Fight to the Finish

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The fight for TPC Group (NASDAQ: TPCG) continued unabated on Nov. 15, as Innospec (NASDAQ: IOSP), a leading U.S. chemical producer, raised its offer once again for TPC to $47.50 per share in cash.  TPC Group initially agreed to be acquired in August by two private equity firms for $40 per share in cash, a negligible premium over the prevailing stock price.  Naturally, certain shareholders were unhappy, with accusations of management side deals and calls for an auction of the company.  In October, Innospec jumped into the fray with an initial offer of $44-46 per share in cash, subject to due diligence.  Since then, both sides have upped the ante as management has a fiduciary duty to secure the best deal for shareholders.  Despite U.S. and European regulatory approval of the original deal and a looming Dec.r 5 shareholder vote, this fight is far from over.

What’s the Value?

TPC Group is a leading producer of chemical products derived from petrochemical raw materials.  Its main products are butadiene and butane-1, which are primarily used in the production of synthetic rubber for tires and automobile products.  In addition, the company produces chemicals that are used in the manufacture of lubricant additives, adhesives, sealants, and as a component of premium unleaded gasoline.  The U.S. government originally created the domestic synthetic rubber industry in 1943, in order to procure rubber supplies for World War II.  TPC Group entered the production business in 1984 with the purchase of plant assets from Tenneco, and the company currently has three processing facilities with convenient access to shipping lanes and pipelines. 

Despite an industry downturn in 2009 that was a result of the financial crisis, TPC has a good track record of growth through plant acquisition and product innovation, delivering sales growth of approximately 55% over the past five years.  In 2011, sales and net income were $2.6 billion and $36.7 million, increases of 63.4% and 20.1%, respectively, over the prior year.  The company benefited from very strong product pricing due to rising global auto sales and economic activity. 

More recently, financial results have been negatively impacted by a decline in both prices and volumes for the company’s core butadiene and butane-1 products.  In the third quarter of 2012, TPC reported sales and net income of $510.6 million and $7.3 million, decreases of 38.9% and 22.3%, respectively, versus the prior year.  While unit product margins have remained stable due to management’s ability to link both sales and purchases to commodity price indices, overall profitability has declined as a result of inventory destocking by TPC's customers.  During their recent conference call, management was hopeful that volumes would improve in 2013, but gave a cautious outlook.

A Strategic Fit

Innospec’s offer values TPC Group at 0.3 times FY 2011 sales and 20.5 times FY 2011 net income, a rich price considering the industry’s declining operating environment in 2012.  However, it is likely that Innospec sees operating efficiencies and an ability to gain a more diversified product line.  The majority of their business consists of chemicals to improve fuel efficiency and engine performance, with a secondary emphasis on personal care and fragrance markets.  In 2012, Innospec’s sales and adjusted operating income have declined due to economic weakness in international markets, although cash flow generation has improved significantly over the prior year.  With a solid balance sheet, a strong financial partner in Blackstone Group, and a long term timeframe for generating shareholder value from the deal, Innospec will probably emerge as the eventual winner of this corporate tussle.

Looking Ahead

Since TPC is fully valued at current prices, where should an investor look for an investment in the sector?  Given that the industry has short term challenges and long term opportunities, investors need to be selective more than ever.  However, I see considerable value in NewMarket (NYSE: NEU).  The company is one of the largest global producers of petroleum additives and lubricants.  For the five year period ended Dec. 31, 2011, the company generated growth in sales and net income of 56% and 117%, respectively.  NewMarket achieved this performance by reinvesting in their businesses through research and development, as well as through an expansion of their operating margins.  Despite current economic weakness in certain global markets, the company continues to grow slowly in 2012 and return value to shareholders through share repurchases and dividends.  It is one for the long-term investor’s portfolio.

rghanley owns shares of TPC Group and NewMarket. The Motley Fool has no positions in the stocks mentioned above. 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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