PPG Industries - Stellar Deal With Akzo, But Valuation Is Too Rich

| About: PPG Industries, (PPG)

Shares of PPG Industries (PPG) jumped 3.8% in Friday's trading session. The global supplier of protective and decorative coatings announced that it would acquire Akzo Nobel's (AKZOF.PK) North American architectural coating business.

The Deal

PPG Industries announced that it will acquire Akzo Nobel's decorative activities in North America in a deal valued at $1.05 billion. The acquisition will double PPG's presence in the North American architectural coating industry. As a result of the deal, the company will expand its company-owned store network to roughly a 1,000 stores.

CEO and Chairman Charles E. Bunch commented on the deal, "This acquisition continues the accelerated pace of our business portfolio transformation through further expansion of our coatings business. It is also an attractive way to significantly increase our scale in the North American architectural paint market, which we anticipate will benefit from a prolonged construction market recovery."

The activities generated annual revenues of $1.5 billion in 2011. PPG will acquire 600 paint stores which will expand its current network to some 1,000 stores. Furthermore paints produced by the unit will be distributed to over 8,000 retail outlets.

Akzo will furthermore assume $60 million in deal closing costs, including defined benefit pension expenses, and amortization charges related to prior acquisitions.

As a result of the deal, PPG expects $30 million in synergies at the end of the first year, increasing to $70 million by the end of the third year.

The transaction has already been approved by the board of directors of both firms. The deal is subject to regulatory approval and is expected to close in the second quarter of 2013.


PPG Industries ended its third quarter of this year with $2.0 billion in cash, equivalents and short term investments. The company operates with $4.0 billion in short and long term debt, for a net debt position of roughly $2.0 billion. Consequently, the company has sufficient liquidity to finance the acquisition.

For the first nine months of 2012, PPG generated revenues of $11.6 billion. Net income attributable to shareholders came in at $714 million, or $4.61 per diluted share. The company is on track to reported annual revenues just north of $15 billion, on which it could earn $900-$950 million or close to $6.00 per share.

Factoring in Friday's jump in the share price, the market values PPG at roughly $20.0 billion. This values the firm at roughly 1.3 times annual revenues and 21-22 times annual earnings.

The company currently pays a quarterly dividend of $0.59 per share, for an annual dividend yield of 1.8%.

Some Historical Perspective

Year to date, shares have risen some 55%. Shares steadily rose from levels in the low eighties in January to fresh all time highs at $133 on Friday.

Shares of Sherwin have seen a great run, rising from lows of $30 in 2009 to $130 at the moment. Shares rose steadily despite the fact that revenues between 2008 and 2012 have fallen slightly. The company did manage to improve its profitability in the meantime.

Investment Thesis

Shareholders of PPG react very favorable to the deal with Akzo. The deal will add roughly 10% in annual revenues and comes at a cheap price. PPG will pay merely 0.7 times annual revenues, compared to a valuation multiple of 1.3 times for its own business.

The deal will furthermore result in annual synergies of $70 million in three year's time, worth over $500 million based on a discount rate of 10%.

Besides the stellar deal, the firm announced that it expects to spend between $500 and $750 million on share repurchases during 2013. As such the firm could retire between 2.5% and 3.7% of its shares outstanding in the coming year. At current prices the firm could retire roughly 5 million shares, or 20,000 shares per business day. The plan would be sufficient to buy almost 2% of average daily trading volume of 1 million shares over the past month.

While I think that PPG has made an incredibly good acquisition at very fair valuation multiples, the valuation of the firm has inched up too far. The valuation of 22 times annual earnings for a cyclical firm is too rich, despite the recovery in the housing sector. Shares remain vulnerable to a setback. A level closer to $100 per share seems more realistic than the current share price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.