November 3, 2017

Breakingviews: Axalta is a Chip in Dow Duponts Paintwork

by Breakingviews

If paint makers Akzo Nobel and Axalta Coating Systems pull off the merger they are discussing, expect no flowers from DuPont. The giant chemicals group – now part of the $170 billion DowDuPont, which on Thursday reported quarterly earnings for the first time – sold what is now Axalta back in 2013 to private equity group Carlyle, which subsequently floated the business. It looks like a poor decision.

Imagine DuPont had kept Axalta or spun it off to shareholders, in either case putting in new management charged with making things more efficient. That’s basically what Carlyle did, and what activist Nelson Peltz of Trian Fund Management later argued would have been a better course for DuPont. From the end of 2012 to the end of the current year, based on regulatory filings and analyst estimates, Axalta has generated a total of $4.3 billion of adjusted EBITDA – a proxy for operating cash flow before capital investment.

New bosses might have made some other changes. They could have increased capital expenditure to the roughly 3 percent of revenue that Axalta spends now, compared with less than 2 percent when it was part of DuPont. Then assume they raised a moderate $2 billion of net debt against the business – less than Carlyle layered on, but equivalent to the three times EBITDA the company targets now. With a 4 percent cost of borrowing and a 35 percent tax rate, Axalta would have made cumulative free cash flow over five years of $2.1 billion, according to a rough Breakingviews calculation.

Investors would also own a company that had grown in value. Based on its real-world enterprise value even before the talks with Akzo became public and drove the shares up 17 percent, Axalta’s equity would now be worth over $8 billion. Add the free cash flow, and the business DuPont sold for $4.9 billion would have delivered total value to equity investors in excess of $10 billion.

That’s five years later, of course. Looked at another way, the owners of Axalta’s equity would have made around an annual 29 percent return just by keeping it and running it better. Investors in DuPont have made an annualized total return of roughly 20 percent including dividends. That’s not bad, but keeping Axalta could have improved it – rather than letting Carlyle take the benefit.

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