Meditation on OM
We are baffled by OM Group’s decision to sell itself for about $1 billion, or $34 a share, to buyout firm Apollo Global Management.
The first question we usually ask when evaluating a deal – our investment firm, Cove Street Capital, is a 1.5 percent shareholder of OM – is whether the upfront premium is reasonably equal to, or does it exceed, the present value of the company’s existing operating plan. Although the offer in this case represents a 28 percent premium to OM’s undisturbed share price and a 21 percent premium to our average cost over the past year, the answer in this case is unequivocally no.
There is an inherent conflict of interest when a management team leads a sale to a private equity firm. During Joe Scaminace’s 10-year reign as chief executive, OM’s shareholder value creation has been very limited. After a recent campaign by an activist investor, Scaminace and the board decided to sell to Apollo the day before new directors were to be elected. Arguably, the board’s first action in our opinion would have been to replace the CEO, primarily due to some very questionable capital allocation decisions.
What’s more, the price being paid materially undervalues the biggest part of the company. After buying OM, Apollo plans to offload its electronic chemicals and organics division, which generated $28 million of EBITDA last year, for $365 million. That’s a multiple of 13 times. The buyer, Platform Specialty Products, is also banking on $20 million of savings.
Value the battery technologies unit staying behind at 9.8 times, using close but imperfect comparisons to publicly listed companies EnerSys and Saft Groupe, and it would be worth about $355 million. Do something similar for the remaining chemicals business – at 10.5 times EBITDA – and it would be worth $204 million.
That adds up to $924 million, and implies that Apollo is paying just 1.7 times EBITDA for VAC, the magnetic materials and components business that produced $62 million of EBITDA last year. That would be $105 million for a business OM Group bought in 2011 for 700 million euros, or $1 billion at the time. For our calculations, we ignore the corporate costs because we think they would disappear if the company was sold to a corporate buyer.
Apollo has one of the best teams in the chemical space. No one ought to be surprised, therefore, that the present value of OM with a new CEO running it properly and getting the benefit of an eventual pickup in the European economy should handily exceed the $34 a share on offer.
What should shareholders hope for from here? The board has an undeniable fiduciary duty to conduct a legitimate go-shop process. Our analysis suggests it is unlikely OM shareholders will receive anywhere near fair value unless the segments are sold separately, either to strategic or private equity buyers.
Cove Street’s sum-of-the-parts analysis has always generated a per-share value in the low $40s, even assuming no improvement in VAC. If, however, Platform Specialty is willing to pay $365 million for only part of the specialty chemicals business, then the number could be even higher.
Barring a shareholder insurrection that forces Apollo to pay more, we will find out in the first week of July – when the go-shop expires – if the private equity firm succeeds in getting a steal of a deal on OM.