I believe that the ChemChina-Syngenta merger will close, which would catalyze an increase of Syngenta’s current ~$80 share price to the agreed-upon deal price of $93 per share.
China National Chemical Corporation (“ChemChina”) is a Chinese state-owned company that produces various chemical products and materials, including industrial equipment. Switzerland-based Syngenta (NYSE:SYT) produces crop seeds, pesticides and herbicides to assist in agricultural production.
With an overvalued US equities market, taking advantage of a strong continuing M&A market is probably a more viable method of extracting value from the market rather than traditional value investing. The proposed $43 billion ChemChina-Syngenta merger could represent one such corporate opportunity to profit from.
Two days ago, the European Commission announced that it was extending its deadline regarding the review of the merger between the two companies by an additional ten days to April 12, 2017. European Union regulators initially began their review of the merger in October 2016, nine weeks after the Committee on Foreign Investment in the United States (“CFIUS”) okayed the deal. The decision was made regarding matters of product overlap that could give the combined entity too much market power in certain segments. The deal was initially slated to go through by year-end 2016 (as of its February 2016 announcement), but has run into a few stumbling blocks that have delayed its prospective close.
It is expected that these concerns will be relatively minor. There is some level of chemical production overlap, but it is very likely that regulatory pushback will be assuaged through minor divestments (if there are indeed any required) that do not significantly alter the financial or operational profile of the company. There is little concern that the commission’s action requirements would materially decrease the probability of a deal going through.
Traditional credit analysis would suggest that a successful acquisition of Syngenta may be slightly negative for ChemChina’s bondholders through increased leverage and standard levels of integration risk. However, ChemChina is state-owned (i.e., wholly owned by the Chinese government), which helps to mitigate credit risk given its backing. Overall, the company will emerge from the deal as a more integrated company with diversified revenue streams and a broader overall operational profile.
ChemChina’s bondholders project to actually be worse off should a deal not go through, due to a $3 billion breakup fee and the fact that a closure of the deal does not materially worsen the company’s credit metrics. ChemChina could nonetheless avoid this fee if Syngenta is required to divest assets of more than $2.68 billion (20% of its sales), as dictated by a non-Chinese regulatory authority.
What happens if the deal doesn’t go through?
ChemChina bid $93 per share plus a CHF 5 special dividend for Syngenta. Should the deal falter, Syngenta is unlikely to return to its functional standalone price on account of potential additional sale interest. Monsanto (NYSE:MON), before its $66 billion merger announcement with Bayer, had been a previous suitor who had offered ~$89.80 per share.
If we conservatively assume $12.9 billion in FY2017 revenue (and 3% year-over-year growth thereafter), a stable 17% EBITDA margin, a 15% effective tax rate, depreciation expense at 4.5% of sales (and correspondent to capex), a cost of debt of 3.7% estimated off comparable A+/A2 rated debt, a long-term growth rate of 1.8%, we would value Syngenta at about $60-$67 per share on a standalone basis if we discounted back at a cost of equity of 7.0%-7.5%. Valuing using the multiples of industry peers returns a similar valuation.
Considering some remaining buyout potential should the ChemChina deal falter, Syngenta may be inclined to trade above this $60-$67 range. In terms of deal closure probability, if we use the lower-bound price ($60), there is currently a 60.6% chance based on the market’s expectations using an $80 current share price and a $93 per share buyout price, excluding the special dividend [1 – ($93-$80)/($93-$60)]. If we use the upper-bound price, which is probably more accurate as my valuation is somewhat conservative, the probability drops to precisely 50% [1 – ($93-$80)/($93-$67)].
In sum, I believe the probability of the deal’s closure is higher than merely 50%-60%. ChemChina has the funding availability and will undergo no material downgrade to its credit profile. Moreover, the company will benefit from the strategic interconnection of the merger given additional scale and operational diversification. Any market overlap concerns from the European Commission is fairly limited and should require little in the way of divestitures, if any, from either company. With 97 days before prospective closing, and a 16.25% price disparity ($93/$80), a finalization of the deal could provide a 76% IRR [(1 + 0.1625)^(365/97) – 1].
Disclosure: I am/we are long SYT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.