LyondellBasell Industries – Analyst Comments on Deal to Acquire A. Schulman, Inc.

LyondellBasell Industries (LYB: Hold, $116 PT) 
The M&A Era Has Begun
• LYB will acquire SHLM in a $2.25bn cash deal. Under the terms of the agreement, LyondellBasell will acquire A. Schulman, Inc., a plastics compounding company, for a total consideration of $2.25bn. LyondellBasell will purchase 100% of SHLM common stock for $42 per share in cash, plus one contingent value right (CVR) per share and assume outstanding debt and certain other obligations. In addition, the CVR generally will provide a holder with an opportunity to receive certain net proceeds, if any are recovered, from certain ongoing litigation and government investigations relating to A. Schulman’s Citadel and Lucent acquisitions. The deal is expected to close in 2H18. 
• Valuation looks a bit steep at first blush. Excluding the CVR, the deal represents a premium of 8.7% vs. yesterday’s closing price for SHLM, which sounds modest. However, the deal multiple of LTM adjusted EBITDA of $205mn or 11.0x far exceeds Lyondell’s own trading multiple of 7.1x CY17 EBITDA. Lyondell aims to capture $150mn in run-rate cost synergies within two years of closing, so on a post-synergy basis, the multiple drops to 6.3x.
• Bank shots: SHLM competes with PolyOne and Clariant. We cover neither stock, but would expect PolyOne (POL) to benefit from increased scarcity value. We note that Celanese (CE, Hold $116) has been an active acquirer of three smaller compounders (SOFTER, Nilit, and Omni) over the past year. We believe the deal renders a potential acquisition of…
• This deal appears to check the right M&A boxes for Lyondell. We had previously summarized key points on Lyondell’s M&A strategy as follows: (1) Lyondell’s financial flexibility is such that the company could deploy as much as $18bn in capital in an M&A scenario, assuming a one-notch downgrade to BBB; (2) management is committed to EPS accretion by year two, but aims for immediate accretion ex items (SHLM is accretive to earnings within year one); (3) the company targets an IRR of at least 12%; and (4) the company aims to improve overall growth and margin characteristics via M&A, but has disavowed any foray into… 
• SHLM is not a shocker in that LYB has been acquiring compounding capacity overseas. While SHLM was not on many investors’ short lists of likely acquisition targets for Lyondell, the company knows the compounding business well and has acquired multiple compounders overseas (India) as we discuss below, so in that context we are not overly surprised by this foray. Within the $65bn global compounding market, the deal effectively doubles Lyondell’s position to one of leadership with market concentrations in Automotive (53%) and EMEA (51%). Lyondell is the world’s largest producer of PP compounds with an annual capacity of 1,300KTPA or 2.8bn pounds per year. In April 2016 Lyondell completed the acquisition of…
• Lyondell’s cash deployment paradigm continues to shift dramatically. We exit Lyondell’s quarter with the view that the familiar FCF return story that investors have enjoyed over the last 6 years has come to an end. This is not the consequence of industry oversupply or other cyclical forces, despite our concerns about the amount of new polyethylene (PE) resin capacity coming to market over the next two years. In fact, the oil price rally over the last year will help to “ease the pain” that we had anticipated with Brent crude closer to $50. Instead, Lyondell’s strategic preference is the primary reason for the paradigm shift. Whereas our earnings estimates have generally moved north, based on an improved outlook in domestic PE margins and a lower tax rate, FCF is headed south, and not only for the winter. Lyondell has embarked on an ambitious four-year program with capital expenditures to average $3bn per annum, more than…
• We rate shares of LYB Hold and with a price target of $116. Our revised price target suggests a return of 7%, including a dividend yield of 3.3%. As a reminder, our LYB price target is based on an average of two valuation frameworks; a relative EV/EBITDA multiple and a relative normalized P/E multiple. Our relative EV/EBITDA multiple uses a 2.5x discount to the group average multiple and reflects a stock price of $113, while our normalized P/E methodology reflects a warranted stock price of $119 based on our normalized EPS estimate and a multiple equal to a 30% discount to the sector average multiple.
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