BNTGF - Brenntag SE: Increasingly Likely Separation Offers Upside Potential

2023-05-31 04:50:43 ET

Summary

• Activist investors PrimeStone Capital and Engine Capital are pushing for a separation of Brenntag SE's specialties and essentials divisions.
• PrimeStone proposes its own candidates for the company's supervisory board - which Engine Capital as well as proxy advisor ISS support.
• The election of PrimeStone's candidates could lead to a strategic overhaul and spin-off of the specialties division, potentially creating significant shareholder value.
• Even if Brenntag tries to fight off the activists, short-term measures to do so may benefit shareholders.

Chemical distributor Brenntag SE ( BTNGF ; BTNGY ) is facing a proxy battle at the upcoming general meeting on June 15 ^th . Activist investor PrimeStone Capital, who are calling on the company to separate its specialties and essentials divisions, has proposed its own candidates for two supervisory board due to be filled. Another activist shareholder, Engine Capital, has already announced its intention to support those candidates. Engine Capital, too, argues for a separation of the two segments via a spin-off of the specialties business.

If those candidates, former Goldman Sachs MD Joanna Dziubak and Geoff Wild who was CEO of various chemical companies including Atotech and AZ Electronic Materials, are elected over Brenntag’s preferred candidates, a separation of the company’s two divisions becomes increasingly likely in my opinion. That, in turn, has the potential to create significant value for shareholders, I believe.

The Case For Separation

As I do not think that a mere repetition of arguments already made by others offers much value to readers, I will only offer a brief overview of why I think a separation of the specialty and essentials businesses would create shareholder value. I largely agree with PrimeStone’s assessment. Thus I will refer readers to their shareholder’s presentation (which is available here ) for a more detailed description.

Bottom line: the activists see significantly higher valuation potential for the specialties business as a standalone entity. Pure play specialty distributors such as IMCD N.V. ( OTCPK:IMDZF ; OTCPK:IMCDY ) and Azelis Group NV ( OTCPK:AZLGF ; OTC:AZLGY ) trade at considerably higher multiples than the integrated Brenntag. Furthermore, being part of a group that also deals in essentials, hinders Brenntag Specialties’ access to customers and bolt-on acquisition targets who prefer to associate themselves with specialized distributors. Hence, a separation would enable faster growth for the specialties business.

While I agree with the general assessment, I am, however, inclined to a somewhat more conservative target price in the case of a successful separation. While Engine Capital estimates a share price of € 140 within 24 months and PrimeStone even sees potential for €170 within 3 years, I think that a share price closer to €105 in the short term and €120 within 2 to 3 years is more realistic. My reasoning behind these estimates is that necessary operational improvements at the separate divisions will take their time, especially taking into account that at least initially many of the same executives would be in charge. A spin-off alone would not automatically put the standalone entity at the same level of execution as competitors.

This notwithstanding, there is certainly ample upside from the current share price. Yet, to create said value, a separation has to be put on track in the first place. So how likely are the activist proposals to become a reality?

Election Chances

To start with, it should be determined how likely the PrimeStone candidates are to be elected. Based on turnout numbers of the last five general meetings, about 80 percent of the registered share capital can be expected to be represented. Hence, any candidate will most likely require the support of shareholders representing about 40 percent of voting rights in order to be elected.

PrimeStone and Engine Capital control about 2 and one percent of the voting rights respectively. BlackRock Inc., Wellington Management Group LLP, Capital Group Companies Inc., Flossbach von Storch and Burgundy Asset Management control a combined share of at least 21 percent of votes based on mandatory notifications in accordance with the German securities trading legislation (section 33 WpHG).

Those institutional investors are pretty likely to vote in accordance with proxy advisory services’ recommendations. ISS already issued a recommendation against Brenntag’s proposed candidates and in favor of PrimeStone’s proposals. While the second large proxy advisor has not yet issued any statement, more often than not, Glass Lewis and ISS agree in their assessment.

That makes for probably around a quarter of votes (the 21 percent figure is the theoretical minimum controlled by the aforementioned institutional shareholders). Add to that all those institutional investors who do not report ownership exceeding 3 percent, but who inevitably must own Brenntag shares due to it being a component of indices and thus included in ETFs replicating those indices, such as Fidelity or Vanguard.

On the other hand only one major shareholder openly opposes the candidates, so far. Klaus-Michael Kühne, via Kühne Holding AG, owns a little over 5 percent of Brenntag. Kühne Holding AG has come out in support of Brenntag’s candidates and the company’s integrated strategy. Members of the supervisory board and executives, meanwhile, do not control a meaningful number of votes.

So, as of right now, I believe that the election of one or both of PrimeStone’s candidates appears not unlikely. This, of course, would only be a first step.

What Comes Next?

Brenntag, being a German company, has a two-tier board system. The supervisory board (“Aufsichtsrat”) is elected by the general meeting (= by shareholders) and in turn appoints (and dismisses) the members of the executive board (“Vorstand”). Due to its legal form of a Societas Europaea (in short: “SE”) rather than an Aktiengesellschaft (the classic public limited company under German law), Brenntag was able to avoid the necessity of employee representation on the supervisory board level usually required under German corporate law. Hence the board consists of only six members who are elected by a simple majority of shareholders.

Per Brenntag’s Articles of Association (a convenience translation is available here ) the supervisory board adopts resolutions with simple majority. A tie is deemed a rejection and if a chairman is elected, they have a tie-breaking vote. Hence, in order to force executive management to consider a spin-off (or else face dismissal), at least four members or three members including the chairman would be required.

I assume both Ms. Dziubak and Mr. Wild, if elected, would favor the activist proposals. Their election, of course, would automatically mean that the company’s candidates, Richard Ridinger and Sujatha Chandrasekaran, will not have been reelected or in the case of the latter elected. If Mr. Ridinger (current chair Doreen Nowotne does not stand for reelection) is no longer part of the supervisory board, naturally, he is no longer eligible to be elected its chairman (as Brenntag hopes he will be).

The supervisory board recommends the general meeting votes against PrimeStone’s candidates and motions. That indicates that a minimum of three members voted in favor of said recommendation. This, in turn, means that at least one of the four members not standing for reelection in 2023 likely is in the camp of management’s current strategy. Let us, therefore, take a quick look at the individual members and how likely they may be to be open to the activist proposals.

Ms. Stefanie Berlinger (elected through 2025) is a partner at advisory boutique Lilja & Co. Her transaction background leads me to think of her as the current member most likely to be able to see the benefits of a separation.

Dr. Andreas Rittstieg (term through 2025), on the other hand, I believe to be a “Kühne-man” – he is a member of the board of Kühne Holding AG, as well as of the supervisory board of Hapag Lloyd AG (of which the former owns 30 percent). Given Kühne Holding’s support for the integrated model, I suppose he is rather firmly opposed to a potential spin-off.

Messrs. Donkers and Ulrich Harnacke (both serving through 2026) are what I would think of as the wildcards among the board regarding their stance on a separation of specialties and essentials. An interesting detail is, that Mr. Donkers’ CV lists stations with various activist investors (namely Cerberus, Petrus Advisers). That makes me imagine, he may also see the value of such measures.

So, under the assumption of both PrimeStone candidates being elected, I think that a board majority for the serious exploration of a separation is in range. Even more so given the clear message of shareholders’ wishes their election would send. In that context I will also pay particular attention to the percentage of votes cast in favor of ratification (“Entlastung”) of the supervisory board’s actions: if the approval rating drops materially below the 93.98 percent figure at the 2022 general meeting (which notably was already slightly less than the 96.x percent approvals usual in previous years), it is increasingly likely that members will consider the activist proposals more seriously.

Alternative Sources of Value Creation

Short to medium term, Brenntag leadership may opt for measures to placate shareholders in order to fight off activists. What upside could be expected from such measures is, however, hard to pin down and would have to be assessed based on concrete information, if and when it becomes relevant.

Measures may include more aggressive buybacks (currently the company already plans for a volume of € 750m which translates to about 6.4 percent of outstanding shares at the current price). Management will also be even more motivated to maintain dividend growth. Historically, the CAGR of Brenntag’s distribution has been 11 percent. For fiscal 2022, however, management proposes a hike of almost 38 percent.

Furthermore, I would not rule out the possibility of Mr. Kühne, through his holding, stepping in as a “white knight”. That would require the purchase of additional shares. By my estimate, a stake of about 20 percent of voting rights would result in an effective blocking minority based on expected turnout at the general meeting. Passing that threshold would possibly require at least €1.5 billion (taking into account the existing stake as well as the buyback program). Notably, Kühne Holding AG recently received a dividend distribution of about €3.3 billion from Hapag Lloyd. Naturally, a deep-pocketed investor acquiring a significant number of shares would be likely to bolster the share price, such are the laws of demand and supply.

Conclusion

The election of PrimeStone’s candidates for Brenntag’s supervisory board is not unlikely. If it comes to pass, this may be the catalyst for a strategic overhaul resulting in a spin-off of the specialties division and subsequent creation of significant shareholder value.

Even if the company were to try and fight the activists off, this may benefit shareholders financially in the short term. I therefore will keep an eye on Brenntag as a potential buy with about 40 percent short to medium term upside potential due to increased likelihood of a specialties business spin-off pending the outcomes of the general meeting (in particular: election results; approval ratings for supervisory board and executive management).

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