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AkzoNobel's [AMS: AKZA] proposed merger with Axalta [NYSE:AXTA] is a defensive move to stave off another hostile approach for the Dutch group but is, nonetheless, strategically sound, according to sector advisers.

Akzo does not want to get swallowed by the likes of PPG Industries [NYSE:PPG] after it sells its Specialty Chemicals unit, the first advisor said. The deal with Axalta is a way for the company to acquire scale and get bigger before streamlining the businesses, he said.

However, Akzo could be shooting itself in the foot with the Axalta transaction, the second banker said. The merged entity would be an even more attractive target for PPG or any other larger player, he speculated. Although, due to high level of overlaps between PPG and Axalta, it would be challenging for PPG to acquire the combined entity, the first banker said.

On 30 October, Akzo announced that it is currently in constructive discussions regarding a merger of Akzo's paints & coatings business with Axalta, creating a leading global paints & coatings company. This followed an unsolicited approach by PPG for Akzo, which the US company abandoned in June. Under Dutch takeover law, PPG faces a six-month cooling-off period, after which it can make another offer for Akzo.

As part of its defence against PPG, Akzo announced plans to separate its Specialty Chemicals unit, with the return of the vast majority of net proceeds to shareholders. It also set profit targets, which it has since said it will not meet.

"I can see the rationale [of a merger with Axalta] as a defensive measure to keep PPG at bay,” said the first banker. The combination makes a lot of sense and has been talked about for a few years, he said.

Akzo does not have much of a choice now, the same banker said. To be a significant performance coatings player, Akzo needs scale and Axalta is the only "kingmaker" transaction, the banker said.

This transaction would help Akzo beef up in performance coatings, relegating its paints business as a smaller portion of its revenues, this adviser noted.

There is strategic logic for an Akzo/Axalta deal, a third banker said. It provides another end market for Akzo's portfolio, which is mostly residential and commercial. Axalta serves more automotive and industrial coatings segments – so it would be a complementary deal, he said.

This banker agreed there was little else of size for Akzo to go after in a well-consolidated industry, other than smaller opportunities such as Tikkurila [HEL:TIK1V], a Finnish company that has been rumoured as a target for quite some time.

The merger is unlikely to see a rival bidder stepping in, a fourth banker said. Axalta, with a USD 8.1bn market cap, is a big bite and only a handful of players would be in a position to buy it, the banker said.

Other strategics such as PPG, Sherwin Williams [NYSE:SHW], BASF [ETR:BAS], Eastman Chemical [NYSE:EMN], Honeywell [NYSE:HON] and DowDupont [NYSE:DWDP] are unlikely to pursue an Axalta deal due to potential overlaps or less strategic merit, among other things, this banker said.

Though the deal has been described as a merger of equals, it looks more like a takeover of Axalta by Akzo, the bankers agreed. Axalta is still partly owned by Carlyle, so a transaction with Akzo could constitute a full exit for the PE group, the second adviser said.

Carlyle acquired Axalta in February 2013 for USD 4.9bn and took the company public in November 2014. In August 2016, Carlyle sold 41.62m common shares in the company, which equates to about a 17% stake.
The deal is expected to have a stock component, the fourth banker said. The merger math is going to work much more in Axalta’s favour as it has a stronger management team than Akzo’s, the first adviser speculated.

Akzo also announced that the separation of its Specialty Chemicals unit remains on track for April 2018 and is unaffected by discussions with Axalta.

The separation of the unit and the merger with Axalta could both run at the same time, one of the sector advisors said. Akzo does not have to wait until the separation of the unit in April 2018 to do a merger, he added.

The dual track process for Specialty Chemicals is progressing and there is already a lot of interest from private equity firms, three sector advisors said.

Discussions are currently taking place on staple financing and the IMs are expected to be sent out mid-November, a source close to the process and a fourth sector advisor said.

It would be more logical for Akzo to sell to a private equity firm rather than carry out a spinoff, so it can use some of the proceeds to fund the Axalta transaction, the second banker suggested. Akzo would want to enjoy the full value of the separation on day one rather than retaining a stake, he added.

Akzo's specialty business is valued at around EUR 10bn, as previously reported.

But it would have helped Akzo to own the Specialty Chemicals business from a cash flow point of view to help the company through the integration period with Axalta, the first banker said. The Specialty unit is a solid business, has better margins and cash flow than rest of Akzo, and is a funding vehicle for the dividend, he explained.

Akzo declined to comment.