An Investment Opportunity From A Reverse Morris Trust Deal

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Recently, PPG Industries (NYSE: PPG) spun off its commodity chemicals business and merged it with Georgia Gulf Corporation for around $2.1 billion. Afterwards, Georgia Gulf changed its name to Axiall Corp (NYSE: AXLL). In order to create a tax-efficient deal for its shareholders, PPG has used Reserve Morris Trust transaction in this spinoff. Let’s look closer to get a better understanding about this deal and to see whether or not investors should be bullish on Axiall at its current price.

PPG Snapshot

PPG, incorporated in 1883, is a global supplier of protective and decorative coatings, operating in six business segments: Performance Coatings, Industrial Coatings, Architectural Coatings, Optical and Specialty Materials, Commodity Chemicals and Glass. The majority of its revenue, $4.75 billion, or 31.3% of the total revenue, was generated from the Performance Coatings segment. The Industrial Coatings ranked second, with nearly $4.38 billion in revenue in 2012. Those two segments were also the two largest income contributors. In 2012, while the Performance Coatings generated $744 million in operating income, the operating income of the Industrial Coatings segment was $590 million. The Commodity Chemicals segment had $1.69 billion in revenue, $372 million in operating income, and around $404 million in EBITDA. Thus, with a $2.1 billion price tag, the deal valued the Commodity Chemicals segment at around 1.24 times sales and about 5.2 times EBITDA.   

A Reserve Morris Trust Deal

A Reserve Morris Trust is often used when a parent company would like to sell its subsidiary to another external company in a tax-efficient manner. Investopedia explains this quite clearly:

The Reverse Morris Trust starts with a parent company looking to sell assets to a smaller external company. The parent company then creates a subsidiary, and that subsidiary and a smaller external company merges and creates an unrelated company. The unrelated company then issues shares to the shareholders of the original parent company. If those shareholders control over 50% of the voting right and economic value in the unrelated company, the Reverse Morris Trust is complete. The parent company has effectively transferred the assets, tax-free, to the smaller external company.

In this deal, PPG created a wholly owned subsidiary, Eagle Spinco, which owned all the assets and liabilities of PPG’s Commodity Chemicals business. Eagle Spinco was then merged into Georgia Gulf to create a new entity named Axiall. Former PPG shareholders owned 50.5% of the new entity ,whereas the shareholders of Georgia Gulf owned 49.5%.

The Lowest Valuation Among Peers

The deal has created a leader in integrated chemicals and building products with a total revenue of around $5 billion. Axiall was expected to generate around $115 million in annual cost synergies, including $40 million cost synergies in procurement & logistics, $35 million in operating rate optimization, and $40 million in G&A reduction. Axiall’s Pro Forma EBITDA was around $785 million and the free cash flow was $458 million. Axiall is trading at $55.65 per share. With 70 million total shares outstanding, Axiall’s total market cap is nearly $3.9 billion. As Axiall had about $1.5 billion in total debt, its enterprise value is around $5.4 billion. The market is valuing Axiall at only 6.9x EV/EBITDA. PPG, with a $20.3 billion market cap, is valued at 9.52x EV/EBITDA.

Westlake Chemical (NYSE: WLK), another major maker of basic chemicals and fabricated building products, is worth $5.87 billion on the market. With a trading price of $88 per share, Westlake is valued at 8.9x EV/EBITDA, much more expensive than Axiall’s EV multiple. Among the three, PPG is paying shareholders the highest dividend yield at 1.8%. Westlake is paying 0.9% dividend yield, while Axiall is not paying any dividends. In the fourth quarter, although Westlake has experienced a 6.8% decrease in its revenue, the net income has increased more than 250% to $1.42 per share. The significant increase in the fourth quarter EPS was mainly due to the low natural gas price that lead to the decrease in operating costs.

Foolish Bottom Line

Going forward, all three companies will continue to benefit from the low cost of natural gas and the ongoing US housing recovery environment. Personally, I think they will prosper in 2013. Among the three, I like Axiall the most due to its lowest EV multiple valuation.

 


hoangquocanh has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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