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Back in June of 2023, I identified OMV AG's (OTCPK:OMVJF, OTCPK:OMVKY) petrochemicals division as a potential takeover target for the UAE's Abu Dhabi National Oil Co. ("ADNOC"). As it turns out the two companies indeed entered discussions (although the deal is likely to be structured differently than what I initially envisioned). Below, I will give an update on recent developments and explain my investment thesis for OMV at the current price level.
Kindly note that all per share figures refer to common stock. There are also ADRs which represent ¼ share each.
ADNOC Deal Taking Shape
OMV and ADNOC are currently engaged in advanced discussions of a deal for OMV's 75 percent stake in petrochemicals company Borealis. I have written about the strategic viability of such a combination in a previous article. My earlier assessment remains unchanged in this regard. Therefore, I will not go into detail here, in the interest of brevity.
Previously, I imagined more of an outright sale with ADNOC paying a sum in cash or a mixture of cash and OMV stock for a 75 percent stake in Borealis. According to Reuters sources, the transaction is actually more likely to be a merger of Borealis and ADNOC-controlled Borouge (in which Borealis, in turn, has a significant minority interest of 34 percent). The transaction is expected to have an overall value of about $30 billion. Presumably, the merged entity would be publicly listed, though it is as of yet unclear at which exchange(s). I imagine that the free float would be somewhere in the range of 10 percent of outstanding shares.
Both OMV and ADNOC would have the same equity interest in the combined entity. Given the valuation differences, that will likely result in OMV making an additional investment of somewhere between €1.5 and €2 billion in order to end up with a 45 percent stake in the new entity.
For perspective: OMV's stake in the combined Borealis-Borouge would be valued near the entire group's current market capitalization, if not slightly above. That is, of course, based on the $30 billion valuation for the transaction and my assumption of around 10 percent of free float post merger. The stock market may end up valuing the new company higher or lower.
While I certainly would have preferred an all-cash transaction resulting in a more streamlined OMV focused on oil and gas, I still believe that such a transaction could very well be a major catalyst. Even factoring in a likely increase in net debt levels (Q3: €1.7 billion) due to the additional investment, the standalone valuation for the chemicals division would be more visible. Also, a stake in a listed company could more easily be monetized going forward, if need be.
At a rather conservative multiple of 3 times 2022 - representing a very strong year for the oil and gas sectors - earnings of €2.4 billion, the remaining divisions (including the downstream oil and gas units) should have a standalone value of around €7.2 billion.
Transformation Investments
While I find the perspective of a Borealis transaction appealing, there are other strategic decisions that I like less. Chief amongst them are attempts to diversify into renewables. For example, the company's Romanian subsidiary, OMV Petrom (OMV owns a little over 51 percent), recently acquired a sizable portfolio of wind and solar capacities as well as the country's largest EV charging network. To be clear, there is nothing inherently wrong with renewable energy investments. I do, however, prefer more specialized companies over diversified conglomerates, unless there are tangible synergies. Shell plc (SHEL; OTCPK:RYDAF), for instance, has recently been moving in the opposite direction. Judging from its recent share price performance, the market seems to broadly agree with my view with regard to more focused oil and gas businesses. OMV's leadership, on the other hand, so far remains steadfast in its commitment to diversify in order to eventually achieve carbon neutrality. The fact that the Republic of Austria, via state holding ÖBAG, controls a 31.5 percent stake probably plays a role here, too. So, all in all, I am not overly happy with these developments. Then again, at the current price, I am willing to live with it.
Dividend
One of the greatest advantages of OMV as an investment is its exceptionally high dividend yield. In addition to its regular dividend, which the company intends to constantly maintain or increase, OMV introduced special dividends. The aim is to distribute between 20 and 30 percent of operating cash flows as dividends, as long as the leverage ratio is below 30 percent. For the time being, the leverage ratio is well below this threshold (Q3: 6 percent). So, for the foreseeable future, I believe that annual distributions of €2.8 + X are to be expected. Based on the current share price, that represents a dividend yield of more than 7 percent before any special dividends.
However, one should keep in mind the relatively high Austrian tax rate of 27.5 percent. But even then, the yield should remain more than decent. Especially taking into account the potential of sizable special dividends based on free cash flow. It is, I believe, not entirely unrealistic that oil and gas prices could spike in the short- to mid-term due to the volatile security landscape in the Middle East. That would be likely to translate to strong free cash flow, thus higher distributions.
OMV furthermore has a strong track record in terms of reliability when it comes to dividends. Notably, unlike several other companies in the sector, the company did not cut back on distributions during the pandemic years, with the most recent cut dating back to FY2008.
Risk Factors
Despite the attractive valuation, there are some risk factors to be considered. One such factor is OMV's geopolitical exposure. One risk that has already materialized is the recent nationalization of the company's Yuznoh-Russkoye operations in Russia. However, this business had already been largely written off in 2022.
The energy division continues to operate in several politically unstable regions. Those include Libya, Yemen and Iraq's Kurdistan region. Of those, I believe Yemen to be the riskiest by far, for obvious reasons. OMV's operations in the country depend on the Ras Isa in Sana'a, which is not controlled by the national government but by the Iranian-backed Ansar Allah rebels - commonly known as "the Houthis" - which have recently re-designated a SDGT by the US Department of State. Both this designation (as it creates additional legal risk whenever dealing with the group that effectively rules the territory) and the ongoing military operations against Houthi positions have the potential to impair operations. Notably, OMV had to halt production entirely in 2015 amid the Saudi and UAE intervention against the Houthis.
Libya, too, is a country in a state of internal conflict. But unlike in Yemen, there is currently little to no active fighting. OMV's operations in the country are located in territories under the effective control of Field Marshal Khalifa Haftar who keeps the region relatively calm. Nonetheless, absent a permanent solution to the conflict, the risk profile remains somewhat elevated. Iraqi Kurdistan, meanwhile, is relatively stable internally, but problems may arise in the form of strikes from outside the autonomous region. For instance, Iran's Revolutionary Guard Corps has recently hit Kurdish targets with missiles. Türkiye, too, has been conducting air strikes against various armed Kurdish factions in recent months.
Another negative aspect is the relatively high percentage of government ownership. The interest of the Austria - or more precisely its elected representatives - may not always align with the interests of other shareholders. In particular, political considerations may contribute to overly ambitious ESG commitments at the expense of profitability in the here and now.
Apart from company-specific risk factors, one should also be aware that both the energy and the petrochemicals divisions are inherently cyclical businesses. Hence, an economic downturn is likely to disproportionately affect OMV. There is, I believe, still a very real risk of a global recession, despite a surprisingly robust climate in 2023. The apparent weakness of the Chinese economy may be a warning sign in that regard.
Conclusion
Naturally, an investment in OMV is not without risks. However, I believe the associated risk factors to be manageable. Near term, the increasingly volatile situation in the Middle East could lead to a negative impact on the company's operations. On the flip side, increased tensions in the region could also send oil and gas prices soaring, thus benefitting OMV's profitability. In that context, it is worth remembering the lessons of 2022.
At the same time, I believe that a deal with ADNOC is not only a distinct possibility but a probability at this point. Such a transaction has the potential to create value (or, arguably, make as-of-yet hidden value more visible). By my calculations, an upside of around 40 percent, translating to a share price of around €53.5 would not be unreasonable. That already takes into account around €2 billion of capital contributions as part of a Borealis-Borouge combination.
I will, however, caveat that absent an additional catalyst at least part of the company's potential value may remain locked for the foreseeable future. As I described in the past, a clean separation of the petrochemicals would be the preferable approach to unlock value (under that scenario, my target price would have been even higher at slightly above €60 per share). That seems off the table for the time being. The shareholder structure is not exactly helpful in this regard, either. But the attractive dividend yield, nonetheless, makes the investment worthwhile, I believe. Consequently, I reiterate my buy rating for OMV.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
