Current idea

Type of situation: Potential incoming buyout offer with >25% upside

Market cap: €9.1B – Share price at publication: €48.60

Moved to current ideas from quick ideas on August 24, 2023 at €49.95

Why look at this?

On June 20th, 2023, it was reported that the Abu Dhabi National Oil Company (ADNOC) had approached the management of Covestro AG and discussed a preliminary takeover offer for the German chemicals company (Link).

Shares of Covestro, negotiated in Frankfurt, rose by 15% on the news. Since the initial report of a potential buyout, the share price has not moved much, briefly touching €50/share and retreating again. A new report about a potential increase in a formal offer price gave shares another small boost to currently €48/share. Still, the company’s shares trade at an attractive discount to the rumored buyout offer price of at least €60/share.

Shares of companies in the sector such as BASF AG (XETR:BAS), Lanxess AG (XETR:LXS) or Braskem S.A. (NYSE:BAK) have been under pressure this year following guidance cuts, profit warnings, longer inventory clearing times and a general disappointment as the China re-opening boom never materialized. All these companies are highly cyclical in their nature as commodity producers and consumers, so it is certainly an opportunistic time for potential bidders trying to scoop up shares in petrochemical companies at currently muted valuations.

Target Company

Frankfurt-listed Covestro is a specialized chemical producer of polymers (polyurethane and polycarbonate raw materials). These high-tech polymers are used in almost all aspects of daily life from adhesives, coatings, paints and inks, composites, elastomers, specialty films, foams, plastics and thermoplastic resins. The company is headquartered in Leverkusen, Germany and was spun-off from Bayer in 2015, then known as Bayer MaterialScience. The company is part of the German leading stock index, the DAX40.

Bayer used to be the company’s largest shareholder as a legacy to its former full ownership of Covestro, however has fully divested its stake in the years after the spinoff.

What’s potentially quite interesting and helpful in this potential takeover setup is that the shareholder structure of the company has no large or controlling shareholder and is essentially consisting of 100% float.

Update: August 24, 2023 – Pressure from shareholders

Reuters on August 24 reported it had spoken to two of the top-15 shareholders of Covestro AG that would like to see pressure put on the companies’ board to engage in formal talks. Among them, only Arne Rautenberg, fund manager at Union Investment was named (Link). As mentioned before, the fact that basically 100% of the companies’ shares are held in free float and that there is no anchor or strategic investor might be a good thing in this setup. As the company is a DAX40 component, the major shareholders are the classic Blackrocks & Vanguards of this world. The chances could be good that most of these passive shareholders agree to a buyout, especially should it be supported by the major proxy advisors.

Also on August 24, a separate report emerged in German business newspaper Handelsblatt (Link) that ADNOC was intensifying its vying about buying the company. It was quoted as offering itself as a reliable partner for the financing and investments into green hydrogen. Germany has a slightly weird obsession with hydrogen frequently being touted as the solution to the climate change and decarbonization. This move could be seen as a potential way to appease to German authorities by the bidder. This is just speculation on my part, though.

Further, ADNOC was quoted in the report as assuring Covestro’s management that the company would stay as an independent entity, despite new ownership in case of a deal. This is important to mention as the company’s management has repeatedly for years stated that it prefers being independent to being bought out and removed from the public markets.

The bidder was also said to view positively that so far, no government agencies or trade unions have voiced any public opposition to a takeover.

According to Handelsblatt, the unofficial negotiations are being kept top secret within Covestro with only a handful of people involved in the matter with their team being led by the CEO.

Update: September 18, 2023 - Advisory Board meets

Shares rose by up 13% on Friday and through last Monday following reports that the company’s advisory board recommended to enter formal talks with ADNOC, the potential bidder from Abu Dhabi.

Rumors still have it that after rejecting informal bids by ADNOC at €55 and €57/share, an offer with a 6-handle could be viewed as a fair takeout price by the company’s management and would likely see shareholder support, too.

Shares have fallen a bit again over the course of the week and still offer about 15% upside to a conservative buyout price of €60.

Bidder

ADNOC is the state-owned oil company of the United Arab Emirates (UAE) and the world's 12th largest oil company by production. The company last year approved a $150B budget (Link) to invest into its own business and purchase other companies the next five years as it seeks to expand its gas, chemicals and clean energy businesses around the world. The strategy comes as the company seeks to diversify and push into higher value oil- and gas related businesses such as plastics. It also listed its gas subsidiary ADNOC Gas plc (ADX:ADNOCGAS) on the Abu Dhabi Stock Exchange earlier this year.

The push to invest into other companies in the petrochemical sector is an extension of previous investment activity by the state-owned company. In 2022, ADNOC purchased a €3.9B stake in Austria’s OMV AG to increase exposure to the production of chemicals, although the purchase was not made on the open market but rather from Mubadala Investment Company PJSC, the UAEs sovereign wealth fund which in turn also owns ADNOC. With that, ADNOC also took over the 25% stake that was previously owned by Mubadala in Austrian chemical and fertilizer maker Borealis AG of which OMV AG owns the remaining 75%.

In this context most interesting is that ADNOC in 2023 emerged in the public markets as a bidder for petrochemical companies. Before reaching out with an informal offer to Covestro, ADNOC in May 2023 teamed up with Apollo Global Management (NYSE:APO) to make an approach to Brazilian petrochemical producer Braskem S.A. (NYSE:BAK) which is controlled by Brazilian state-owned oil giant Petrobras (NYSE:PBR) and the more or less insolvent Odebrecht-conglomerate.

The deal to acquire Braskem seems to be hanging in the balance currently as other bidders have emerged, the situation around Odebrecht is unclear and Petrobras not having made a decision on whether to divest the company’s stake or to partner up with one of the bidders to run the company together. In any case, the Braskem transaction will likely take more time to go forward or not go forward at all.

I believe the fact that the Braskem deal is delayed and hanging in the balance increases the chances that ADNOC and their team will put full effort into a potential takeover of Covestro.

Given the relatively modest absolute valuations of Braskem and Covestro for a bidder the size of ADNOC, I do not believe that both deals would be exclusive to each other.

New reports regarding offer and potential definitive offer price

A new Bloomberg report gave shares a small bump this week which stated that ADNOC would be weighing the submission of a formal written offer for at least €60.00/share on the condition that Covestro’s management engages in discussions (Link). An offer at this price would value the deal for Covestro’s equity at €11.6B. Given that ADNOC has put in place a budget for investing in its own business and M&A in the region of $150B, the deal seems appropriately sized for them as a potential target and, as said earlier, not exclusive to a deal to acquire Braskem, either.

Some commentators have voiced that an offer for the company would have to come in with at least a 6-handle and a more realistic offer that could see the management actively recommending a sale to its investors would likely have to be in the range of €65-70.00/share.

An offer in that range would still see an upside to current share prices in the range of 35-45%, while the share price retreating to its pre-rumor level of €38 would materialize in a 20% drop. A deal at €60/share as mulled by Bloomberg still has an upside of around 25%.

As stated earlier, the ADNOC team after so far not succeeding to go through with a purchase of Braskem, may want to get this done with a higher priority and won’t try to lowball the offer as an incentive for shareholders to potentially pressure management to agree to a deal.

Muted response by management

So far, management of Covestro has not made any comments regarding the ADNOC approach. However, in a recent interview with German business newspaper Handelsblatt (Link), the company’s CEO Markus Steilemann sounded far from enthusiastic about a potential sale due to concerns about the bidder’s geographic and political origins. He was quoted as saying that “the trend that more and more [strategic] companies are coming into the hands of autocratic regimes can be seen across all sectors – including entertainment and sports, for example. You just have to think about what it means for the entire Western world if this trend continues unabated and conflicts break out."

Further, he said that “Due to increasing regulation, certain capital market participants have turned away from financing plants - for example oil, gas and coal plants, but also in petrochemical chemistry, which needs oil as an input factor. Sovereign wealth funds, some of which are in the hands of autocratic regimes, have stepped into the breach."

I believe that his arguments are quite valid on an objective basis and I would see the management or even potentially the German government trying to shut down a sale to a UAE-state owned enterprise as the potentially largest risk to a deal going forward.

Conclusion

An offer for Covestro by ADNOC would likely run into some opposition be that by management or potentially even the German government. However, ADNOC is in the situation that one of their deals has been hanging in the balance, potentially making Covestro a highest priority item now. The bidder would do itself a favor in offering an attractive price here to put pressure on management to even seriously consider the offer and potentilly to recommend to its shareholders. As there is no large or controlling shareholder with any strategic or tactical interest in the company that could shut down such a move, Covestro makes for a compelling target if ADNOC plays it right here with an attractive offer.

Further, the target is also not priced to perfection. While shares would certainly re-rate downwards following news that a deal fell through, the downside is quite reasonable at 18-20% to pre-rumor levels.