Resco Products, Inc. (RHIM) Earnings Call Transcript & Summary

Good morning, and welcome to the analyst call to discuss the acquisition of Resco. My name is Drew, and I'll be the operator on today's call. [Operator Instructions] At this time, I would like to turn the conference over to Stefan Borgas, Chief Executive. Please go ahead.

Thank you, Drew. Good morning, ladies and gentlemen. Thank you for dialing in and being interested in our next transaction. This is about the acquisition of Resco Group in North America, which we announced last Friday evening. Ian Botha is with me today, he will get you the details of the numbers just in a few minutes from now. But let's start with two key messages that you should take away from today's announcement. First message, this is really an important step for us in our U.S. business. The U.S. business is currently our most profitable region. We are, however, with this transaction closing a market segment gap that we had by adding a significant piece of industrial refractory business. This is a segment where we have previously been quite underrepresented in North America. So with this, the Resco deal is a complementary acquisition, and it's not so much a synergistic deal. Second message is this acquisition will enhance significantly RHI Magnesita's a local production capability in the U.S. and Canada. We received feedback from many, many of our customers over a long period of time that they would really like to see refractories made in the U.S.A. to a much further extent than we did now to the fullest extent possible actually. And this transaction delivers now the possibility for us to do just that. We will be able to reduce Magnesita's imports into the U.S. as well as converting finished goods that are currently imported by Resco into domestic U.S. production. So from both sides, we can convert imports into domestic U.S. production. There are also benefits in addition to this, to raw material supply chains. They can now be diversified again from both sides towards RHI Magnesita's sites in Brazil, Turkiye and Europe. Let me describe a little bit more in detail the strategic rationale for this transaction. As you know, our M&A strategy is based on seeking growth in geographic or product markets in which we are still underrepresented. We're seeking to build a broad-based refractory business, which can supply heat management products and heat management services to a wide range of customers in the steel and industrial sectors. This will then enable us to drive production network efficiencies and to offer full lead management solutions to our customers around the world. Resco's main strengths are in the petrochemical, cement and aluminum industries, where RHI Magnesita has very little business thus far in North America. And Resco's activities in steelmaking also are complementary to those of RHI Magnesita. Resco operates two raw material sites and seven refractory plants with two plants located in the U.K. and in Canada. This transaction now rebalances the group's North American business towards the industrial segments and towards integrated steelmaking. Whereas, RHI Magnesita until now is much stronger in electric arc furnace-based steelmaking. The acquisition also offers progress in growing our alumina-based refractory offering complementing our magnesite and dolomite-based refractories that we offer out of our U.S. production. When seeking to grow through M&A, companies are often looking for new customers to expand their footprint. In this case, however, we have listened and reacted to customer feedback regarding increasing our domestic footprint in the U.S. In making these acquisitions, we are living up to our customers' expectations, which is the #1 of our core values at RHI Magnesita. Following the acquisition, RHIM will restructure the combined production footprint by onshoring production into the U.S.A. This will require some additional investment in the first 2 years following the closing of the transaction, but it will fundamentally change the customers' experience in the short and in the midterm. Our customers will benefit from shorter lead times, more reliable and flexible supply chains and from technology transfer from all over the world into North America. Let me hand over to Ian to give you more details on the financials before I come back. Ian?

Thanks, Stefan, and good morning, ladies and gentlemen. As set out in the announcement, we are paying an enterprise value of up to EUR 430 million. This corresponds to an EBITDA multiple of up to 9x before further investments and before the meaningful synergies which we expect to generate in the medium term. There was competitive tension in the deal negotiations, and this is reflected in the terms of the consideration payable, with the ticking fee intended to incentivize a speedy timetable to completion. The ticking fee is $2 million per month and would amount to EUR 18 million if we completed on the 31st of December 2024 or a maximum of EUR 36 million if it takes the full 18 months to a long stop date which would be the 30th of September 2025. The enterprise value that we announced of up to EUR 430 million assumes a maximum payout of this ticking fee being an 18-month completion process. It also includes our transaction costs. The assets that are the subject of the transaction generated revenue of $252 million in the year to 31 December 2023 with gross assets of $191 million. Goodwill is likely to rise on the acquisition subject to a purchase price allocation process which will be concluded in due course. We expect the transaction to complete in the second half of 2024 with completion subject to normal approval processes, including merger control authority approval. We cannot make any detailed comments on the competition process at this stage other than to say that at Resco, the business is focused on the Industrial segment, where we are underrepresented in the U.S., and there is limited product overlap. Based on our external guidance for 2024 full year and the impact of this Resco acquisition, if it occurs in the second half of the year, we expect gearing to increase by approximately 0.3x at the 2024 year-end to 2.6x on a pro forma 2024 EBITDA basis. This compares to the 2.3x level recorded on the 31st of December 2023. This is slightly above our target range, but in line with previous guidance on leverage for 2.5x or slightly above for compelling M&A. There will be a benefit in the form of reduced working capital intensity once Resco is fully integrated into our production network as we shorten our supply chains into North America. We currently import around 50% of our sales volumes into the U.S. and that will reduce over time in line with our local-for-local production strategy. In our 2023 annual report that we published very recently you can see the extent to which our regions are self-sufficient and how much product is imported. The full details are shown on Page 5 of the annual report, if you would like to go and look at more detail. Following the acquisition, onetime costs totaling EUR 60 million are expected to be incurred in the 2 years following completion. This comprises costs of restructuring the combined supply chain, including restructuring in non-U.S. plants and integration costs. The acquisition will be funded by our existing cash resources and undrawn debt facilities, together with a new committed facility of EUR 200 million. The group had available liquidity of EUR 1.3 billion at the 2023 year-end and will continue to maintain a significant liquidity reserve going forward. I'll now hand you back to Stefan for a summary and some more details on how this acquisition fits into our overall growth strategy.

Thanks, Ian. To sum up, let me put this transaction in context against our broader M&A progress over the last 2 years. Since December 2021, we have acquired 10 businesses, as we continue to pursue our strategy to grow through M&A in the global refractory industry. Resco is the largest single acquisition we have agreed. And when completed, it will result in over EUR 1 billion of capital that has been allocated to M&A over that period of 2 years. We have been able to do this at a time of lower demand for refractories, and therefore, our strategy is kind of countercyclical. We are structurally strengthening the RHIM platform rather than simply targeting short-term gains through M&A synergies. We have utilized long-dated, low-cost debt financing to do this, while maintaining significant liquidity headroom in order to be prepared for any eventuality as keeping gearing well controlled within the guided range that we're comfortable with. This package has enabled us to cease this opportunity and position us well for any future recovery refractory demand from current low levels whenever it will occur. As we have described to you previously, we're highly selective when pursuing M&A. And there are many possible transactions which have been looked at closely, but where we ultimately decided not to proceed and walk away. This particular addition to the RHIM network is the most customer-centric transaction yet, as it really primarily focuses on filling the clearly expressed needs of our customers in the U.S. The addressable market for a global leader in refractory products and solutions is large. And we continue to see excellent opportunities like this to grow our business in a value-accretive way. Sorry, I would like to mention that businesses are ultimately built on the foundation of their people, first and foremost. In this transaction, while we have been speaking, we have been seriously impressed by the quality and the caliber of the teams at Resco and also at Balmoral Funds, the owner, with whom we've had close dealings during the negotiations and the diligence phase of this transaction. When we integrate, we always take a bottom-up and transparent approach to assessing how best to capture all the skills, experiences and talents of the different teams and individuals who join us via M&A. The combination of our businesses in the U.S. is effectively a merger of two large organizations. We are keen to welcome the new colleagues of Resco into our group to learn from them, listen to them and to provide global career opportunities within our wider network all over the world. I'm confident that the combined team will set new industry standards and assist us in further developing and executing our strategy as an industry leader. After all, the whole team, especially North America, will delight our customers. We are happy now to take all of your questions. Thanks for listening.

[Operator Instructions] Our first question today comes from Jonathan Hurn from Barclays.

Just a few questions from me, please. First one was just in terms of the growth rate for Resco. Obviously, you've talked a little bit about profitability, where that sits. But can you just give us a feeling for how this business has kind of grown over the last few years? The second one was just in terms of the synergies. I wonder if you could sort of put a number to that? Obviously, you've stated there's a EUR 60 million cost in terms of creating the synergies and reorganizing the supply chain. But is that payback sort of one for one in terms of the benefits you're going to get from that? And then the third and final question was just in terms of the leverage you'll see. Like you say, pro forma 2.6x at the end of this year. Does that kind of put any sort of future M&A ambitions on hold at least for the near term?

All right. Let me start with the first and the third question and then Ian can go on the synergies. Well, the growth rate, the Resco business went through a, let me say, from our due diligence up and down, rollercoaster development over the course of the last 10 years. It's a traditional, long-standing, established, high reputation, refractory business in North America, which grows with the North American growth rate. So it's a low-growth business in its basis. It's growing a little bit faster than the average because it has a very, very big industrial business and the growth rate here is a little bit faster, but we're talking maybe half a turn or something like this. So it's a 1% to 2% growth if you look at the market base. And Resco had in the middle of 2010 years lost a lot of -- lost a bit of market share. And the current management team, when it took over a few years ago, has done a marvelous job in stabilizing operations, bringing the plants back to a stable customer-focused operating level, really good operational skills and there was also brought back some market share that they had lost over the years before. It's more or less now from a market share perspective where it was 10 years ago, but really, really good people in this business. That's why we were so impressed with them, and that's why I made this comment before. And if you look forward now, the growth rate is maybe 0.5 turn, 0.5% to 1% points faster than the average refractory growth rate in a mature market, such as North America, but this is not really the focus here. On the leverage side, yes, we're now just slightly above our guidance for sure that will incentivize us not to do very major deals. We have, however, a number of smaller transactions that will not really materially affect leverage. And those, of course, we will continue to do because they have to round up the portfolio. So we're not going to zero in M&A. You can never do this. You have to keep bringing deals into the company when they occur. So we're not going to zero, but there's nothing very sizable in the pipeline. So I think from a planning perspective, from an analysis perspective, the leverage is going to be at the end of the year, what Ian has indicated. Ian, any words on the synergies, please?

Yes. So Jonathan, we've guided in the past that we do M&A transactions where we can unlock meaningful synergies. We expect 30% to 50% in a typical M&A transaction, and this transaction will not be an exception. The key synergies really come through from revenue growth, specifically on the industrial side. They come through from plant network optimization. As we shift production into the U.S., we believe that we can increase the use of recycling. We can see important benefits around logistics where we can bundle inbound and outbound freight and rationalize our warehouses. We can also in-source some of the production that Resco is currently reselling. And then as we've seen in previous M&A transactions, the bundling of our purchasing volumes, the saving of commissions and general support functions; no, we would not expect a euro for euro against that EUR 60 million upfront cost, probably for modeling, around 1/3 would be the top end of what we would look at.

There's another component here on the synergies, and this is the working capital optimization. Because of this inshoring that we will do, of course, we will shorten the finished goods supply chain, customers will be able to get much, much faster reaction from the combined RHI Magnesita-Resco offering because we will manufacture almost everything in North America with this finished goods. The meaning of this is that the import material flows will be converted from finished goods to raw materials. And of course, raw materials have lower value, so there's a working capital benefit that comes out of this. Also, the raw materials will not come from very far away anymore. They come from a little bit closer, so that the transportation time here also goes down, and that adds to the working capital synergies. The material that Resco now imports, mostly from China, our products that Resco at the moment cannot at least competitively produce in North America in their plants. But with the combined volume of Resco and RHI Magnesita and with RHI Magnesita's production technologies, not in North America, but in other parts of the world, we will be able to retrofit the Resco plants in North America, invest there, retrofit them and then be able to make quite a few of those products that were previously imported from third parties and make them locally in the U.S. So all this adds to the synergies also that Ian described.

Our next question today comes from Harry Philips from Peel Hunt.

Just [indiscernible] from myself, please. Just on the restructuring charge, previously assumed 1st of January, just to make life easy. Just in terms of the cash sort of profile, is it an even split between the 2 years, you suggest? Or I'm guessing if there's transaction costs and what have you is sort of more front-end loaded? And I suppose then also the benefit in terms of the range you are suggesting, fairly suggest sort of back-ended, but just to make sure that is correct. Then just in terms of the split of the Resco business in terms of if the market -- is it sort of pretty even across the 3 segments beyond steel you outlined? Or is there a particular bias the statement itself talks more about refinery and petrochem? And then lastly, just to help me on the 9x EBITDA mass. You've got $20 million of pretax profit. I'm guessing depreciation is probably about 4% of sales. So there's quite a hefty interest number in that by the look of it. So just some help around that would be appreciated, please.

Okay. Ian, if you can take the first and the last question. Let me talk about the benefits scheduling. Like always, unfortunately, Harry, the charges will come relatively early and the benefits only come afterwards. Why? Because the charges are mostly around investments in the U.S. network in this new big production plant network that we have, if we are -- if we put the combined organization, it's more than 10 plants in North America. So they need to be upgraded. And of course, this requires CapEx, so this is a big piece of it. And another piece, the smaller piece is restructuring, of course, in the RHIM network outside of the U.S., which actually part of it is also noncash. This is the restructuring charge. And the benefits come once this is done and customers have tested the products made and the local facilities are happy with them, then actually we'll get the benefit. So the benefits comes a little at the end and that charges come more at the beginning. Market segment-wise, yes, there are these Industrial segments; petrochemical industry; incineration plants; aluminum, where Resco is very strong, they have an admirable installer network, which we are keen to embrace and foster -- give additional products to help that network to grow as well because this is the way to the market here, so that existing Resco dealer network, installer network should benefit a lot, also from the combined -- from the combination. But of course, as RHIM, we have not that much experience in managing this, so here the Resco team will take the lead and continue to build out this network. That's one piece. If we talk about the steel business though, the Resco offering because of the product offering has been very much focused around the integrated steel plants, especially the iron making, where RHIM has been very weak with a very low market share. And therefore, this is a very synergistic approach even in the steel or synergistic deal even in the steel industry as well. Resco is not very much present in the electric arc furnace, but RHIM is very present in this area. So for customers also, this is not the elimination of another supplier, but it's a combination of two offerings that they were anyway having already in the past, which they will continue to have and enjoy actually strengthen each other. So it's a benefit here as well. But they're synergistic also. The overlap is actually surprisingly low both from a customer segment perspective as well as from a product perspective. Therefore, of course, we engaged into this deal. Ian, the answer on the other two questions, please?

Thanks, Stefan. Harry, on your first question, restructuring costs, if you see 1st of January 2025, it would be 60-40 split between 2025 and 2026. And then as Stefan has confirmed the benefits are indeed back-ended. And in particular, the working capital reduction only flows after the CapEx program has been completed. On your last question on the multiples. So the top end of the range, that simply takes EUR 430 million of enterprise value divided by EBITDA of 48, that gives you a 9x multiple. If you assume the transaction completes after 9 months, it's EUR 412 million enterprise value, that includes the ticking fee, it includes the transaction costs divided by 48, that's 8.6x. You are absolutely right that the current Resco business has high finance charges, having previously been -- or currently being owned by private equity. We would settle this debt, we would make use of our long-term low-cost borrowing and markedly reduce the cost of that borrowing. We would expect our marginal fixed cost into this funding to be less than 4%.

Okay. And so assuming the very high interest, I mean, it looks like the EBITDA margin, it's currently -- well, in '23 it's higher than you've been doing if that math is correct?

Yes, that is correct. Higher than the average of the group, but it is still lower than our North American business, and this is some of the potential that we see over time.

Right. Okay. And -- so as you say, crazy sort of EUR 48 million EBITDA is to sort of the start point to sort of work this off going forward. No, that's very helpful.

[Operator Instructions] Our next question today comes from Chetan Doshi from [indiscernible] Capital.

Yes. As I see, you are into -- more into mergers and acquisitions, and that is how you want to grow your business. So my first question is, in India, you have acquired two units. Your top line is growing very fast, but it is at the cost of bottom line. Now if you acquire such a big unit in North America, is it going to hit your balance sheet? And second question is, are you still open to acquisition in India? What will be your focus in Asia when you want to improve your top line and bottom line?

Okay. So if I may respectfully disagree. In India, our growth has not been at the cost of bottom line. Just if you take fourth quarter numbers and there are many onetime effects included in the India number, but this is not long-term trend. So the acquisitions in India are value creating, and there will continue to be -- there's still opportunity here. Otherwise, of course, in Asia, in Middle East as well as in Southeast Asia, we still have wide gaps and we will continue to grow there also with acquisitions, not just with acquisitions but also with acquisitions.

But quarter-on-quarter, there is degrowth in margins as far as your Indian operations are concerned. See, how parent company is going to support this? Because ultimately, globally, if you speak, your market share is much, much higher than the next competitor.

They're same in India. Look, we can take the discussion on India off-line, and happy to have it with you more in detail. I think this call is about the Resco acquisition. So let's move on, please, with the next question, and then we will call you back and have a discussion on India. Shall we do that? Next question, please.

We have no further questions at this time. That concludes the Q&A on today's call. I will now hand back over to Stefan Borgas for any final comments.

Wonderful. Thank you very much for dialing in this morning. Again, two key messages from this acquisition. This is an important step forward for our U.S. business where we are closing market segment gaps and product gaps because we were underrepresented in this business. And the second message, this acquisition will significantly enhance RHI Magnesita's local production in U.S. and Canada. This was a long raised wish, request of our customers of many, many of our customers in North America. We listen to this, of course. And with this acquisition, we are now able to implement what our customers are asking from us. This is a very significant step forward into localization in North America. Thank you very much for listening. We are looking forward to talking to you into the next days and weeks. Goodbye.

Thank you all. Bye.

That concludes today's analyst call to discuss the acquisition of Resco. You may now disconnect your line.