Recently, I discussed the PPG / Georgia Gulf arbitrage opportunity. The basics of the opportunity were pretty simple: buy PPG (NYSE:PPG) shares (less than 100), tender them in an exchange for Georgia Gulf (GGC) shares, and make a quick 11% or so.
However, a lot of the readers had a problem with one aspect of the deal: the market risk. Specifically, an investor is exposed to price swings in GGC for a week or so as they wait for the shares to be tendered into their account, and many brokers weren't allowing GGC to be shorted, so there was no way to hedge out the exchange risk short of buying some very richly priced puts. Many investors seem concerned that GGC's price will tank once all of the new shares hit the market, or simply didn't want the market exposure.
While there's certainly some risk here, and GGC's price may experience a bit of volatility in the near future, I don't think the exposure to GGC for a week or two is a huge deal for one simple reason: GGC's share price looks quite attractive post deal. The reasoning behind that is pretty simple. GGC is acquiring PPG's sub at a fairly attractive price, and there are significant synergies between the two companies that should unlock a ton of value.
A look at the merger presentation shows that GGC is acquiring PPG for just over 5.1x trailing EBITDA (see slide 26). Slide 14 shows there should be $115m in synergies between the two companies, with the majority of those to be quickly realized ($30m immediately, $60m w/in first year, all within two years). Mid-cycle EBITDA is projected at over $850m (slide 16).
GGC is paying $1.1b in cash and assumed debt to acquire PPG chemicals. In addition, the company has $500m in net debt on its balance sheet. Post deal, the company will have 70 million shares outstanding. At the current share price of $50, the whole company will have an enterprise value of ~$5.1B.
On a trailing basis, the combined company has done $770m in EBITDA (see slide 28 of the merger presentation linked earlier), which puts its EV / EBITDA at a very reasonable 6.6x. Add in the value of its synergies and its EBITDA jumps up to $880m (roughly consistent with the company's mid-cycle EBITDA projections) and the drops even further to 5.8x. That multiple's cheap on its own-- but compare that to, say, Dow's (NYSE:DOW) 8.8x trailing EV / EBITDA multiple, and GGC looks extremely attractive.
So there's a lot to like here, and plenty of catalysts for the share price to rise. The easiest to point out is a cyclical upswing. This is a cyclical business, and it's still recovering from rock bottom 2009 levels. Current earnings are consistent with mid-cycle levels, and they should continue to grow as end markets (namely, housing) continue to recover. Of course, past share prices mean nothing, but it should be noted that the stock traded just below $200 a share in early 2008, and given the new acquisition, it's not crazy to picture shares hitting that level if end markets really heat up.
The second catalyst is an increased dividend or share buyback. The company suspended its dividend in the fourth quarter of 2008 and just reinstated it last March. As the company begins to see improved margins and cash flows from the deal synergies, it will have to do something with all of that cash. Leverage ratios post deal will be very reasonable, so there's no real need to put cash towards debt pay down. That leaves only returning cash to shareholders or further acquisitions as options for using that excess cash. While shareholders would likely welcome another transaction if it's as good as this one (GGC's share price rose 16% on deal announcement and has been on a tear ever since), it's much more likely the company chooses to focus on integrating PPG's business and simply returns cash to shareholders.
Finally, there's a very real chance the company gets acquired. Westlake (NYSE:WLK) tried to acquire the company earlier last year. While the new GGC would take a much bigger bid, there's certainly interest in the company and further acquisition interest can't be ruled out.
So, yes-- there's plenty to like here. New shareholders from the exchange offer should likely consider holding on to their shares, and investors would be wise to pay attention to the stock and consider purchasing any if the new shareholders create some price weakness by dumping en mass.