Sherwin-Williams (NYSE:SHW) announced Nov. 12 that it was acquiring Mexico's largest paint company, Comex, for $2.34 billion including the assumption of debt. Comex sells paint in Mexico, Canada and the U.S. In 2011 it had revenues of $1.4 billion. The deal furthers Sherwin-Williams' growth plans for Latin America. I'll look at why this is good news for shareholders.
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What's It Buying
Sherwin-Williams is buying a 60-year-old business, the second largest specialty paint organization in the western hemisphere. Comex conducts 66% of its business in Latin America and 34% in the U.S. and Canada. Approximately 75% of its sales come from architectural paint and 20% from industrial coatings. In addition to adding scale in Mexico, this deal allows Sherwin-Williams to expand in the western part of the U.S. and Canada as well. With the addition of Comex, Sherwin-Williams goes from $8.77 billion in revenue to $10.2 billion, doubling its Latin American coatings business. Paying 1.7 times sales, it's getting a business that will be accretive in the first 12 months. Although it's adding $2 billion in debt, it should be able to repay most of it by 2018.
In order to facilitate this acquisition, Sherwin-Williams is foregoing stock repurchases for the next two years. Never a fan of stock repurchases, I believe debt repayment over the next few years is a much better use of its cash flow. It's too bad it wasn't able to use its stock as currency in this deal because it's trading at an all-time high above $150. Over the past three years, Sherwin-Williams has repurchased 18.7 million of its shares at a cost of $67.91 per share. While it appears the company did a good job repurchasing its stock given the current price, Sherwin-Williams paid 60% more than the three-year low of $42.19 that was achieved between Dec. 31, 2008, and Dec. 31, 2011. If it had instead saved the $1.27 billion in cash and used that to help finance the Comex acquisition, the debt-to-capitalization ratio would drop from 62.3% to 49%, providing a much stronger balance sheet moving forward post-acquisition. Nonetheless, its pre-tax income in 2011 was $742 million, so it will have plenty to absorb the additional $120 million in interest (based on 6% financing) to finance the new debt.
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As mentioned earlier, Sherwin-Williams said it is paying 1.7 times sales. That's higher than PPG's (NYSE:PPG) current price-to-sales ratio as well as Valspar's (NYSE:VAL), Masco's (NYSE:MAS) and even its own at 1.6 times revenue. Although profitability isn't mentioned in the press release, Comex's business is very similar to Sherwin-Williams' so it wouldn't be out of line to suggest an enterprise value of 13.6 times EBITDA and an EBITDA margin of 12.2%. Based on Comex's 2011 revenue of $1.4 billion, you're looking at $170.8 million in EBITDA and an enterprise value of $2.3 billion, which is right around the final price. The fact that Sherwin-Williams gains a huge foothold in Latin America suggests it paid a steep, but necessary price. This could be a game changer for the company.
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The Bottom Line
It's easy to second guess this move because it triples Sherwin-Williams' level of debt. Deals like this don't come along every day, however, especially with companies that are privately owned. If Sherwin-Williams didn't make the acquisition, you can be sure one of its competitors would have been making inquiries of its own. Sometimes to play good defense you have to go on the offense. One plus one in this situation looks to add up to more than two. I guess time will tell, but from where I sit it looks like a winner primarily because the housing markets continue to strengthen. Sherwin-Williams shareholders should keep an eye on its future debt repayment, but as long as it keep knocking down the outstanding balance, this deal will look better and better the more time passes.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.