LANXESS Aktiengesellschaft (LXS) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the LANXESS conference call. I would like to turn the conference over to André Simon, Head of Investor Relations. Please go ahead.

Yes. Thank you very much, Alexandra. Good morning to everybody from Cologne, and a warm welcome to our conference call regarding the acquisition of Emerald Kalama Chemical. I have our CEO, Matthias Zachert, with me. And please take notice of our safe harbor statement. And with that, I'm happy to hand over to Matthias for our presentation and afterwards, the Q&A. Matthias, go ahead, please.

Ladies and gentlemen, a warm welcome from my side as well on this Monday in 2021. After we finished the year 2020 on a successful operational note, we started 2021 with 2 bolt-on acquisitions which somewhat set the scene for 2021 because, as communicated to you a few years ago, this is the year where we start our acceleration chapter. And we started this with 2 bolt-ons. We started it on a good footing as far as operational performance is concerned because, beginning of the year, we continued the good operational models like we finished 2020. And with the communication we have done on Sunday morning, I think it shows you that we are fully on track to accelerate; however, in a very disciplined and focused way. In the night from Saturday to Sunday, we concluded our negotiation with American Securities on Kalama Chemicals. It's a business that I personally know since many, many years and have basically followed it for more than 10 years because we were looking at these assets already in 2007, 2008, 2009 and '10. At that point in time, it was divested by DSM, and we were in the due diligence at that point in time and know the assets basically for several years and have seen the successful transformation that Kalama went through over the last decade. So in short, where does this business stand sales-wise? Around about EUR 400 million to EUR 450 million EBITDA in 2020, adjusted from our point of view because the seller's numbers were a little bit tweaked upwards, as always the case in these kind of divestment processes. So we have concluded this transaction from our side with an underlying EBITDA of EUR 90 million. This is, by and large, the profitability which this business has shown over the last few years with margins between 18 and 20 percentage points in 2017, '18, '19. And also, 2020, a rather tough year, EUR 90 million EBITDA was delivered with high EBITDA margin of around about 20 percentage points and cash conversion, pretty awesome. We've paid an enterprise value of USD 1.075 billion, which pre synergies is, of course, a higher multiple, but post synergies, we get into the corridor that we have conveyed to you a few years ago, which is for us -- the target we are striving for. As you can see for EPS accretion, this will be not only on an EPS pre but also EPS reported basis accretive from day 1; of course, driven also by the financing which we will do with existing liquidity. So instead of paying for our strong cash position, which Oliver holds on his balance sheet, around about EUR 1.5 billion, EUR 1.7 billion cash we have, we will no longer pay negative interests on our cash but now rather leads -- this will lead, once the deal has been concluded, to a nice accretion EBIT-wise and net income-wise. Expected closing from our point of view is end of '21. Of course, we will file this transaction with all respective jurisdictions where this is necessary. To reference this business somewhat, which is not easy, but of course, we try to give you some peers, Valtris, Eastman, Celanese could be used as good reference base. Business structure, basically strongly present in North America. Why is this so? There is basically only one business, and this is Kalama in Washington State, that has local assets in the United States. And demand is pretty strong in the Western Hemisphere with business also driven by the underlying trends that antibiotics are being replaced by preservatives, and therefore, North American markets on animal feed is pretty strong in this regard. As all of you know, we all have steaks in American steakhouses. By and large, however, the business is focused pretty much on consumer specialty. 75% of top line is going into this direction. And the remaining part goes into industrial specialties, industrial preservatives. Also, this is a segment which is growing nicely, which we like a lot. What is the rationale? Pretty obvious. It's a specialty business fitting very strong with our Consumer Protection business. What we also like, you've seen that when we bought the Virkon and Oxone business from Chemours, it pretty much fits into our way we run our business. So it's backwards integrated. We produce the active ourselves and then go into the finishing and to the derivative products like the sodium benzoates and the derivatives that go into flavor, fragrances, food, pharma, et cetera. So we will own the entire value chain, which makes this business so compelling, competitive and high margin, highly accretive and a true leadership business globally versus peers. We love the expansion into markets where we are currently already present, but of course, enlarge our market share nicely like food and animal nutrition. Of course, we benefit like in materials protection from attractive secular growth rates, which are at or above GDP, highly synergistic. Look at the EUR 90 million EBITDA, which is operationally achieved. We will add on to this synergies of around about EUR 30 million. This is a major synergistical transaction, therefore, and with little complexity. I mean EUR 400 million sales, 3 sites, so the integration here is a very focused, very disciplined one and can be digested, so to say, in a relatively speedy way. So operational integration from my point of view is going to take a short period of time. And then the LANXESS pirates can sail on and move on. I turn your attention to Page #3. We show you here the sales configuration of Kalama Chemical. So 75% is basically going into consumer specialties as it relates to animal health, food or beverage, just giving you an indication. I'm sure that many of you are drinking Diet Coke or the males often, for brand reasons, drink Zero Coke (sic) [ Coke Zero ]. This Coke is so lovely and drinkable, I drink it as well, because, of course, you need to preserve it. And the preservatives that you're using for Diet or Zero Coke is sodium benzoates, which, of course, Kalama is a leading producer globally of. Flavors and fragrances. We are in this segment already ourselves so we have around about EUR 50 million of sales going to the F&F industry. It's a lovely high-margin industry, pretty stable and growing strongly. Kalama has here direct sales exposure to the F&F industry, which is far bigger than ours. We are adding another, give and take, EUR 150 million of F&F sales to our portfolio. So all in all, if we add our F&F sales to the Kalama F&F, we have a EUR 200 million business now, and this is, of course, leading to cross-selling opportunities, far better access to customers. We love it. Home and personal care, also here, Kalama is present, and it will be a new channel that will open up for us where we are taking a minor position as far as sales are concerned, and we'll clearly get a boost in this regard. So my team is pretty enthusiastic about that. Next to consumer specialties, where Kalama basically put its focus on in the last 6 years -- and we were impressed how American Securities has accelerated this market access through their experience. But next to this consumer specialty segment, there's a clear, nice footing in industrial specialties here, CASE and polymers. We are in this business already through our plasticizers. But here, we get a nice add-on to our portfolio in the segment of phthalate-free plasticizers. So as far as our business unit PLA is concerned, with our great product Mesamoll, which is our true specialty, we now get bread and butter products in a category that currently we had a lack of products and product gum. And we will open up the phthalate-free plasticizers now with full acceleration and conquer the marketplace. Well, ladies and gentlemen, with this, I move to Page #4. We give you a breakdown here on the Consumer Protection side of this business. So animal health, we strengthen our footprint in microbial solutions with a backward-integrated market player. So we -- before we bought Chemours, we had our wonderful business with the brand and trademark Preventol. Being backward integrated, we bought Chemours with Virkon as trademark and brand, backward integrated in the Oxone. And now we bought -- buy, of course, through Kalama another preservative, backward integrated into benzoic assets. So world-scale assets with active production and very nice differentiated derivatives directly to the end consumer as it relates to animal health. As it relates to food and beverage, where -- with sodium benzoates, we basically get the bread and better -- butter preservative for the drinking -- beverage industry. We have our premium brand, Velcorin. With Kalama, we will get access to completely different new customer accounts that we were looking but not access yet. And therefore, it's an enlargement of our customer portfolio, which is mouthwatering. Of course, we are having here also access to water purification and the agro industry, and all of you know we love these end industries. Let's move on to sales. We've shown you here a little bit our configuration. We are in the pharmaceutical industry. We are in home care, in beverages, animal health, food, personal care, cosmetics. So we basically enlarge with Kalama our presence in these end industries nicely and by and large, have now sales of around about EUR 700 million, EUR 800 million in these industries, which we, going forward, of course, would like to further enhance, enlarge because stability in margins is pretty awesome. Resilience is strong. And the differentiation here, because you are operating in niches with registration, with data -- with data protection, everything is needed here. You need to give data proof to the pudding in order to play here. And this is something we love to do, and of course, we can do that in a far better way going forward. Page 6, financial synergies. Synergies we will have, on top line -- around about 1/3 is top line synergies; 2/3 bottom line synergies, notably coming from SG&A. And of course, the respective overhead structure that Kalama has, we can absorb that in our existing business. OTCs will be, by and large, EUR 35 million we are mentioning here, spread over 3 years. And as far as CapEx are concerned, this business has been managed extremely well on the market sites, on building over the last few years the markets in the derivatives with consumer -- with end consumer exposure. So here, an excellent job was done. But as companies that are onboard PEs, they normally are pretty scarce on maintaining the assets the way that companies, strategic companies at least, like to do it. And therefore, from our point of view, some of the production plants, and there are only 3, need some upgrade in order to make sure that the high-technology expectation is fulfilled, that we are having. So clearly, we flag here that over the next 2 years we will have incremental CapEx to upgrade the production plants to our standards so that we move the production plants also to the digitization age where we would like to have it, which, of course, once it is implemented, should lead to returns on better quality, better safety standards, better productivity. And these CapEx investments will come on top of the normal operational investments. They are fully embedded in the financial plan, on the basis of which we have paid the purchase price. And if you run the models on discounted cash flow, et cetera, et cetera, you can see that as far as synergies are concerned, the value of the synergies we could, by and large, protect to ourselves, which I think is justified because we would do the hard work on unlocking the synergies, thus unlocking the value. So ladies and gentlemen, with this, I turn to Page #7 as a sum-up before we open the floor to, hopefully, all your intelligent questions. So by and large, this is a fantastic 100% strategic fit. This is a business that has 100% overlay -- overlap to our business. It's not like other assets, 60% fits, 40% in completely different territories. So this is in the heart of our company. We benefit here from secular growth -- positive secular growth that we've seen with our material protection business, and we see this as a strong add-on to our Consumer Protection business. It's a company with high synergies and the good thing which I truly like, very low complexity. This is plugging it in and accelerating again. This can be integrated in a relatively fast way. So the operational integration as far as sales forces are concerned, supply chain, et cetera, will go extremely speedy. And my organization is hungry for doing this. And I think the team that we will welcome, the Kalama professionals, will rejoice because they would see the global muscle we will now have in bringing this business together, bringing people together, bringing professionals together and then accelerate in the global markets. As far as financials are concerned, we consider this as attractive from a -- definitely, if you factor in synergies. We like this business from a cash conversion. It fits our profile. And as far as EPS is concerned, it will rock the needle positively from day 1. And with this, ladies and gentlemen, we open the floor to your questions. Please go ahead.

[Operator Instructions] The first question is from Thomas Wrigglesworth of Citi.

Hopefully, 2 intelligent questions from me. The first one is -- I think we've made a very clear point about how LANXESS -- this can crystallize growth for LANXESS' new customer areas. But perhaps you could give us a little bit more color about what LANXESS can do that maybe the private equity owners couldn't do previously for this business going -- and hence, why they sold. That would be helpful. Second question, looking at that consumer specialties business. Obviously, 20% EBITDA margin for the group. Could you give us some kind of color, flavor to how -- for the margin range across the different business areas? Is the F&F or the chemicals business higher margins than, say, the food and beverage or animal health business? Just some kind of -- so we get a sense of where you focus on growth and the margins that might be associated with that growth. Those are my 2 questions.

Well, Tom, let's address one by one. As far as PE is concerned, I mean, the beauty of this business is we play already in this business. As you know, we have a global sales muscle. If you look into Consumer Protection, we do have a global sales muscle here. We do have so-called regulatory affairs departments that you need in order to register products in these derivative markets like consumer, animal health, et cetera. So we have an established global sales force, potentially one of the most powerful ones in this industry, and we are present in these markets already. So we basically can here not only scale up the existing products through our sales muscle and to our customers, of course, we can also benefit on the other side from products where Kalama is pretty strong, has a better access to consumers, customers. And here, we will benefit from their access. So the benefit we truly have is the combination of 2 strong players and in essence, scaling up here the access to the customer side. This is one thing. Second thing is, of course, as far as benz products are concerned, they are not new to us. We are also in the benz product value chain with our production that we have in Erding for instance. It's a competitive one. We now have -- of course, this is a global market. We team up with, here, the global leader, and therefore, this is complementary from not only the sales perspective but also from the entire value chain perspective. And last but not least, of course, as far as the end markets are concerned, Kalama also, over the last several years -- and that came as a surprise because that was new, at least to me. When I did the due diligence a decade ago, Kalama was not in markets that they're in now. The owner, American Securities, has very nicely, with the management team of Kalama, opened up niche markets in the consumer and animal care that were for us not visible that they were playing in this area. And these are new markets that we would now be able to penetrate due to customer access with our products. So this will lead to clear cross-selling opportunities for us, and this is what we like. Now as far as the end markets are concerned and the margin question, as a matter of fact, all the consumer-close specialties that Kalama is offering are all in our target margin segments, i.e., having margins -- the variable margins -- not EBITDA but variable margins before SG&A which are in area that we consider as first in class. So they vary but not to a large extent. They're all very high in the gross margin area, basically reflecting the end market profitability. And here, it's not a volatility of 10, 20 percentage points. They are all in the very high margin area and 1%, 2%, 3% differences between food, beverage, F&F, but bottom line is they are all in the high-margin territory. So we like the end market exposure here in total.

Our next question is from Martin Roediger of Kepler Cheuvreux.

A few questions from my side. Mr. Zachert, you said the margins have been at 18% to 20% over the last few years. Was the EUR 90 million EBITDA figure stable or shrinking in the crisis in 2020? And how did sales develop in 2020? That would be a year-over-year comparison to figure out how the pandemic has impacted Kamala Chemicals. The second question is on your statement about -- you said that -- you indicated the official earnings data from private equity are a bit inflated; therefore, you refer to the underlying EBITDA of EUR 90 million. What is the risk that this underlying EBITDA is also still elevated? You made this kind of experience with the Chemtura deal a couple of years ago. And the final question is on Chart #5. Am I right that these combined sales figures here, the 25% exposure to industrial specialties is not part of this illustration?

So I come to your first 2 questions. The third one, you need to repeat. I did not fully capture the content. So let's address 2020. As far as the performance is concerned, 2020 Kalama showed a better performance than the previous 2 years. As a matter of fact, it was a strong year for Kalama. And in these information memorandums that you normally get from PEs and others, I mean, numbers are never being adjusted downwards. They're always being adjusted upward. I've seen that in any process that our company was in, not only in the last 2 to 3 months but basically over the last years. This is what you have on the table. So numbers tend to be inflated. And we deflated the numbers again when we had -- we made our stand-alone analysis. And besides our stand-alone analysis -- or after our stand-alone analysis, with our operational adjustments and prudence on our end, even after these adjustments, 2020 would have been better than the 2 years ago, which were in the areas of EUR 85 million, EUR 86 million. Now as far as 2021 is concerned, of course, we do a -- we are cautious. So in our own financial plan, we have taken up the EUR 90 million as a starting base for '21, but basically adjusted the plans for this year to rather EUR 85 million because our assumption is like, we've seen with other companies where we did due diligence over the last several months, the numbers are always somewhat positively inflated, especially when you are looking into the Consumer Protection business, because people are not traveling. There are no fares. You still sell your goods, and therefore, you need to take a discount on the improved operational performance, which, in this case, we have done with around about EUR 5 million for the year '21. Is this conservative or not? To be discussed. We like to do financial projection based on hard numbers and not virtual numbers. And for that very reason, we are a bit cautious here. And after 2021, once we've closed the deal, '22 onwards, our assumption is synergies will kick in, and we will expand the margins of Kalama from the 20s, clearly, upwards. So this is the answer to question 1 and 2. And on the third question, you need to repeat, please.

Okay. As you know, Kalama Chemicals has 2 segments. One is consumer specialty, and the second is industry specialties. So do I understand it correctly that on Chart 5 of your handout, you just combined the consumer specialties activities of Kalama Chemicals with LANXESS activities in the same area and here, on this Chart 5, therefore, the activities about industrial specialties is not part of this slide?

Now I understand, Mr. Roediger. And the answer is yes, sir.

The next question is from Matthew Yates of Bank of America.

I'd just like to follow up especially on Martin's question about the track record and the history of this business. The slide is referencing these as being very much GDP-plus growth assets, but it sounds like what you're saying is that profitability actually hasn't grown between 2018 and your forecast for '21. So can you provide us with a bit more longer context historically of sort of what the underlying profit growth of this business has been doing? The second question, just to come back to your remarks on the CapEx and the incremental investments that are needed, whether you could just maybe just flesh that out a little bit for us, whether there's any concern there about the cash conversion being artificially inflated by the private owners.

Well, Matthew, thanks for both questions. I start with CapEx and then move on to growth. Well, this is part of the due diligence that you have to do. The cash conversion that we are referencing is, of course, the past history, but the cash conversion, we believe, going forward, once synergies are being implemented. So the cash conversion is one that we clearly also strive for in the years to come, but there will be a period of 2 to 3 years where we will, of course, have a lower cash conversion due to the upgrades we want to do. And this is something that you normally find in acquisition processes. If you're coming -- if you're buying something from corporates, strategic players or from PEs, whenever a business is deemed to be divested, you always see that owners are shrinking CapEx, delaying investments that basically have returns of over 3, 4 years or that are going into the area of sustainability, et cetera, et cetera. But this is something where the buyer has to factor in the respective incremental costs. We are doing this with all clarity and transparency. And we are well aware that in other processes, buyers are just closing their eyes and then dream prices that from our point of view, they will never ever see in terms of unlocking value. So in all transparency, we opened up here the comments to you. There is upgrade needed, and we will not sacrifice our own standards. Now as far as growth is concerned, it's basically playing in the same direction. We went into the due diligence and basically looked at this topic in detail because we saw that Kalama showed a nice margin expansion over the last 5, 6 years, which, for us, is surprising and strong. And the name of the game was here that Kalama puts -- has put a lot of emphasis to really open up the end consumer markets and go into specialties derivatives that are high margins. So whilst the volume growth was modest, we clearly saw on the product mix a very nice development over the last 4 to 5 years. Where the strategy was clearly successfully implemented, the mix going into the specialty end markets and continuous margin improvement developed over the last 4 to 5 years with the corresponding enlargement of the cash conversion. So that was the strategy that Kalama was pursuing successfully. And now of course, we will embark on this because this is basically what we are doing in materials protection as well. So we will team up. And however -- next to the enlargement in the end consumer space, of course, we will put money also behind growth possibilities. So we would like to par growth with high margin, which, in a sense, leads to happiness -- financial happiness. I need to be concrete. And guess what, instead of sending roses to my wife yesterday, I woke her up and said, "Hey, my love, as present, you get benzoic acid and sodium benzoate. Isn't this a great Valentine's gift?"

So the next question is from [ J.D. Pandiyah ] of [ Onset Research ].

Sorry to ask this again, but on the CapEx side, Emerald has spent about $40 million, I think, a few years ago, expanding the Rotterdam site quite significantly. And as you said -- I'm assuming this site is the ex-DSM site. So could you give us a little bit more information about the 55 million plan that you have to upgrade the sites? Is it mainly focused in the U.S. and the U.K.? Because I'm assuming that if they have spent money upgrading the Rotterdam site, standards should be sort of at industry level? And if not, would love to know a little bit more. And the second question really is around the sort of benzoic acid family. Do you think that longer term, there is a scope for natural benzoic acid to sort of come in the market from the likes of enzyme players like Chr. Hansen, et cetera, and therefore, longer term, you will have to sort of go away from the synthetic route? Or are you very confident in your business plan that this is 10 years out and therefore, we shouldn't worry about this?

Well, you are probably -- you're bringing up a very good point on the investments that were done by Kalama several years ago. But here, predominantly, the investments were done especially in areas that we love, i.e., the high purification. Kalama is one of the very few players, if not to say the only one, that produces the benzoic in ultra-high purification. And therefore, if you read more about this, the expansion that was done, there are a few customers that are referencing to the source, European customers, that are extremely delighted because they depend on this ultra purification that currently no Chinese, no nobody can offer. And therefore, due to this ultra-high purification, we -- our engineers were impressed by this purification unit that was built on Rotterdam. Kalama has entered into a new segment, which, of course, is the nice extension of the value chain. And therefore, this is not addressing the bread-and-butter capacity. This capacity was upgraded as well. But what we were very impressed by were the expansions that were done in the derivatives area with respective capacities close to the active ingredient production. And now let's come on your second question as far as synthetic benzoics are concerned. We see no concern. In return, we see the opposite due to the growth that you have in these markets. You depend heavily on the synthetic production. It's pretty much like the menthol production that we have. We see that the synthetic menthol is having underlying strong trends because the natural menthol is simply leading to -- in very often cases, to a low volume growth, seasonal dependencies, weather dependencies, often off-spec qualification. And therefore, we see that the synthetic menthol, like the synthetic benzoic or benzoates, are on the rise, and this is an underlying trend that we feel strong about.