It's interesting that Eastman Chemical (NYSE:EMN), Eastman Kodak's discard, is going to be the company that survives as the more viable going concern. To management's credit, they seem to understand the value of defensible markets and the need to wall off and dispose of businesses in long-term decline. With the announced acquisition of Solutia (NYSE:SOA), Eastman Chemical is taking another important step towards being a diversified specialty chemical company.
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Is Solutia the Solution?
Eastman is paying about $4.7 billion in total enterprise value for Solutia, or about nine times trailing EBITDA. That's not an especially cheap price, but it's not so unusual for a takeout of a quality specialty chemical name. When Berkshire Hathaway (NYSE:BRK.A) acquired Lubrizol, the premium it paid was only about 80% less even though that was a very different market at the time. (For related reading, see EBITDA: Challenging The Calculation.)
Apart from the usual synergies that go with combining broadly similar businesses, Solutia brings new products and new markets to the table for Eastman. If the deal goes through, the combined company will get about half of its revenue from four markets, split evenly between packaging, tobacco, consumer goods and building/construction. So, in addition to some better top-line growth, Eastman shareholders can also look to a more diversified model.
Not Quite Chopped Liver
It's not as though Eastman is a terrible business today, either. Revenue for the fourth quarter rose 18% on both higher prices and volumes. Margins were admittedly more problematic, though, as the year-on-year growth in operating income was fairly minimal.
Still, Eastman arguably doesn't get enough credit for management's willingness to realign the business as conditions change. Seeing relatively little future in the PET business, management largely got out of that business. Likewise, management has been repositioning the company to cope with the ongoing declines in demand for acetate yarns. Since the company lacks the scale of DuPont (NYSE:DD) or Dow (NYSE:DOW) this is an eminently logical move - if you can't win a game that's based on scale, get out of that game.
What's more, the company could be in line to benefit from some near-term trends. C3 spreads (that is the difference between the cost of propane and propylene-linked selling prices) should get better in the coming quarters (helped in part by low natural gas prices). Other inputs like coal gas methanol and waste pulp should also be more favorable.
The Bottom Line
Eastman boasts solid (and improving) returns on capital, a management team unafraid of change, a relatively undemanding valuation, and what should prove to be favorable cost trends in the near future. That's not a bad set-up for a specialty chemical company in a slowly improving economy.
Perhaps no chemical company is a safe buy-and-hold stock, but investors could do worse than to consider Eastman Chemical over the next six to nine months. (For related reading, see Finding Solid Buy-And-Hold Stocks.)
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.