Sick of Wall Street's cold shoulder,
is dressing itself up to be noticed.
With an overseas suitor waiting in the wings, Engelhard disclosed an elaborate plan Wednesday under which it would use borrowed money to repurchase 20% of its outstanding stock at a major premium to its current market price. The proposal is both a repudiation of -- and an enticement to --
( BF), the German chemical company whose hostile offer in January shook Engelhard's stock out of a decade-long slumber while earning the scorn of management.
Specifically, Engelhard is proposing a transaction in which it would buy back 20% of its outstanding stock for $45 apiece -- $7 a share more than BASF has offered, and about $15, or 50%, more than Engelhard had fetched at any time before BASF's offer surfaced. The company justifies the big premium with a price-to-earnings analysis that focuses on earnings projections and the valuation afforded to some of its peers.
The looming question is whether BASF will be willing to see it Engelhard's way and make a new bid that recognizes the company's math. One question: does the willingness of lenders to pony up money for Engelhard's buyback suggest that Wall Street agrees the shares are valued too stingily by investors and BASF?
Maybe. Still, it's important to recognize that by offering $45 for one-fifth of its outstanding stock, Engelhard is not implying that the whole company is worth $45 a share. A successful counteroffer from BASF would presumably lie between its current bid of $38 and a pro-rated ceiling in which Engelhard's $7-a-share premium was spread over many more shares.
A quick analysis of this so-called blended price -- taking into account 20% of shareholders selling at $45 and the remaining 80% at $38 -- suggests a fair value for the shares is closer to $40. The arithmetic is visible in Engelhard's share action Wednesday: The stock is up 64 cents, or 1.7%, to $38.94.
In a response Wednesday, BASF was noncommittal, although it did note that Engelhard's repurchase proposal came after the company failed to find any other potential buyers for its business.
"BASF is considering all its options," the company said. "As stated during Engelhard's investor conference call today, no party participating in Engelhard's robust process valued Engelhard at greater than $38 per share or offered an attractive proposal for any part of the business, notwithstanding full access to nonpublic information and access to management."
On Wednesday, analysts praised Engelhard's approach, which now -- absent any white-knight bidders -- seems to be the only way to give shareholders a choice ahead of the annual meeting on June 2. Interestingly, the company is floating a proposal at that meeting which would expand the company's board by three members, a request of BASF.
Engelhard's hard-lined approach to BASF is likely only possible in the liberal environment for debt financing that exists today. Its semiexotic "self tender" is similar to other recent leveraged share buybacks that were instituted amid buyout interest (like
Affiliated Computer Services
( ACS)) or moribund share prices (
"In corporate bond markets overall, cost of financing is attractive," said Ed Marrinan, head strategist at JP Morgan, in a conversation with
earlier this month. "If the cost of raising equity is 8% but I can borrow capital at 6%, and that is supported by tax deductions with interest, there is a clear, compelling reason to borrow money."
Leveraged buybacks are attractive to managers for several reasons. In corporate finance, a theory exists that a company with more leverage on its balance sheet can be worth more to equity investors. For example, if a company borrows money at a rate that compares favorably to the "earnings yield" of its common shares, it can theoretically boost per-share earnings through share repurchases. In addition, companies receive a tax break on interest, also pushing up shareholder returns. These market conditions work well enough for Engelhard that the deal will supposedly add 6 cents a share to 2007 earnings, contingent on the company receiving an additional $15 million in cost savings from its existing operations.
Engelhard's leveraged share buyback is different in meaningful ways from other recent share buybacks, however, namely in scope -- the buyback would redeem only one-fifth of the company's outstanding shares. Its true target appears to be the hearts and minds of investors, who for years have refused to get excited about the financial prospects of a chemical company.
Engelhard, as well as many industry analysts, believe those prospects have brightened significantly in recent years thanks to the economic expansion in Asia. The company is now projecting double-digit annual earnings growth (about 16%, according to executives on a conference call Wednesday) through the end of the decade.
As a result, Engelhard and its financial adviser, Merrill Lynch, believe the company has been saddled with a ridiculously low earnings multiple. BASF's $38-a-share offer values the company far lower than Engelhard's competitors currently trade, at 14.9 times 2007 earnings. Meanwhile, competitor
trades at 15.3 times projected earnings, and
fetches 17.6 times.
Despite how BASF values the company, now shareholders have a choice. And if investors buy management's story over the next five weeks, Engelhard may have found the next best thing to a white knight.