Sherwin-Williams, market cap as of 15/04/2016: $27.154bn
Valspar, market cap as of 15/04/2016: $8.469bn

 

Introduction

Sherwin-Williams, the largest producer of paints in the United States, agreed to buy rival Valspar Corp., for about $9.3 billion, to become the world’s biggest coatings maker. This compelling combination will lead to a significant expansion in Asia-Pacific and EMEA markets and at the same time it will allow Sherwin-Williams to secure a competitive position in the challenging paints industry. The deal will generate $280 million of annual savings, expected to be achieved by 2018, and the implementation of improved technology capabilities in order to accelerate product innovation.

About Sherwin-Williams

The Sherwin-Williams Company was founded by Henry Sherwin and Edward Williams in 1866 and is headquartered in Cleveland, Ohio. As third-largest worldwide firm in the development, manufacturing and sale of paint, coatings and related products, it has an extensive retail presence throughout the Americas, and a growing network in Europe and Asia-Pacific. The company is composed by four reportable segments: Paint Stores Group, which operates for Sherwin-Williams branded products in the U.S., Canada and the Caribbean; Latin America Coatings Group, that sells a wide range of architectural paints and industrial coatings in Latin America; Consumer Group, which manages a highly efficient global supply chain in North America; Global Finishes Group, which manufactures and sells a wide range of protective, marine and automotive finishes. Now the company is focused on strategies that will drive long-term growth in revenues, market share and profitability: broaden the share of the do-it-yourself market and the stores’ density, strengthen the retail availability of products throughout Latin America and differentiate the global product offering. The Company’s financial condition, liquidity and cash flow, in FY 2015, continued to be strong, showing an EBITDA margin of 15.9%. It consolidated net sales generating $11.3bn, with an increase of 1.9% over 2014. Furthermore, net operating cash increased by 34%, to $1.45bn, and allowed to return about $1.3bn to shareholders, through dividend payments and share repurchases.

About Valspar Corporation

The Valspar Corporation, founded in 1806 by Samuel Tuck and listed on the New York Stock Exchange, is headquartered in Minneapolis (MN) and is the 4th largest producer of Coatings and Paints globally. The paints segment includes consumer paints whereas the coatings segment includes four lines (packaging, general industrial, coil and wood coatings). Both distribute products in over 25 countries between North America, Australia/New Zealand, Asia and Europe. The company highlighted a strong performance in China in FY 2015 and reached an EBITDA margin of 16.3%. In June it acquired the performance coatings businesses of Quest Specialty Chemicals, which included automotive refinish and industrial coatings. This strategic acquisition doubled the size of the existing businesses and provided Valspar with another strong platform for future growth. In FY 2015 the consolidated net sales were $4.3bn compared to $4.6bn of 2014, with a five year CAGR of 6%, which includes FX effect. The decline was primarily caused by the impact of foreign currency exchange and lower sales in Consumer Paints product line, but it was partially offset by the acquisition of QSC. For the 37th consecutive year, the company consistently increased cash dividends for a total amount of $1.20 per share, with a CAGR of 14% and generated nearly $400 million in cash, this allowed to repurchase 5% of stocks.

Rationale

From a strategic point of view, the companies involved are complementary: the acquisition will allow Sherwin-Williams to diversify its range of products by exploiting Valspar’s resin technology and its portfolio of patents and it will be able to further reinforce its presence in the US market through Valspar’s well-recognized brands. The acquiring company will also leverage the established presence of Valspar in EMEA and Asia-Pacific in order to boost its own international growth. This will allow Sherwin-Williams to increase the current proportion of international revenues from 16% to 24% when the acquisition will be completed. The new conglomerate will now be the first player in terms of global sales ($15.6bn), just ahead of PPG ($14.2bn) and Azko ($11.1bn). In this industry there are still many competitors with similar market shares, it is therefore unlikely that the regulator will stop the deal, however in that case the acquisition price would be revised according to the proportion of divestures required.

However, adding new products or entering new markets does not create value for shareholders if the acquisition price is fair. Indeed, the main source of value for this transaction is driven by cost synergies. The annual value of cost savings is estimated to reach approximately $280m when the transaction will be successfully completed. The acquisition is expected to be accretive already in the first year, excluding exceptional costs.

With regard to the offer price, considering an Enterprise Value of $11.3bn, the multiple EV/EBITDA is 15x, which is above 9x which is the average for recent transactions in  the same industry. This might suggest that Sherwin-Williams overpaid for Valspar also taking into account the low-growth of the industry.

Deal Structure

The enterprise value of the transaction is valued at $11.3bn including Valspar’s $2bn debt. Sherwin-Williams agreed to pay $113 in cash per Valspar share, representing a 28% premium to the all-time high closing price. The equity purchase will be financed with a combination of $1bn in cash and $9.3bn of a bridge financing facility fully committed from Citigroup. The new debt financing will include both new bonds as well as low interest term loan.

The deal already anticipated potential regulatory clearance requiring divestitures of assets. Therefore, the agreement took into account the possibility of divestitures of assets for $650m, in this case the transaction price would drop to $105 per share. Sherwin-Williams has the right to call off the deal if required divestitures exceed $1.5bn in 2015 revenues.

The deal has been unanimously approved by both Valspar and Sherwin-Williams Boards of Directors and is subject to the approval of Valspar shareholders and customary closing conditions, including the expiration or termination of the applicable waiting period under the U.S. Hart-Scott-Rodino Antitrust Improvements Act and regulatory approvals in various other jurisdictions. The acquisition is expected to close in Q1 2017.

Market reaction

As you can see from the graph below, the market reacted differently for the companies involved. Valspar’s share price spiked because of the 28% premium that Sherwin-Williams will pay if no major divestures will be required. Since Valspar’s share price is now trading around $107, it seems that the market does not consider sure the positive closing of the transaction.

On the other side Sherwin-Williams’ share price dropped almost 5% on the first day of trading, confirming the initial consideration that the price was a bit high, especially comparing transaction multiples. However, the stock recovered pretty well on the following days, over performing the S&P500 and rebounding above preannouncement levels. This may signal that the market is starting to reevaluate the price paid for the acquisition.

Graph

Financial advisors

Citibank and JP Morgan acted as financial advisers to Sherwin-Williams while Goldman Sachs and Bank of America Merrill Lynch are acting as financial advisers to Valspar. Citigroup Global Markets will also provide bridge financing.

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