Analysis of the merger between Axalta and AkzoNobel with Alex Comanita

(upbeat music) So, welcome everyone to the European coating spot cast. We are now in our third episode. This time it's gonna be a little bit special because we are approaching Christmas and we were thinking to just record one episode for December but since we got very, very big market movements in these last weeks, we decided that it would be great to give you one episode before Christmas and then directly after your Christmas break, we will have another episode. They are going to be about AXONOVEL and AXALTA and also about ADNOK and COVESTRO. We have in today and also in the next episode, Alex Comanita, he's the vice president of MarketChemka and Associates. And we will be discussing this time AXONOVEL and AXALTA. And since these two companies are one of the biggest players we have in our industry, it would be worth it to provide you a little bit of background before we jump right into the deal itself. So, we are going to take the vision a little bit back in the past. But for that, I will welcome now Alex. Alex, do you hear me? - Hear you loud and clear your ray. How are you doing? - I'm doing very, very excited actually to record this episode with you. From your point of view, what is the highlights from the past that you could remark from AXONOVEL? - For sure. Well, when I think about AXONOVEL, the words chemical and royalty come to mind soon thereafter. So this is the third oldest chemicals company on record for looking at corporate lineages. And AXO ties back to the 1600s, only being outdated by Merck and Mitsubishi Tanabe Farma. On the coding specific front, their legacy division in this space was established in 1792 via a company called Sickens. And that quite literally makes them the oldest coatings company in the world that is still in operation. Now, over the centuries that follow, they continue growing into what would probably be described as a chemical conglomerate, before sharpening into the pure play coatings manufacturer that we see today. But along the way, they divested a number of non-core divisions and assets that candidly became leaders in their own right and other industries. - It's very nice to see that such big companies are finally breaking their silence, so to speak, and taking these kind of big movements that hasn't happened that much before. Do you think there is any other big companies that already tried to do such movements like the ones we are seeing right now? - Absolutely. Some have tried and succeeded over the past decade. There's been a handful of mega coatings deals. The first one to come to mind would be the 2017 acquisition of Val Spar by Sherwin Williams, who is the global leader of architectural coatings. So one architectural coating player buys another one. Candidly Val Spar was quite similar to Sherwin Williams in terms of their product portfolio and capabilities. And just continuing growing Sherwin Williams into the mega coatings company that it is today. It has an $80 billion market cap. I think the second largest is Asia paints at $40 billion then you get PPG at $22, but that will shortly be overtaken by Axel Exalta, which should come in around 25 billion. And now we are at Axel and Exalta. And this was not the first time that the two entities explored a combination together. So the year is 2017 and PPG comes knocking on Axel Nobel's door to try and do a hostile takeover. Now, Axel Nobel's shareholder base was quite divided about half of them wanted to engage in discussions with PPG. The other half said nope, we're happy to stay the course. We don't want to be bought out. And they're not wanting to engage in discussions. So as part of their defense strategy and trying to push the acquisition out of PPG's budget, Axel Nobel approaches Exalta. They publicly engage in exploring an acquisition. The PPG takeover falls apart. And ultimately the Axel Exalta deal falls apart as well. But I thought it was interesting that while they successfully included a merger here this year, this is not the first time that these two businesses have explored a combination. So but now we are closing 2035 chapter. And both companies are closing the chapter not in a very strong position, but they still play this card of merging, but it's supposed to shake the industry here. It's supposed to create a global coating slither with an enterprise value of approximately $25 billion. What are the strategic movie motivations behind this all-stop merger? Now the flip side of the coin are the cost energies that can be achieved. And we'll touch on the main ones as I see them. So the merge entity would become one of the largest global buyers of coding raw materials in the world. The more you order, the more leverage you have with your suppliers. So they should boat well when negotiating with Chinese suppliers. And the larger order sizes should flow through into lower feed stock unit costs. Another cost energy that would be achieved will be spreading ESG and regulatory costs, which have been steadily mounting over the past years and providing margin pressure to chemical manufacturers across the spectrum, not only in coatings, but now that they have a wider base to spread these costs across, it will be proportionally lower relative to each company as a standalone. Now I think the cost energies were candidly the main driver, or it's tough to say the main driver, because there's strong revenue synergies in the deal as well. But when I look at a merger of equals where no premium was paid by one side to the other or vice versa, fundamentally, that says, you know, I'm OK by myself. But I think that the future is brighter if we join forces and look past the horizon together. I'm not willing to pay a premium for this. You're also not willing to pay a premium for this. But fundamentally, we still get the merger done. So while there are considerable revenue synergies that can be achieved, I think it's these cost synergies, this overall theme of resilience and diversity across various product types that can damper any softness in any one-end market, that ultimately pushed both Axo and Exata towards the steel. I would like to come back to the point that you mentioned. We have two different headquarters now. And both companies have influence in different sectors or different sides of the world. Now with this merge, it's clear that the rich will be hard to compare with other top five big players. But what happens now? So how might this be continental structure impact corporate culture and operational efficiency? To answer the question in two words, not easily. I think it's already incredibly complex to run a multinational organization as a standalone. So let's say Axo and Exata prior to the merger. Then you combine the two entities. And on top of this, you don't combine them into one headquarters, but you maintain a dual headquarters. So the existing Axo headquarters remains. The existing Exata headquarters will also remain. And Chain of Command starts to become a little bit less clear. You're navigating the time difference between the whole footprint of the company. You're merging two different corporate cultures. I think you could even say you're almost merging two different national cultures in terms of the bulk of the underlying employee base. So this will require some pretty heavy hand holding by post-merger integration specialists. And my specialist, I think, there's going to be teams and teams of folks that only work on bulge bracket deals. As a definition, bulge bracket is a billion dollars and plus at the time of transaction. On my front, I'm much more so working in the lower middle market, which we define as transactions between 10 to 200 million at the time of transaction. So with that being said, I've navigated cross-border deals or multi-site deals as well, but not nearly to the complexity that exists in this Axo Exata merger. So to give you a very candid answer, I'm not entirely sure. Let's see how the post-merger integration kind of plays out. It's incredibly important, particularly when we're thinking about Exata and the high touchpoint in nature of their sales and automotive refinish. There cannot be any slipups in terms of chain of command or confusion of operations. Because when you're talking to your client every day, and you need to be communicating with them regularly to provide a quality service offering. If there's any hiccups there, they will just move to your competitor. So how it happens, not entirely sure, is it complex? Very. This is just one of those wrinkles. Let's say in the deal, that will need to be worked out over the coming months and years. And, candidly, I'm curious to see how it plays out. For sure. I mean, we have now a market that is struggling. So the coatings market is lately struggling along with a lot of pressure and new regulation. They need for faster and better results. And actually, this could open a door for better and more production lines, better resources, better products at the end. But now, it combines very complementary portfolios. If we want to shift a little bit now more to R&D topic, their portfolios include powder, refinish mobility, industrial coatings. Now, with this merge, which or what opportunities are presented for innovation and market expansion? OK, you're right. Please have mercy on me here. I am a finance background that has accrued all of my chemical knowledge through osmosis and chatting with folks much more experienced than knowledgeable in the industry than I am. So I'm going to steer this question more towards market expansion than the innovation pipeline. But on that front, I think there's a couple of verticals to keep an eye out when we look at further consolidation. The first one I'm going to mention is let's call it broader industrial coatings. But in the size range that is underneath the regional players of the world. So let's say tier ones are PPG, Sherwin, Kansai, Nipon. Regionals are Jotan, Hample, KCC. I think we'll fall in that bucket as well. And then maybe the next tier down size-wise of these medium-sized industrial coatings manufacturers, are not quite yet in the tier, let's say, of the bona fide regional coating leaders. So I think you find a lot of these targets, if we're thinking about the EU in the Dutch region, in the Nordics, in Italy as well, they have some clusters. For looking at the American markets, then there are a number of these entities in the Midwest and the South. And I'd be remiss if I didn't mention India, which is the fastest growing industrial coating market at a domestic level. So these are three locations where I think they are ripe for the picking in terms of industrial coating assets that we will see transact in the months and years to come. Now moving maybe towards a more specific product type would be the powder coatings market. I think it's much more ripe for consolidation in Europe and Asia. And when I say Asia, I'm leaning a little bit more towards India again. On the North American front, they've been heavily rolled up either by strategics or by private equity. And I mentioned thematic private equity, because there's a number of funds with very high credibility in North America that invest exclusively in the specialty chemical space. And I can say that across their portfolios, powder coatings was definitely a platform that they were interested in. And the bolt-ons that they aggressively pursued thereafter. So it's not quite as fragmented on the powder coatings front in the US. Most of these powder coating entities have reached considerable scale and have already been rolled up. But I think there's considerable market expansion opportunity in Europe and in India on that front. Now, the last one is a little bit more of a generality as well. But it's moving into higher value added coating specialties. So I can tell you a space that we've spent some time in recently has been thin film coatings, particularly being applied to electronic components and circuit boards. And they are actually feeding into a number of end industries that have very strong tailwinds. So I'm thinking aerospace and defense. These are going into unmanned aerial devices. These are going into rockets. These are going into any kind of ruggedized military application that has electronics but must perform under the most demanding circumstances. Medtech is another one. If we're thinking about implantable medical devices and biocompatible coatings, it's important that the electronics in these devices are coated properly and that they don't fail. That could be a huge issue. Industrial tech-- so let's say sensors on manufacturing lines that need to perform in difficult conditions and automotive as well. So this is an example of a highly-specced in specialty that is feeding into mission critical end markets. And when the mission is critical, the cost sensitivity is far lower, which points towards a higher margin. So this is one example of a specialty coating entity. But there are other ones. And I think as we see Axol-Axolta continue to grow and pursue their inner-ganic growth strategy, it will be in the direction of these value-added specialties, which I think was even confirmed by Axol's openness to enter into the merger with Axolta with a large part of the rationale being their shift from lower margin products into some of these higher value-added specialties. But let's try to check out the overview. So instead of just talking about Axol-Axolta and Axol-Axolta, let's see how this in general affects, or which are the signals that we can identify when we see such merge. So which trends in merge and acquisitions within the chemical industry, which trends can you identify and what factors are driving these trends? - Absolutely. We can approach this one from a couple different angles. So maybe starting with the macro and jumping back into the ideas of reshoring and near-shoring, we're seeing increased activity in chemical M&A markets by domestic manufacturers that are rolling up domestic companies on the heels of these reshoring initiatives and the underlying incentives put forward by local government. On the other side of this coin, there are the foreign manufacturers who are selling into Western markets, albeit now with a more complex and expensive path. But I don't want to see themselves get shut out of having market access and are actually acquiring small to medium-sized enterprises in NATO-friendly nations to ensure that they have a beachhead or let's say a regional headquarters that should provide them with continued access to these critical end markets and customers that they've already been selling to. Now, if we're zooming out a little bit and looking at the private equity front, I can say that this is broader than solely in chemicals, but it absolutely pertains to the chemicals, particularly on the North American front. I'm talking about here, but it exists in Europe as well. And that's what's called a flight to quality. So in prior years, there were various private equity groups and single-family offices with different risk profiles and generally just different types of investors that would buy different types of assets. From high-performing ones, let's call them A-list, all the way from B slightly underperforming, C underperforming all the way down to F the stress assets. And it was fairly uniform across the different quality of assets in terms of investor interest. But since 2022, 23, once rates started going up, we've seen a huge consolidation or a flight to quality in terms of investors that were formally going after, let's say, maybe slightly more underperforming assets, exclusively focusing their acquisition efforts on the top performing assets in the industry or the A-listers. So these are the companies with strong margins, recurring revenues, strong market share, historical, stable historical financials and defensible future projections. And we're seeing these companies trade at near 2021 level multiples, which was a record year for valuation and multiples, not only in chemicals, more broadly speaking, but also in chemicals. So this flight to quality is a very real thing. I can say for A-list assets, you see 3, 5, 7, 10 bidders coming in in a very competitive processes. And once you start moving down in terms of companies that maybe aren't performing exactly up to par or that leave some room to be desired, you see the investor interest taper off much more heavily than you would have seen in years prior. Now, maybe the last aside, and particularly on the financial sponsor front, there are a couple sub segments that are very hot in terms of interest and investor intention, let's say. Amongst these are case, and not only because I'm on the coding's podcast, but for some dynamics that I'll mention a little bit later on today. So, coding's adhesive sealants, elastomers, any chemicals feeding into electronics. It's a strong and market demand, which are driving stronger turns for the chemical manufacturers feeding these industries. What else can I say? Active pharmaceutical ingredients remain quite hot. This isn't a new dynamic though. I think, candidly, these are also being supported by a number of these reshoring and near-shoring initiatives, at least in terms of multiple support. And I can say that the, if we're talking broader, chemical businesses, the ones that are unattractive are the commoditized offerings, and the ones that are operating on cost leadership, particularly the small to medium-sized enterprise range. I think it's a losing proposition, which I'll also get into in another segment here. And I can also say that the black sheep of the chemical industry from a private equity perspective are those exposed to oil and gas. So the cyclical nature of the underlying business, when oil prices are high, they open pumps, and they pump like crazy. When they're low, they shut down pumps. And by extension, you get high variability in overall revenues in terms of the chemicals that are going down, whole chemicals that are lubricating the drills. It's closely tied to the price of oil, and it becomes very hard to predict future revenue lines. That's a very good point, that's a very good point to highlight. And before we jump into conclusions, or the last question for the conclusion, there is a question that comes up into my mind, because when such big companies join, there is a spot left, no? How this impacts innovation and competition in the industry? There is always a need to improve, and this need of improve is given always by competition. But when the competition merge, are there a risk of reduced innovation due to decreased competition? This is not something that concerns me. Axel Exalt are not competing in the vacuum. There are many other players in industrial coatings and automotive coatings and architectural coatings, all with their own respective R&D pipelines and new innovations to solve problems. So the idea that two mega entities albeit are merging and this could create blind spots and the broader coatings are in the future or initiatives. I don't see it playing out that way. I've always viewed intellectual property as cumulative. I think there's many small to medium size enterprises that have their own unique solutions to specific problems. They're then acquired alongside their technologies by larger players who are then acquired again by larger players. So this basket of intellectual portfolio, excuse me, intellectual property exists. And for as long as it solves a real pain point within the market, it's still a useful technology. If not, then companies will refocus to remain competitive in the market, come up with new solutions, new product types to carve out market share and when and ultimately continue growing the broader or the global, let's say, coatings innovation pipeline. So I don't think this merger of two entities creates any true blind spots in the grand scheme of things. - It's great that you mention that to take away a little bit the stress of the pressure but the fear that they will not be such that much competition anymore. And it's also great that you mention small and medium enterprises because always we tend to talk just about the big players in this industry because everyone knows action, no value or no, it's excel time. But to conclude, to finish up this episode, I would like to ask you, if a medium-sized company contacts you and asks you where do I stand now? What should I do, how should I react? What strategies should they should adopt to remain competitive and innovative in a market that is now shifting just towards big players movements? - Well, before I'd answer a question like that, there would typically be a kickoff meeting that had my hands on some materials and could far maybe a bit more of a poignant answer to the needs of the client. But in this context, let's give it a broad brushstroke. I think it's always important for chemical operators to understand how they're competing. So that starts with understanding the market you want to approach segmenting this market. Then you target a segment of the market and then within the targeted segment of the market, what is your positioning relative to your competitors and why would the customer choose you? So now that we're in this targeted segment of the market, how do we position ourselves? If we're thinking about the continuum of products from a commoditized offering into a value added specialty, commoditized products are high volume, low margin, and the value added specialty is much lower volume, much higher margin. So as it pertains to small medium-sized enterprises, I'm always going to recommend that shifts towards value added specialties. It's not exclusive to small medium-sized enterprises. We see Axel trying to make the same move in the industry at the mega scale right now. But why is this important? As a small player, if you're competing on a commoditized offering, you're functionally competing using cost leadership. So you want to make the cheapest, acceptable product and you are competing on cost. Why is this a losing proposition in my eyes? Well, you might win in your targeted market segment. That strategy lends itself to increased scale. We're going to need to have pretty deep pockets to continue playing in that game and making sure your scale is up to part to have a cost-effective operation. And from the small medium-sized enterprises perspective, it's just not realistic to plan these commoditized markets with the capital required or in play when you're looking at the leaders in these markets, which are global multinationals. Now, where can you be much more competitive? That would be in carving out a specialized niche application, ideally where you're spec'd in, where it's a recurring customer, there's high switching costs for them. And the fact that you are a value added specialty lends to the margin profile of the offering as well, which should be higher margin. If I'm tying it all back together in terms of a recommendation for a small to medium-sized chemicals enterprise in case, it starts off with understanding where you're competing, who you're competing against and why you're going to win against them. And then keeping in mind this scale of a commoditized offering versus a value added specialty and having focus on making sure that if not the existing product portfolio, but the new ones that you are introducing are moving towards that value added side of the scale. - And with this note, I would like to thank you so much for being today with us and talking about AXALTA, an AXA Nobel and also giving a little bit of another view on how these kind of market movements affect all of us. Thank you, Alex, for today. And thank you to all our listeners that are still with us. And then I hope to you all have a nice Christmas and then see you in January.