KKR - Chase Corporation And KKR: High-Probability Merger Arb

2023-07-24 09:05:58 ET

Summary

• Chase Corporation is getting acquired by KKR & Co. Inc. at $127.50/share.
• The transaction is highly likely to close.
• There is also a possibility of a price bump to over $140/share.
• Why might higher/competing bids be in the cards?

This discusses a recently announced merger that has a high probability of closing successfully. The merger consideration comes at a tiny premium to pre-announcement levels, suggesting that the downside here should be well-protected.

Chase Corporation ( CCF ) is a $1.2bn market cap specialty chemicals manufacturer. The company produces protective materials, including coatings, adhesives, sealants, and tapes for a wide variety of end-markets ranging from automotive and electronics to energy. Last week, the company announced that it is getting acquired by the alternative asset management giant KKR & Co. Inc. ( KKR ) at $127.50/share in cash. Currently, there is a narrow 1% spread to the merger consideration. The transaction will require approval from CCF's shareholders. 26% of outstanding shares, held by CCF's founding Chase family members (including the CEO), are already in support, indicating that the equity holder approval condition is likely to be satisfied. The merger is expected to close in Q4 2023. The downside to pre-announcement prices is minimal at 2%.

The transaction appears highly likely to close, making it a low-risk merger arbitrage opportunity. Perhaps the most interesting aspect here is the possibility of higher/competing bids. Media reports from June indicate that the company received multiple bids from private equity suitors, including Pritzker Private Capital, before agreeing to be acquired by KKR. Several arguments suggest that there might potentially be a higher offer coming from KKR and/or other financial/strategic industry players.

Firstly, KKR's current offer only represents a tiny 3% premium to CCF's unaffected share price. Even if we consider CCF's share price on June 9 when the sale exploration was first reported by WSJ, the premium remains a meager 3.6%. The steep share price rise this year before the buyout rumors (+40%) seems to have been unrelated to the company sale talks and was instead driven by CCF's strong underlying performance, with revenues and adjusted EBITDA continuing on their steady growth path despite the challenging macroeconomic environment. Worth noting is that the acquirer KKR has a track record of sweetening its takeover bids:

• At Circor, the private equity ("PE") firm has recently lifted its bid from the initial $49/share to $51/share and eventually to $56/share in the span of less than two months. The transaction is currently pending.
• In Nov'21, KKR approached Telecom Italia, proposing to take it private at a $12bn valuation. The PE firm has since raised its bids several times, with the latest one coming in Jun'23 at $25bn.
• In Nov 2017, the alternative asset manager boosted its tender offer price to acquire Hitachi Kokusai Electric to JPY 3,132/share. This was 8% above the previous bid in Oct '17 and 25% higher than the initial price proposed in Apr'17. The tender closed successfully in Dec'17.
• In Sep '17, KKR sweetened its bid to acquire Pepper Group to A$682m. This came after the parties agreed to a merger valuing the target at A$676m in Aug '17.

Secondly, the transaction values CCF at 13.4x TTM adjusted EBITDA. While this may appear an already lofty multiple, CCF stands out as a high-quality specialty chemicals roll-up with an impressive performance over the past decade. Over the last ten years, the company has displayed solid topline growth (8% CAGR) with above- sector average gross and operating margins (mostly >35% and >17% respectively), leading to significant cash flow generation. CCF's solid performance can be attributed to several factors:

1) Significant switching costs for consumers (as CCF's products make only a tiny part of the customer's total costs but are critical).

2) Market-leading positions across its markets with mostly no/little competition due to small addressable markets of its products.

3) A widely diversified customer base, implying low cyclicality.

While no directly comparable peers exist, a look at other specialty chemical producers suggests there might be potential for a price increase:

• RPM ($12bn market cap) is currently valued at 14.7x TTM adjusted EBITDA. RPM produces waterproofing, coating, and roofing systems as well as sealants, air barriers, tapes, and foams.
• KWR ($3.5bn market cap) trades at a 15.5x multiple. The peer produces metal removal and cleaning fluids, corrosion inhibitors, and other specialty chemical products for heavy industrial and manufacturing applications.
• SHW ($69bn market cap) is currently trading at 21.1x TTM adjusted EBITDA. SHW manufactures architectural/industrial paints and coatings.

While admittedly smaller than its comparables, CCF has shown higher TTM adjusted EBITDA margins at 24% compared to SHW (17%), RPM (14%), and KWR (14%). Additionally, CCF's net leverage ratio is significantly lower at 0.9, while its peers have ratios above 2.7x. The three peers have demonstrated comparable topline CAGR of 6-11% from 2012 to 2022. Given these arguments, valuing CCF at 15x TTM adjusted EBITDA would not be unreasonable. At this multiple, CCF's estimated value would exceed $142/share.

Finally, it is worth noting that CCF's shareholder base includes the Neuberger Berman Group (owns 9%). Neuberger has previously ran several activists, including at Nuance Communications, where the shareholder pushed for management changes. After pressure from the activist, Nuance eventually announced a spin-off of its Automotive business. There is a tiny chance of Neuberger Berman opposing the current merger given its tiny premium.

These arguments suggest that there is a possibility of a higher bid coming from KKR and/or other strategic/financial acquirers. However, even without any competing/higher bids, the downside appears to be protected as the current transaction is highly unlikely to be derailed. CCF's founding Chase family has steered the company since 1946. The fact that they have suddenly decided to launch a sale process and subsequently came to terms with KKR indicates that they are willing sellers here. If the transaction closes successfully on current terms, the founding family would receive c. $315m from the sale of their ownership stake, coupled with another $5m received by the current CEO and chairman as part of the change in control severance. Meanwhile, the buyer KKR is highly reputable (>$500bn in AUM) and is not walking away from this transaction. The acquisition would allow KKR to add CCF to its industrials portfolio, which has over the years included Minnesota Rubber and Plastics, Charter Next Generation, and Hyperion Materials & Technologies. Minnesota Rubber, acquired by KKR in 2018, has been a successful investment for KKR, with the firm reportedly making three times its original investment after the company's sale in 2022.

Takeaway

Chase Corporation offers investors a low-risk merger arb. The transaction is highly likely to close, given the founding family's willingness to sell the business and the acquirer's reputation. There's a chance of a higher bid given the current offer's tiny premium, existing headroom for a higher bid based on relative valuation as well as KKR's history of bumping offers. There is no certainty of an offer increase, but at current prices the downside seems to be protected, offering investors this low-risk optionality.

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