Huntsman Still Brewing a Chemical Deal

Huntsman (HUN-$20.20) is one of the world's largest manufacturers of diversified and commodity chemicals, with leading market positions in MDI, titanium dioxide, epoxy-based polymer formulations, maleic anhydride, amines and surfactants.

SUMMARY

• In July 2007, Apollo Management (through its subsidiary Hexion Specialty Chemicals) agreed to purchase the chemicals maker for $28/share, $10.6 billion (inclusive of $4 billion in debt). Hexion will acquire all of HUN’s outstanding shares for $28/share, and this price will increase 8%/annum starting April 6, 2008 if the merger has not been completed prior to that date.
• Recently, Hexion exercised its right to extend the Termination Date for the merger by 90 days, from April 5 to July 4 (Hexion is allowed a total of two 90-day extensions). If the deal should fall through, HUN will receive a net breakup fee of $225 mn. The transaction is not subject to a financing condition and Hexion obtained commitments for all necessary debt financing from affiliates of Credit Suisse and Deutsche Bank AG.
• However, given the current state of credit markets, one has to take these financing guarantees with a grain of salt, which is why the rumour that Hexion is considering selling HUN's titanium dioxide (weak performance) and epoxy business (anti-trust issues), respectively.
• In addition, the European Commission delayed the deadline Tuesday for it to approve or reject the purchase plans, moved back the deadline to June 30 from June 16. The additional time will allow customers and competitors to review and comment on the proposals.

OPERATIONAL ASPECT

• Chemical companies are sensitive to oil prices because they utilize them for their raw materials to produce products. The majority of US chemical companies, even global, have recently announced price increases i.e. Dow Chemical, even HUN by 25%, and some have even contemplated adding an energy surcharge for a wide range of products.
• Across two HUN divisions (Material & Effects and Performance Products - 25 and 24% of HUN's portfolio), results in Q108 benefited of industry pricing power, largely due to rising commodity/raw material prices, and sales volumes were lower, except in the case of Polyurethanes (40%) where sales & volumes were high enough to offset raw material costs. Pigments (11%) continued to be depressed by the extremely weak NA housing market, US dollar and increased SG&A costs (alongside raw materials, lower average selling prices).
• Its MDI (Methylene diphenyl diisocyanate, used in the in the manufacturing of polyurethane) business has been benefiting from higher prices, improved volume in both Asia and Europe due to its new MDI plant in China, and FX. The MTBE business is seasonal and the upcoming driving season should help to improve margins. However, while Asian demand for MTBE will keep growing, MTBE's competition ethanol will benefit as MTBE is being phased out in the United States.** MTBE is added to gasoline to improve combustion and to reduce harmful carbon monoxide emissions. It is added to gasoline to improve the overall quality of air.
• Furthermore, given HUN derives 66% of sales from outside the US, results benefited by FX gains. On average, EBITDA across HUN divisions declined by 25% YoY (Polyurethanes being the only division EBITDA improved due to improved productivity gains and stronger demand).

CONCLUSION

Given Apollo's previous chemical acquisitions (Hexion chemicals, formed by a merger between two Apollo companies + currently Apollo & Blackstone are bidding for another, smaller chemical related company Chemutra), and the shareholder/management deal approval, a large spread does exist. Part of it can be blamed on the current credit environment (meaning financing) and part of it on the regulatory issues leading to uncertainty about the deal closing on its original terms.

Even if a lower price is negotiated, say $25-6, the risk/reward is worth the deal (which looking at the spread seems likely).If the deal should fall through, the downside could be to $17, but since there was interest in HUN by Basell for $25.25, who acquired Lyondell for $19 billion in 2007, at the time of the Hexion’s offer, that should provide a floor around $17, the pre-bid price.

Contributor Yaser Anwar does not hold a financial position in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure policy.