Bill Ackman and Platform Specialty Products... Revisited

It was on 9 December, 2014 that I published an article on Platform Specialty Products. (PAH)

Back then I gave a rather detailed analysis on the company. Initially I thought I was getting a real bargain, but that's due to using the wrong numbers. I then explained the correct estimation of the then leveraged earnings yield should be closer to 7.5%. After giving it some more thoughts back then, I decided to pass on the opportunity. (At last I "wisely" put more money into WTW instead...)

In the subsequent months, PAH went as high as $28.35/share, comparing to the $22.05/share when I first wrote about it. However, PAH has since come back down to $22.48 as of today. This of course prompts me to take a look into PAH again.

How I have missed you, PAH!

Let's take a look at what our friend PAH has been up to in the past 8 months.

On June 1, 2015, PAH made an offer to acquire OM Group’s Electronic Chemicals and Photomasks businesses for $365 million. That part of the business earned approximately $28 million in adjusted EBITDA. As such, they effectively are paying a price to EBITDA multiple of 13.03. Interestingly though, Platform is expecting to achieve synergy in access of $20 million over the next two years! If I am thinking this right, then they are really paying $365 million to capture $48 million in EBITDA, a multiple of 7.6 only. This makes it a bargain deal for Platform.

Then on July 13, 2015, they announced the big deal of the year of acquiring Alent plc, their main competitor in the Performance segment from the U.K. for approximately $2.3 billion. (a 49% premium to the then stock price of Alent) In 2014, Alent earned $680 million in revenue and $172 million in adjusted EBITDA, spending $19 million in capex. They plan to pay 78% in cash, and the rest in stock.

So what is the earning power we should expect from the present Platform? Let's take a quick look at what I came up with.

According to their investor day presentation, Platform should have earned $570 million in pro-forma EBITDA - CapEx in 2014.

In the subsequent presentation after they announced their intention to acquire Alent, they showed the 2014 PF earnings including Alent, would have been $814 million, with EBITDA - CapEx at $721 million.

Interestingly though, it seems this number doesn't include the earnings they will get from the assets acquired from OM Group. When we add the $28 million, PF EBITDA for 2014 should be $842 million. I would assume those assets require capital expenditure needs on a similar scale as the other assets, meaning $3 million of CapEx. As such, the PF EBITDA - CapEx should be roughly $746 million in 2014.

The earnings calculation is the easy part though. The valuation we will be paying for the company now is the much trickier one.

According to Bloomberg, at $22.48/share with 210.861 million shares, the current market cap is $4.74 billion. Now, it's important to know that this share count includes the equity offering they did for the OM Group's asset acquisition. Even more important though, is to remember this does not include shares to be issued for Alent. Again, Platform plans to pay 78% of that purchase in cash, and the remaining 22% in stock. The only thing left to determine is how much of that cash will be from more equity raising from the public or debt issuance.

One hint I used from management is their desire to get a 10% cash on cash return from their initial equity investment. (This means cash return after burdening of everything from capital expenditure, interest payments, cash tax and working capital changes) In order for Platform to really earn that 10%, they can't raise more than the 22% in stock to Alent shareholders. As such, they probably won't issue more shares on top of that 22%. (This also means they can't really get 10% cash on cash return this time)

78% in cash equates $1,758 million. Do they need to raising debt for all of that?

On March 31, 2015, they say they have $297.3 million in cash. They raised $483 million from the equity offering in June. $365 million will be paid to Apollo with regards to the OM Group's transaction. This means they should have $415.3 million in cash left. Assuming they don't plan to have any cash buffer left, they only need to issue $1,342.7 million in debt.

Adding that to the debt level of $3,618.5 million on March 31, 2015, total debt will become $4,961.2 million.

Market cap is not the current level of $4,740 million though! This is because they still haven't issued shares for the remaining 22% transaction value. Including that amount of $495.88 million, the total market cap will be $5,235.88 million. Capital IQ tells me there is preferred shares valued at $645.9 million and minority interest of $109.1 million. Adding all this together will bring us an Enterprise Value of $10,952.08 million.

Comparing this with PF EBITDA of $842 million (see calculation above), the resulting multiple will be 13.

What about the leveraged cash flow which I said should be the focus? We need some more assumptions.

Let's assume the average interest rate on that debt load to be 6%, effective tax rate at 30% (a good estimation I think due to their global footprint). Interest rate will then be $297.7 million. With PF EBITDA - CapEx of $746 million, the estimated after tax free cash flow will be $313.8 million. The adjusted free cash flow yield ($313.8/$5,235.88) is then... 6%. Oh! Wow! After two potential acquisitions, one being big, and without any price being flat essentially, the leveraged earning yield dropped?! What happened? Did they destroy value?! What's with all this acquisition they think is value adding? How are they supposed to generate 20% increase in intrinsic value per share p.a.?

This troubled me for like half an hour before I realize the above earnings number probably didn't include they synergy they are expecting.

Management is saying they expect $150 million in synergies from all the transactions they did in the past two years. (including the OM Group's transaction) Now, adding back into the equations, the estimated free cash flow will be $437.21 million, resulting in an leveraged cash flow yield of 8.4%! Now that looks much more attractive! Given the business quality of Platform, I would say it's genuinely attractively priced. (They probably won't realize all the synergies at once though, so the immediate free cash flow yield is probably between 6% to 8.4% in reality)

The only problem to me is the leverage Platform will have after the acquisition of Alent is completed. EBITDA should be roughly $992 million post synergies. Then the Debt/EBITDA will be 5, and EBITDA/interest at 3.33 if the weighted interest rate is 6%.

Is an 8.4% free cash flow yield a good enough return under such a debt load?

Hmmm... I don't know yet. I guess I again need some time to consider my options....

What about you? What do you think? Any advice to share?