The Other Shoe Drops For Calumet

| About: Calumet Specialty (CLMT)

When Calumet Specialty Products Partners (NASDAQ:CLMT) completed a stock issuance a month ago, we knew that the company had some options.

With yesterday's announcement of the acquisition of Royal Purple, we now know the direction CLMT took: acquire a complimentary product line.

Royal Purple is a line of high-end lubrication products which is highly regarded in racing and other high performance automotive applications. According to this website, some of the products sell for nearly $10 per quart, a premium in the marketplace.

There will be a conference call discussing the transaction on Friday June 8.

It might be fun to do a little speculation about the deal, knowing like we do that the actual details will be forthcoming.

Transaction Cost $335,000,000
CLMT Price/Sales Ratio 0.31
Transaction Price/Sales (Hypothetical) 3
Possible RP Sales Volume $111,666,667 Per Year
Current Est Gross Margin (Ashland Synthetic Oil business) 30.80%
NOI at Ashland Gross Margin $34,393,333 Per Year
Stock Issuance 149,000,000
Debt Required 186,000,000
Interest Rate 9.39%
Annual Interest Expense Increase 17,460,750
Gross Margin Needed to Break Even 16%
Net incremental income 16,932,583
Current Units Outstanding (post-issuance) 57,500,000
Additional EPS 0.29
PE Ratio 11
Incremental Stock Price Benefit 3.24

We know that CLMT's price-to-sales ratio is 0.31, and it is really unusual to find basic chemical type companies that are selling for more than 1X their annual sales. If we make the assumption that this is a specialty consumer goods company worth 3X its annual sales, annual Royal Purple sales might be around $110M.

How likely is this?

I did a stock screen of companies which have a price/sales ratio of greater than 2.0, with market capitalization of over 100M, in the specialty chemicals business, and ended up with a select group of 16 companies including some household names, such as WD-40 (NASDAQ:WDFC) which is valued in the marketplace at 2X sales. So, unless CLMT paid an unusually high price for Royal Purple, the $100M sales estimate may be on the conservative side, and it could actually be closer to $150M

We also know that per page M-13 of its annual report, Ashland Chemical sells a very similar line of products to consumers through various retail outlets, and the gross margin of this product line is 30%. This is a big improvement over CLMT's 7% average gross margin for its synthetic lubricant business, per its most recent annual report.

If (big if) Royal Purple's annual sales are on that order, at those margins, there should be about a $30M positive effect on net income.

Per the transaction announcement, CLMT raised $149M from the recent share issuance, and will probably have to finance the remainder of the $335M. The company's line of credit is just under 9.5% interest, so we know that the incremental increase in interest expense will be about $17M per year.

The net of all of this is an increase in NOI of plausibly $17M which amounts to $0.29 per unit, and given the company's 11:1 PE ratio should mean an additional $3.34 to the stock price, or more if the Royal Purple sales are more than $111M.

Of course, these numbers could be validated (or not) in the conference call on Friday, but based on what we know in the marketplace, the figures above are reasonably plausible.

The world is chaotic, and there are no guarantees on anything, but based on an educated guess, we are looking at a potential benefit for the stock price based on this transaction. We will know the exact numbers shortly.

Disclosure: I am long CLMT. I was going to wait until August to increase my position in CLMT but may do so sooner depending on what happens in the marketplace in the next couple of weeks.