In the current merger and acquisitions frenzy, the problem facing most predators is that the valuations of their prey are so inflated that it has become difficult to generate economic returns. Consider this perennial takeover target:
Turkey of the week: ICI (ICI), rated as ADD by Evolution Securities
In the current merger and acquisitions frenzy, the problem facing most predators is that the valuations of their prey are so inflated that it has become difficult to generate economic returns. Consider perennial takeover target ICI. Last week its shares rose 6% to close at 540p – their highest level for more than six years. Rumours are swirling that US giant Dow Chemicals is poised to launch a knock-out 620p offer – even though Dow is also viewed as a possible $50bn target. Akzo Nobel and India’s Reliance Industries are also mooted as potential acquirers. With all these bees circling around the honeypot, any acquisition is likely to be very expensive.
In February, ICI reported that operating profits slipped 11% year-on-year in 2006 to £431m. Alan Brown, chief financial officer, said margins were under “significant pressure” in the US. The firm said there was “no easy fix” for the US paint business and chief executive John McAdam warned there were few signs of improvement. It also outlined its strategy for 2007 and beyond, saying it would focus on strengthening its leading positions with purchases in “attractive niches” – thus warning shareholders of possible dilutive future acquisitions.
More interesting for the long queue of purchasers was ICI’s sale of Quest, its flavours and fragrances unit, to Givaudan for £1.5bn. This now leaves the group more focused and with only £0.5m of net debt. Akzo looks to be the prime bidder; it’s the world’s largest paint maker and recently sold its pharmaceuticals business to Schering-Plough for e11bn in cash. Buying ICI would make strategic sense for Akzo, although regulatory concerns could be a problem as the UK market share of the enlarged group would be about 70%. Akzo would probably have to sell its Crown brand in the UK.
But I don’t see a marriage consummated at a price much above current levels – and here’s why. City analysts are forecasting ICI’s 2007 EPS at 31.4p, which on a 14 times p/e would value the standalone business at around 440p per share. Assuming that Akzo could lift ICI’s profit margins by 2.5% (or £125m per annum) by cutting its raw material costs and corporate overheads, then total synergies might be worth around 60p per share. Hence ICI’s share price looks as if it already includes all the synergies (and more) that would be derived from a takeover, making it vulnerable should no bid occur. My estimate of possible synergies might even be too optimistic, since ICI is leaner than it was and there may be little fat left to take out. It already generates top-quartile operating profit margins in many of its divisions when compared with international peers.
Recommendation: TAKE PROFITS at 536.75p