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Rockwood Holdings (ROC) saw a modest uptick earlier this week after the manufacturer of specialty chemicals and advanced materials announced the divestiture of its titanium activities.

I am not too enthusiastic about the deal, which is dilutive to shareholders. Furthermore, the remainder of Rockwood after the divestiture is quite a small company. Although it has promising assets, am not sure if they can continue to support the current valuation as shares have rallied some 40% year to date.

I remain on the sidelines with a slightly bearish stance.

The Deal

Rockwood announced that it has entered into a definitive agreement to sell its Titanium Dioxide Pigment business, and four other related businesses to Huntsman Corporation (HUN).

Rockwood will fetch $1.1 billion for the operations and get rid of $225 million in pension obligations, with the final deal value being subject to customary adjustments.

The businesses being part of the deal include Titanium Dioxide Pigments, Color Pigments & Services, Timber Treatment Chemicals, Rubber/Thermoplastics Compounding, and Water Chemistry.

CEO and Chairman Seife Ghasemi commented on the rationale behind the sale, "With the sale of these businesses, we have successfully completed, ahead of schedule, all of our key objectives for 2013. In January of 2013, we announced a plan consisting of four strategic initiatives to further maximize shareholder value. We have delivered on all of them."

The businesses generated $1.54 billion in sales in the twelve months up to June of 2013, according to Rockwood's press release.

The deal is subject to normal closing conditions, including regulatory approval, and is expected to close in the first half of 2014.

Valuation

Rockwood ended the second quarter of its fiscal 2013 with $321.7 million in cash and equivalents. The company operates with $2.22 billion in total debt, for a net debt position of around $1.9 billion.

Revenues for the first six months of the year totaled $1.61 billion, up 5.6% on the year before. Net earnings fell a whopping 83% to $51.2 million, partially on the back of one-time charges.

Note that these results exclude the contribution from the ceramics business which was sold in the summer. Adjusted earnings of the continuing operations fell by 43% to $112.2 million.

Trading around $68 per share, the market values Rockwood at $5.1 billion.

Rockwood currently pays a quarterly dividend of $0.45 per share, for an annual dividend yield of 2.6%.

Some Historical Perspective

Shareholders of Rockwood have seen solid returns ever since the company has gone public. Shares have risen from $20 in 2004 to highs of $40 in 2008.

Shares fell to $10 in 2009 amidst the financial crisis, but have steadily risen to all time highs around $69 at the moment.

Between the calendar year of 2009 and 2012, Rockwood has increased its annual revenues by a cumulative 27% to $3.51 billion. Net earnings rose to $383.5 million over the past year.

Investment Thesis

Rockwood's transformation process continues at an aggressive pace as it sells the third business so far this year. In July it sold its Clay Based Additives business for $635 million. The business generated annual revenues of around $191 million.

Rockwood furthermore sold its CeramTec business to private-equity firm Cinven for net proceeds of $1.75 billion.

So Rockwood ended the first half of the year with revenues of $1.61 billion; note that these were revenues from continuing operations, so this excludes the contribution from CeramTec, among others.

This does not exclude the revenue contribution from the sold Titanium Dioxide Pigments business, if I read the quarterly earnings report right, which generated revenues of $549 million, while reporting negative EBITDA of $0.9 million.

Note that Rockwood mentions in its press release that the unit reported $1.54 billion in annual trailing revenues, while Huntsman said in its press release that it sees EBITDA of $200 million from the acquired businesses, excluding synergies.

So you can see my confusion here. Based on the performance in the first half of the year, annual revenues could come in around $3.2 billion. Yet we have to exclude the revenue contribution of the to be sold activities to Huntsman which amount to $1.5 billion according to Rockwood itself. This leaves a company with merely $1.7 billion in annual revenues, if my calculations are correct.

This is a similar story with regards to EBITDA. First half year reported EBITDA of $238 million implies annual EBITDA could approach $500 million, assuming similar market conditions. Yet the divested activities generated EBITDA of $200 million according to Huntsman, resulting in a company with annual revenues of $1.7 billion and EBITDA of $300 million.

Yet the market continues to value Rockwoods' equity at $5.1 billion, while the net debt position will be reduced below $1 billion following the deal. No matter how promising the remaining lithium and surface treatments business might be, the valuation seems a bit rich to me.

If the analysts above is even slightly correct, the equity in the business is now valued at 3 times annual revenues and 17 times EBITDA, which is a bit steep.

Back in June of this year, I last took a look at Rockwood's prospects. I concluded that the ceramics divestiture could propel shares to fresh all time high.

At the time, the company continues with its strategic transformation, which has already created a lot of value for its shareholders. yet after selling three businesses over the past summer, it appears not much is left of Rockwood. Back in June I was optimistic as divestitures could results in shareholder presents through dividends or share repurchases.

Now I think the company has sold a bit too much of its activities, as I am not happy with the divestiture to Huntsman at cheaper EBITDA multiples of around 6.5 times, when factoring in the assumption of pension liabilities.

The dilutive divestiture and the fact that Rockwood is now transformed in to a much smaller company, although operating in a promising business, is a worry to me with shares around their highs.

Valuation multiples for the remaining businesses are very elevated, if my calculations are correct, so I remain on the sidelines. While I initially had a bit of an upbeat stance, I have turned slightly bearish following the news.

Source: Rockwood Holdings - Dilutive Divestiture Reduces Any Leftover Appeal