Even Warren Buffet likes the "business of chemistry" ….another stamp of approval for chemical industry thorough acquisition of Lubrizol

During the last few years, Berkshire Hathaway Inc. has made many investments in chemical and chemistry related businesses such as Nalco, Dow (Rohm and Haas), Great Lakes Chemical (GLK), Kaiser Aluminium & Chemical Corp. Sealed Air Corp, GSK, J&J etc. along with some petrochemical companies like ExxonMobile, ConocoPhillips, PetroChina and so on. Mr. Buffet’s notable commitment to the chemical industry is illustrated thorough Monday's announcement to purchase Lubrizol (LZ) for $135 a share, 28% above Friday's closing price! The consummate value investor, Mr. Buffet is expected to pay $9.7bn (which includes $700m in net debt) for the transaction. Even after paying a $30 premium (i.e. 28%) over the $105 closing price on Friday, Lubrizol transaction is priced at approximately, 7x 2011’s EBITDA and 5.4x 2012’s EBITDA.

Now if you consider today’s availability of cheap money in the capital structure, the WACC is no more than 8.5% (assuming at least 2x interest coverage with a realistic leverage 4.7x - 5x), Mr. Buffet is expected to generate top quartile returns (with a minimum Internal Rate of Return (IRR) percentage in the 20s within 3-5 years!).

We can talk all day long about the public market anomalies, various deal dynamics, and business related topics such as sustainability of margins in the lubricant additives value chain or excessive swings of commodity feed stocks (e.g. energy price, oil and petroleum derivatives). However, a company’s success will continue to depend on the management’s ability to control risk and take advantage of perceived market risks. For example, Lubrizol is a well managed company that poses an excellent profile of a “very good” specialty chemical company, growing its revenue consistently (for example: $3.4B in 2004; $5.4 in 2010), generating very strong cash flows and returns on capital, displaying a strong balance-sheet and flush with cash. We should also realize that Lubrizol has been increasing earnings at a compounded growth rate of 16% (at least for last 10 years; and Lubrizol's earnings growth has accelerated to over 25% per annum during the last 5 years).

Lubrizol continues to maintain its specialty status in a “so called commodity risk” environment by focusing on: its proprietary product (not necessarily patent protected product), mastering its product application for their customers’ system/process, delivering process/system monitoring services and maintaining overall strategic focus etc. (note: Relatively speaking, Lubrizol is neither capital intensive nor over reliant on R&D expenditure). Ultimately, Lubrizol’s strong performance over the years coupled with an excellent new owner should position Lubrizol to be even more successful as it moves forward. What are your thoughts?

Chemical Industry Going Green By the day

Recently, chemical industry leaders BASF and Dow Chemical Company have received recognition from the U.S. EPA’s annual Presidential Green Chemistry awards for creating economically viable and sustainable technologies. Specifically, Dow and BASF won the Greener Reaction Conditions Award for their joint development of an environmentally friendly process for producing propylene oxide via hydrogen peroxide, which reduces waste water by about 75% and energy use by 35%. In the past, BASF has won the award 3 times, Dow Chemical 6 times, and other leading companies such as Merck & Co. have also received this award.

You may be asking why this is important and what impact does it have at all in the chemical industry? True, receiving this award will not likely have a significant impact on the companies themselves; however, it serves as an indication as to the direction of the broader chemicals industry and helps rectify pervasive misinformation about the industry. If you were to ask the average individual what they imagine in association with the words ‘chemical industry’, they will likely imagine immense factories spewing endless amounts of smoke. However, people fail to realize that the interests of chemical companies often align with what is best for the environment. Most importantly, folks fail to recognize that chemistry is essential to modern life;… sectors like pharmaceuticals/healthcare, electronics, personal & beauty care, home and building material, battery and energy storage system etc. depend on the basic science of chemistry. Many innovations that stem from this mentality often end up being beneficial for the environment in terms of fewer by-products, less usage of oil and gas inputs, and more. I am not saying that chemical industry processes are good for the environment in general, but that there is a conscious effort within the industry to become as efficient as possible and minimize impacts to the environment.

In essence, the industry has been ‘going green’ per se, and this effort by leading companies to innovate so as to develop environmentally sustainable and benign processes and products is exactly the mentality required, and will ultimately lead to greater efficiency and more sustainable/consistent growth within the industry, given the proper investment into these novel ideas.