Acquisition of A. Schulman doubles LyondellBasell's annual sales, capacities

FAIRLAWN, Ohio—Joseph Gingo grew up knowing all about A. Schulman Inc.

His father worked at the company's first plant. He remembers meeting founder Alex Schulman at company picnics when he was a child.

And, of course, he led the company through its massive growth years, serving as CEO from 2008-14.

But the company he now oversees, which is about to be acquired by LyondellBasell Industries (LBI) in a massive $2.25 billion deal, is far different from the one he once led, suffering from a troubled purchase of Citadel Plastics in 2015.

"When I first got here, we had very little debt, so I was able to re-open a plant, buy companies and equipment and expand all over the world," Gingo said in a Feb. 15 phone interview following the announcing of the pending LBI purchase.

"When I came back, we were $1 billion in debt and Citadel wasn't generating the profits that we had expected."

The $800 million Citadel acquisition, which first began when Gingo was CEO but was completed under his replacement, Bernard Rzepka, went bad after problems arose with some materials made by Citadel units.

Those problems led to Schulman taking a $402 million charge in 2016, and ousting Rzepka. Gingo resumed the CEO post in 2016, ending his retirement plans.

At that point, Gingo said Schulman started "a robust strategic alternatives process" with its board, including the possibility of keeping the company going. When Schulman received the LBI offer, he said it was "a good offer that we needed to let our shareholders know about."

Schulman's current options also are limited because of its debt, according to Gingo.

"I could invest in the company, but acquisitions are off the table, and I couldn't close plants because of severance costs," he said.

The LBI deal will mean a major shakeup in the global materials sector.

LBI, based in Houston and London, is one of the world's largest producers of olefins and polyolefins, including polypropylene and polyethylene. Fairlawn, Ohio-based Schulman is a leading compounder and concentrates maker in North America and Europe and also ranks as one of Europe's largest resin distributors.

The transaction would create an industry-leading compounding business with combined sales of $4.6 billion and adjusted EBITDA of $446 million over the last 12 months. The new business expects to capture $150 million in cost synergies within two years, creating significant value for shareholders.

The deal adds Schulman's $2.5 billion in annual sales, 54 manufacturing sites and 2.4 billion pounds of production capacity to LBI's own PP compounding unit, which has $2.1 billion in annual sales, 18 manufacturing sites and 2.5 billion pounds of production capacity.

One of the main benefits to LBI from the deal—as seen in materials presented before a conference call with analysts—will be diversifying a PP compounding business that gets 90 percent of its sales from the automotive market. By comparison, Schulman's top five market segments are more varied, led by packaging with a 25 percent stake.

Combining Schulman with LBI's compounding would create a unit with 53 percent of its sales from automotive, but also with sizable chunks from packaging, electrical/electronics, building/construction and other markets.

The deal still needs the approval of Schulman shareholders and regulators, but is expected to close in the second half of 2018.

On a conference call, LBI CEO Bob Patel said the Schulman deal reminded him in some ways of when Lyondell Chemical Co. and Basell Polyolefins combined to form LBI.

"When we complete the integration of the two companies, I think you'll see greater strength on both sides," he said.

Patel added on the call that he was "personally very excited about this transaction."

"I have a lot of respect for Schulman," he said. "This is a unique opportunity to acquire a company with a great long-term reputation."

A 90-year history at Schulman

The 90-year-old Schulman began as a rubber brokerage in Akron and now employs 5,100 at 54 locations worldwide.

Business was rocky when Gingo took the reins in 2008 after a career of more than 40 years as an executive with Goodyear Tire & Rubber Co.

Schulman's European operations had been outpacing its U.S. ones for so long that, by fiscal 2007, Europe was accounting for 72 percent of Schulman's total sales and all of the firm's profit. New York investment firms Barington Capital Group LP and Ramius Capital Group L.L.C. had been hammering Schulman for underperformance, leading to the departure of longtime CEO Terry Haines.

Gingo steered Schulman away from automotive and into areas like packaging and color concentrates, while balancing its global sales profile before retiring in 2014.

For its 2017 fiscal year ended Aug. 31, Schulman had sales of $2.46 billion, down roughly 1 percent from the prior fiscal year. Profit came in at $34.2 million, up from a loss of $356 million in 2016.

Custom concentrates was Schulman's largest product category in fiscal 2017, generating 46 percent of total sales. Europe/Middle East/Africa was Schulman's largest regional market, generating 49 percent of total sales.

Compounding accounted for 6 percent of LBI's 2017 sales total of $34.5 billion. That amount was up 18 percent vs. 2016. The firm's total 2017 profit surged 27 percent to almost $4.9 billion.

A different future

The future of Schulman's resin distribution businesses was not addressed in the news release announcing the deal. Schulman distributes resin for several firms in Europe,the Middle East and Africa; including PE and PP made by ExxonMobil Chemical Co. Schulman also distributes PE for ExxonMobil in the U.S. and Canada. The two firms have worked together for more than 20 years.

The fraud alleged by Schulman against Citadel's former owners "was a significant factor in [Schulman's] problems paying down our debt," Gingo said. If the Citadel deal had performed as expected, Schulman "would be continuing to grow as we did before, and would be adding onto the business," he added.

Schulman filed a lawsuit in Delaware Chancery Court in June 2016 against former Citadel owners, including Huntsman Gay Capital Partners and Charlesbank, as well as several former Citadel executives. Recent court documents listed an April trial, with no set date.

That ongoing lawsuit is leading consulting firm Northcoast Research of Cleveland to suggest that Schulman shareholders hold on to their shares in spite of the LBI offer.

"We don't think shareholders should necessarily sell [Schulman] shares just yet, as there could be some upside to the $42 [per-share] purchase price," research analyst Kevin Hocevar wrote in a Feb. 15 note.

The main reason, he explained, is the contingent value right (CVR) received as part of the compensation package in the LBI offer. If Schulman wins the case, Hocevar said, it could recover far more than the $38 million in escrow that is still owed to Citadel.

Northcoast's understanding of the CVR, as outlined in the LBI purchase, is that Schulman shareholders would receive that first $38 million, but the remainder then goes 80 percent to shareholders, 15 percent to LBI and 5 percent to attorneys.

Other possible outcomes include Schulman recovering $200 million of the $400 million impairment charge that Schulman took on Citadel—the portion related to the thermoplastics business—or even recovering the entire $800 million purchase price.

"Though we are not lawyers, we have always felt Schulman has a strong case," Hocevar wrote. "And even if Schulman can simply recover the $38 million in escrow, that's $1.25 per-share with potential for significant upside."

Overall, he added that Northcoast is not surprised to see Schulman being sold.

"Since Gingo resumed his role as CEO in 2016 and made changes to the remaining C-level suite, we felt there was no clear succession plan in place," Hocevar said. "We feel the purchase price is a fair value for Schulman."

Pivotal profit

Plastics financial adviser Bill Ridenour has worked on deals with Schulman in recent years. In a Feb. 15 phone interview, he said the LBI transaction could benefit both sides, adding that $2.25 billion was a fair price and was similar to what he estimated Schulman's value to be several months ago.

Ridenour, president of Polymer Transactions Inc. in Foxfire, N.C., added that recent U.S. tax reform both increased Schulman's value and gave LBI more funds to spend on the acquisition.

He also said Schulman's recent profit improvement was "a pivotal factor" in the deal, and that the transaction will give LBI a good downstream outlet for its PP and PE resins.

Looking ahead, Ridenour said he would not be surprised if Schulman eliminated a large number of jobs at its Fairlawn headquarters, since they could be duplicated elsewhere within LBI. He added that some smaller PP compounding assets in Evansville, Ind., might close, and that Schulman's thermosets business could be sold, since it has no real match at LBI.

The failure of the Citadel deal proved to be the first step that led to Schulman's eventual sale to LBI, according to Ridenour.

"I think the Schulman board was impatient to do a big deal before [Joe] Gingo retired," he said. "I have to give Gingo credit for what he was able to accomplish, because he always was under pressure to do deals from the time he got there."

In a Feb. 15 email, market veteran Phil Karig, managing director of the Mathelin Bay Associates L.L.C. in St. Louis, said the LBI/Schulman deal "is at least partly analogous to what went on in the PVC business years ago, when PVC resin producers integrated downstream into PVC pipe production in order to increase their overall gross margins."

In LBI's case, he added, the Schulman deal offers LBI "a captive, in-house customer" for large quantities of PE resin while the overall North American polyethylene market "is facing years of substantial overcapacity and downward pressure on margins."

As for whether downstream integration for resin producers makes sense overall, Karig said, "these things tend to run in cycles."

"When investors periodically decide that they would rather see pure play resin companies instead of integrated companies, the pendulum will swing back toward divestment of downstream operations," he explained.

"I think this type of deal is a good way to gain competitive position in a North American market, which is about to be oversupplied with new capacity," said Paul Bjacek, chemicals and natural resources research director at Accenture Research in Houston. "Exporting companies will have likely lower netbacks on their product. Therefore gaining an intermediary path to final customers could be a very good approach, especially when turning products into higher value goods.

"I have blogged/presented in the past on how the [North American] market is becoming more demanding in terms of quality and performance as it raises it's sophistication to stay competitive and innovative," he added in a Feb. 15 email. "This [deal] plays well here."

Bjacek also said that distribution and global market access "will be very important" in a new era of high and rapid North American volume growth.

Schulman's financial challenges also have affected its per-share stock price. The price peaked above $48 in early 2015, but had fallen to near $26 by mid-2017. It had recovered to close near $39 on Feb. 14.

Immediate positive reaction to the LBI deal sent Schulman's stock price up more than 10 percent, to almost $43, in late trading Feb. 15.