price ratio. Accordingly, PP has become more expensive relative to polyethylene, promoting shifts from PP to alternative products like HDPE, where possible.
d. Analyzed global demand by end use
- PE has the largest end market overlap with PP; specifically, PP and HDPE have the greatest intermarital competition in injection molding and film & sheet
- PP End Uses: Injection molding (35%), film & sheet (23%), raffia (17%), fiber (14%)
- PE End Uses: film & sheet (51%), injection molding (13%), pipe (10%), blow molding (12%)
e. Analyzed natural gas and oil pricing trends
- In recent years, natural gas prices have decoupled from crude oil prices as reflected in the oil/natural gas ratio increasing dramatically over the economic equivalency of ~8
- Opportunity now exists for North American-based gas feedstock consumers to leverage a significant cost advantage
f. Analyzed ethylene and propylene production mix
- North American production of propylene: 50% by product of petroleum refining, 45% co-product of ethylene cracking
- North American production of ethylene: 26% naphtha, 69% gas liquids
Walk me through the firm specific research that you did.
Analyzed the catalyst and licensing competitive landscape
a. Analyzed PP technology licensing market shares by capacity
- Analysis of PP sites globally indicates that target has the #2 position with 17% share of licensed capacity even though it is a very minor producer of PP resin
b. Target geographic distribution
- 19% NA, 25% Middle East, 39% Asia, 13% Europe, 5% SA
What was the strategic rationale for the investment?
The polypropylene catalyst and licensing business is an attractive complement to our client’s Catalyst Technologies division, specifically its specialty catalyst business unit. Our client is attracted by a number of factors including:
(1) the target’s leading market position
(2) history of innovation
(3) globally recognized brands
(4) blue-chip customer base
(5) potential for growth
There is substantial potential for a synergistic combination between the target and our client’s existing polyolefin catalysts manufacturing, development and marketing operations
What are the five most notable merits of the deal?
Acceleration of specialty catalyst growth plan
(1) Become #2 player
(2) High growth market at 5% per year
(3) Fits with emerging markets strategy for future growth
(4) Accelerates implementation of existing PP strategy
(5) De-risks existing PP strategy by acquiring strategic manufacturing capabilities
What are the potential risks and pitfalls?
(1) Integration risks
(2) Uncertainty of what to do with PP licensing business
(3) Synergy realization; huge component of returns on investment
Describe the catalyst industry.
The definition of catalyst is a substance that alters the velocity of a chemical reaction without itself being consumed. Although this is theoretically true, in practice catalysts decrease in activity with use and suffer losses in material handling, thus requiring periodic replacement. These factors, together with economic growth and discoveries of new uses for catalysts, contribute to the continued growth of the catalyst business.
The other side of the picture is the drive to find ever-more-efficient, long-lived, active and selective catalysts. Economic and practical considerations provide incentives for the development of new catalysts and greater understanding of catalysis in general. Development is further driven by the need for new sources of energy and chemicals, concern over environmental pollution, the desire for new types of products, and the cost of and potential restrictions on the availability of the noble metals used in many metals.
What is the size of the market and its growth prospects?
Process catalysts, a $16 billion-per-year business worldwide, play a vital role in the economy. The value of products dependent on process catalysts, including petroleum products, chemicals, pharmaceuticals, synthetic rubber and plastics, and others, is said to be around $600 billion per year. About 90% of chemical manufacturing processes and more than 20% of all industrial products employ underlying catalytic steps.
There are three major process catalyst market segments, including chemical processing, petroleum refining, polymerization The global catalyst market value can be broken down into three segments (1) chemical processing catalysts ($6.5 billion) (2) petroleum refining catalysts ($5.6 billion) (3) polymerization catalysts ($3.9 billion)
Major market segments within the polymerization catalyst market include polyethylene, polypropylene and polyvinyl chloride. Polyolefin catalysts are the largest single market sector with about 50-60% of the total polymerization market (~$2.1 billion). Polyolefin catalyst consumption is nearly flat. The 6-7% growth in polyolefin production is compensated mostly by the development and use of higher-efficiency catalysts
The polypropylene catalyst market is expected to grow at 5% annually.
Discuss the industry outlook and trends.
Polymerization catalysts are required for the production of polypropylene and other plastics. Polypropylene is the second most commonly used plastic in the world with approximately 25% of the global polymer demand. Due to its balanced product performance, advantaged specific gravity and market versatility, PP is often used as a substitute for other plastics (PVC, PE, PET, PS) and can replace other materials including metal, paperboard, and glass in specific applications. Increasing demand from emerging geographies for sustainable product solutions and durable alternatives to other plastics and materials is expected to drive worldwide growth of PP by ~5% annually over the next five years.
The global trends in PP resin development can be summarized as lighter, tougher, faster, cleaner and clearer. The latest catalyst and donor developments for the target’s proprietary process technology address these trends with improved stiffness-impact balance, higher melt flow for faster processing, lower volatile organic compounds, and improved organoleptics and reduced haze
PP Catalyst Market participants and market shares: Lyondell Basel: 30% Other: 18% BASF: 16% Sinospec: 11% Dow: 10% Mistui: 8% Grace: 7%
Combined #2 player with 17% market share
How will the target company outperform, underperform or be neutral with the industry?
Outperform. Annual growth rates are expected to be about 5% over the next 5 years, with highest growth rates expected in the emerging geographies of China, Central and Eastern Europe, Latin America and Middle East & North Africa. Over 50% of PP demand is expected to be in China and Asia where the target’s proprietary process technology is well positioned with positive momentum resulting from recent licensee wins. This technology has been selected in 33% of the licensing decisions made in China over the past 5 years, which provides strong basis for additional growth, as China looks to be become more balanced between demand and installed capacity.
Its PP catalysts currently benefit from the widespread adoption of the PP licensed process technology. As the technology continues to maintain its recent track record of licensing success, the target expects organic growth of their catalyst systems. These catalyst systems can also be used with other widely adopted gas-phase polypropylene manufacturing technologies, including those of Lyondell Basel and BASF. One of the target’s key initiatives is to expand the use of catalysts outside of its proprietary PP process technology, which is expected to provide significant growth opportunities.
Is there fragmentation in the PP catalyst market?
The catalyst industry is highly segmented, with 40 major firms supplying the North American market for catalysts. No single company manufacturers all types, and companies generally specialize in types of catalysts that fit their technical or raw material strength.
The two largest producers are BASF and WR Grace. These two companies account for 25-30% of the total North American market on a dollar value basis. Because catalyst suppliers generally do not compete directly with one another across all market segments, market shares and relative sizes tend to be somewhat meaningless.
There are only a handful of major players within the PP catalyst market. Six major producers represent 82% of the global PP market.
Is there seasonality / cyclicality?
Process catalysts play a vital role in the economy and demonstrate relative resilience during market downturns. Additionally, seasonality does not have a significant overall effect on catalysts
Is the polypropylene catalyst market attractive?
Relatively attractive market
Intensity of competition: (MODERATE) numerous competitors but differentiated product
Threat of new entrants: (LOW) high R&D requirements; capital intensive; high customer loyalty; proprietary technology is difficult to replicate (huge secrecy factor)
Threat of substitutes: (LOW) highly differentiated technology with high switching costs due to underlying process technology requirements
Bargaining power of buyer: (LOW) although buyers are highly concentrated, catalyst business provides a relatively inelastic demand and strong customer retention characteristics; continuous need for catalyst supplies translates into relatively inelastic demands; furthermore, catalyst supplies are often specifically tailored to a given production facility, meaning sales are often “sticky” with infrequent switching between catalyst suppliers
Bargaining power of supplier: (LOW) commoditized metals that can be accessed from a number of different suppliers
Describe the customer.
The target has strong positioning with core growth oriented customer base
Customer = global polypropylene producers (Braskem, Petrochina, Sinochem, Sabic, Reliance Industries, Shenhua Group
Due to the strength of the target’s proprietary process technology, it has enjoyed broad based adoption from customers around the world. Customers recognize the value of the target’s proprietary process technology’s mechanical simplicity and operational efficiency as approximately 60% of the currently licensed capacity is with repeat licensors.
Customers are motivated by quality of catalysts an on-going contact after the licensing of technology – key to maintaining strong customer relationships.
What does your client do? What are its key financial metrics?
Our client is a global specialty chemicals company operating out of three business segments, including Catalyst Technologies, Materials Technologies, and Construction Products
Total Sales: $3.2 billion Total EBITDA: $608 million TEV / EBITDA: 8.9x PE: 62.8x Debt / EBITDA: 1.8x
Describe the business segments of your client.
Catalyst Technologies (40%, $1.3 billion): Produces and sells fluid catalytic cracking (FCC) catalysts and hydroprocessing catalysts (HPC) for the refining industry (78% of segment revenues) as well as Polyolefin Catalysts for the plastics industry (22% of segment revenues)
- Catalysts for refining industry facilitate the processing of heavy crudes into lighter, high-value end-products as well as upgrade petroleum products by removing impurities
- Polyolefin catalysts are used in the production of polypropylene and polyethylene
Materials Technologies (27%): includes silica-based engineered products used in a variety of applications as well as sealants and coatings for packaging
Construction Products (33%): offers a number of chemicals and solutions to enhance the properties of building materials
What does the target company do?
The target business consists of two core businesses:
(1) PP Process Technology Licensing – develops and licenses polypropylene process technology
- Enables 17% of global installed PP capacity, which ranks #2 in the industry
- Based on PP licenses awarded in the last 5 years, the target’s proprietary process technology has successfully obtained over 25% of newly licensed capacity
- The broad adoption rate of the process technology is primarily driven by its technical superiority, low investment and operating cost, and capability to produce the broadest mix in the industry
(2) Polypropylene Catalysts – develops, manufactures, markets and sells catalysts and donors used in the manufacturing of polypropylene resins (second most common plastic)
- Offers integrated catalyst and donor solutions that are advanced and easy to use
- Although they are custom-engineered for the target’s process technology, they also have application in competing gas phase processes
- Catalysts primary function is to polymerize the propylene and other monomers into polypropylene and drive the product morphology and bulk properties
- External donor works in conjunction with the catalyst to control the specific properties of the PP produced and fine tune product performance
What are the company’s competitive advantages?
(1) Technological superiority that results in simplicity, low investment costs, low operating costs, and reliability
- Smallest footprint in the industry
- Lower conversion costs
- Lower ongoing operating costs
- Higher reliability and on-stream time
(2) Customer service – on-going customer support has led to customer retention (60% of currently licensed capacity is with repeat licensors)
What the company’s strengths, weaknesses, opportunities, and threats?
Strengths: #2 market position; technological superiority (simple, low cost, effective)
Weaknesses: custom engineered catalyst systems with proprietary process technology; need to develop capabilities across other competing processes
Opportunities: well positioned to capitalize on high growth in emerging countries such as China, eastern Europe and India
Threats: competing technologies eroding market share
What is the management team and culture like at the company?
98 total employees Manufacturing and Engineering (50) R&D (27) Supply Chain (2) Commercial (13) Other (6)
Comprised of highly experienced experts in the catalyst industry
What does the company’s supply chain look like?
Chemical elements such as Titanium trichloride are transformed into usable catalysts, which are sold to polypropylene producers. The end users include packaging, container, automotive and textile producers, such as Dixie and Produmaster
