On 24 August 2021, LANXESS announced its acquisition of the Microbial Control business unit of International Flavors & Fragrances (IFF) for an enterprise value of up to USD 1.3bn. The transaction is expected to be closed in Q2 2022, subject to approval from the relevant antitrust authorities. While Scope expects the most relevant ratio, Scope-adjusted debt (SaD)/EBITDA to deteriorate to 2.7x in 2022, it should strengthen to 2.4x in 2023, the first year of the target’s full earnings contribution. This is based on: i) the company’s commitment to a solid investment grade rating and anticipated focus on lowering financial leverage; and ii) the contribution to earnings from the acquired entity. Consequently, Scope expects key credit metrics to remain in line with the requirements for a BBB+/Stable issuer rating.

IFF’s Microbial Control business unit produces biocides, which are used to protect against harmful micro-organisms and pests in multiple industries, such as energy, water, paints and coatings, as well as home and personal care. The company achieves sales of roughly USD 450m and an EBITDA margin above 20%. In view of its historical roots, a large share of business is conducted in North America and Latin America.

Scope believes the tuck-in acquisition to significantly reinforce the market position of LANXESS’ Material Protection business unit, part of the Consumer Production division. In addition to an increased market share, LANXESS will have the widest product portfolio in the industry, including many applications in various industries and geographies. This will provide a considerable moat in a business characterised by technical expertise/knowledge and the regulatory framework.

As mentioned in Scope’s last rating report (see: Scope affirms BBB+/Stable issuer rating of German LANXESS AG), IFF’s Microbial Control unit fits perfectly into LANXESS’ blueprint for M&A, based on the agency’s understanding of the company’s corporate development strategy. This includes developing its Consumer Protection division to a core pillar of the whole entity.

From a diversification point of view, Scope foresees marginal positive effects on LANXESS’ revenue generation by end-market diversification and geography. The acquired division is exposed to multiple industries, predominantly energy, paints and coatings, home and personal care, together with a large share of business in North America and Latin America.

The strong, resilient profitability generation of the acquired business and targeted synergies of up to EUR 30m by 2025 also supports management’s communicated target of an EBITDA pre-margin (before exceptional costs and through-the-cycle) of 14%-18%.

Following the public announcement of the deal, which is anticipated to be completed in Q2 2022 (pending regulatory approval), Scope has updated its rating case for 2022 and extended the rating scenario for the year 2023. This indicates a deterioration of key credit ratios in 2022, including SaD/EBITDA moving to 2.7x at year-end 2022. LANXESS intends to finance the tuck-in acquisition by issuing two bonds, but maintain a well-structured maturity profile, including heathy ratios on internal and external liquidity coverage.

On the positive side, Scope anticipates that SaD/EBITDA will move back below 2.5x in 2023. This is based on: i) the company’s commitment to a solid investment grade rating and anticipated focus on lowering financial leverage, including no exploration of further external growth at least in the next 6-12 months as well as no share buybacks in the foreseeable future; and ii) the contribution to earnings by the acquired entity from the expected completion in Q2 2022, in the context of attractive free operating cash flow generation thanks to cash conversion ratio of around 90%. If necessary, LANXESS’ leadership team has stated that it will explore potential asset sales in order to repair the balance sheet. Such a step would strongly support the credit rating if the current positive economic momentum slows noticeably.

Similar to the acquisition of Emerald Kalama Chemical (see: LANXESS: Acquisition of Emerald Kalama Chemical), Scope believes the purchase of IFF’s Microbial Control unit involves low execution risk, due the fairly simple line-up of the target, which includes only two manufacturing sites in St. Charles (USA) and Institute (USA).

This monitoring note does not constitute a rating action nor does it indicate the likelihood of a credit rating action in the short term. For the official credit rating action release click here. On 4 August 2021, Scope affirmed its issuer rating of BBB+/Stable on LANXESS AG.

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