Potential Sale of Water Would Leave Earth, Wind and Fire
In late-July 2013, Ashland Inc. (NYSE-ASH) announced that it was exploring strategic alternatives for its Water Technologies unit, including a potential sale. On its 4Q FY13 earnings call (11/5/13), ASH reiterated that it expects to make an announcement regarding the water business segment in calendar 1Q14. The plan to streamline its operating units from four to three came about three months after Jana Partners LLC (“Jana”) made a 13D filing on 4/11/13 (5.8M shares or 7.4% S/O, acquired in 2013); Jana subsequently made another 13D/A filing on 9/20/13 (6.5M shares or 8.4% S/O). In mid-May, ASH announced a $600M share repurchase program (including a $150M ASR, executed at a price of $86.32 for ~1.7M shares delivered in June), which replaced its previous $400M program. In addition, ASH refinancing its senior debt issued with $2.3B of new senior notes (4.37% blended interest rate); $600M is due 2016 and $700M is due 2018). Last, the company announced in October a restructuring program with annualized cost savings of $150M-$200M; the program will start in FY14 and reach a full run-rate in 12-15 months. The announcement of a strategic review, the encampment of an activist investor, the expanded share buyback, the repayment extension and reduced debt financing and the restructuring program are all positive developments for ASH shareholders. The company’s operating segments include Specialty Ingredients (polymers), Water Technologies, Performance Materials (resin and adhesives) and Consumer Markets (Valvoline and related brands); earnings are lumpy due to cyclicality, commodity inputs, discretionary consumer budgets and international trade factors. Selling the Water Technologies unit (with its high single digit EBITDA margin and weak revenue growth) would help simplify the investment story and improve the overall EBITDA margin, potentially leading to margin expansion. The potential transaction value was recently reported to be up to $1.5B (based on a rumored joint bid by Danaher Corp. (NYSE-DHR) and Blackstone (NYSE-BX)). The company has stated any deal proceeds would be primarily used to return value to shareholders (such as funding the share repurchase program). Given the recent debt refinancing, ASH could pay a substantial one-time dividend; $8-$12/share would require $620M-$930M. We note that ASH has aggressively increased its quarterly dividend the past two years; the May 2013 payment finally exceeded the previous high (in 2008). The company’s current 1.5% dividend yield is in the mid-range of our specialty chemicals peers. Despite the all-encompassing nature of the initiatives, we feel investors have yet to fully embrace the potential improvements as reflected by the current stock price. The ASH CY14E valuation multiples ($92.15 closing price and a $10.1B EV) are 1.2x EV/Revs, 7.6 EV/EBITDA (16% margin) and 13.1x P/E (1.4 PEG ratio to 9.4% LT growth). ASH trades at the low end of our peer group multiple range of 7.5x-10.5x EBITDA; an 8.5x-9.0x multiple range would imply an ASH value of $109-$118/share, with every 0.5x multiple worth ~$8.50/share. We believe some of the multiple discount is due to debt leverage of 2.5x FY14E EBITDA (vs. 2.0x leverage in FY13); ASH has below investment grade debt ratings (Ba1/BB/B+) as a result of acquiring International Specialty Products for $3.2B cash in 2011. In addition, fluctuating commodity costs have primarily impacted two operating units - Specialty Ingredients (the largest and most profitable segment) and Performance Materials (the smallest and least profitable). Consumer Markets has benefited from the economic recovery, but this growth trend is expected to moderate in 2014. Water Technologies has had the most consistent profitability over the past three years, which makes it the ideal candidate for a private equity acquisition or a leveraged buyout. While a sale of this business unit would allow for a small recapitalization (i.e. share repurchases) and potential return of equity to shareholders, we believe more value can be created from operational improvements and (more importantly) revenue/volume growth. Last, ASH also intends to sell its Elastomers unit (Performance Materials), but that is a relative sideshow ($410M FY12 revenues) compared to monetizing the water segment. The Water Technology business reported $1.722B revenues and $153M EBITDA (8.9% margin) for FY13 (ended September). Assuming some nominal growth and $30M-$35M proportional allocation from the cost savings initiative, the segment’s 2014E P/F EBITDA would be in the $190M-$200M range. A $1.5B purchase price would imply a 7.5x-7.9x EV/EBITDA valuation multiple and could be financed with up to 5x debt/EBITDA leverage. We conservatively estimate that 10% of the proceeds would be required for transaction expenses (including any gain-on-sale taxes) and another 30% would used to fund the remaining share buyback (4.75M shares at $95/share resulting in ASH P/F 72.8M S/O). A $10/share special dividend would require ~$775M; that would leave $125M for general corporate purposes. We note that most of the company’s $346M cash balance (as of 9/30/13) was held in foreign subsidiaries, subject to repatriation taxes; some additional cash cushion would be useful in lieu of borrowing to fund working capital. Using an ex-dividend $82/share price and P/F $6.3B Revs, $1.1B EBITDA (~17.5% margin), $6.15 EPS and $2.8B net debt, the P/F ASH 2014E valuation multiples would be 1.4x EV/Revs, 8.0x EV/EBITDA and 13.3x P/E. A 9.0x-9.5x EBITDA multiple (the median of out peer group mid-cap specialty chemical stocks) would imply a total value (including our $10/share special dividend assumption) of $107-$115/share. The ASH share price closed at $75.23 the week before and $78.83 the day before the Jana 13D was filed, or ~15% and ~10% below the $86.66 closing stock price on 4/12/13. The company’s share price has advanced only 6% since the day-after effect from the Jana filing. Based on 4/10/13 closing prices, the average price gain of our peer group (six companies) is ~21% (11%-42% range, 18.5% median), right inline with the ASH price gain over the same time period. ASH has not helped itself; the company widely missed (~9%) consensus 3Q FY13 EPS and had underwhelming 4Q FY13 results. We see two key catalysts for the ASH stock price; the sale of Water Technologies (which could come with the release of 1Q FY14 results or the annual meeting, both of which typically occur the last week of January) and improved EBITDA margins (“consistent with the top quartile of its specialty chemicals peer group”). The first catalyst appears to be close-in-hand, while the second one is a taller (but theoretically manageable) hurdle. However, investors have been notably cautious in the absence of neither to-date, and as a result the stock has underperformed as it up only 14% YTD. Overall, we view ASH as an early 2014 story that investors may be overlooking at year-end 2013.