Eastman Chemical Deal Takes Sector Out of M&A 'Penalty Box'

KINGSPORT, Tennessee ( TheStreet) -- After Eastman Chemical ( EMN) announced a $3.4 billion acquisition of specialty plastics and chemicals maker Solutia ( SOA), the news sent both company's shares soaring. For the chemicals sector, the tie-up may have a larger significance.

Since the financial crisis, there have been few notable U.S. deals outside of Berkshire Hathaway's ( BRK.A) $9.2 billion acquisition on Lubrizol, CF Industries' ( CF) $4.7 billion purchase of fertilizer producer Terra Industries and Cargill's spinoff of Mosaic ( MOS).

Meanwhile, ambitious hostile offers like Air Products & Chemicals ( APD) $7.5 billion offer for Airgas ( ARG) and Agrium's ( AGR) $3.3 billion offer for CF Industries ( CF) failed as targets fended off bids at what they called cyclically low and undervalued prices. In 2012, more buyers and sellers may come together on scarce opportunities in the sector as stock prices and balance sheets recover.

"2011 was an unusual year, in that chemical companies that conducted large M&A did not remain in the penalty box for long," writes Jefferies analyst Laurence Alexander, in a note reacting to Eastman Chemicals bid.

Alexander expects that the deal and a Jan. 13 hostile $1.1 billion offer by Westlake Chemical's ( WLK) for Georgia Gulf ( GGC) signals continued consolidation within the sector.

Albermarle ( ALB), Celanese ( CE), Cytec ( CYT), Huntsman ( HUN), OMNOVA Solutions ( OMN) and W.R. Grace ( GRA) are all potential take-out candidates notes Alexander, with Huntsman and OMNOVA Solutions offering the biggest upside to Jefferies buyout models. Both of those companies saw their shares rise over 5% on news of the deal.

Jefferies expects that U.S companies may cut deals to add hard to get emerging market chemicals growth, while Asian and Middle Eastern giants may look cutting deals to get a greater access to basic material supplies. "We expect consolidation to continue in the sector, with U.S. and European firms looking for scarcity value and market-leading positions, Asian firms looking for technology and Middle Eastern firms looking for vertical integration," writes Alexander.

The move to buy Solutia, which makes aftermarket materials like glass and coatings that are used by automotive and architectural customers, is also expected to diversify the Eastman Chemical's revenue further into emerging markets and boost earnings through cost synergies. Those businesses could also benefit from a continued post-crisis recovery in global auto sales and real estate construction.

Under the deal, Eastman Chemical will pay $27.65 for each Solutia share, a premium of 42% to Solutia's closing price Thursday of $19.51. Solutia shareholders will get $22 in cash from Eastman Chemical and 0.12 of an Eastman share for each of Solutia share, the companies said in a Friday statement. The deal values Solutia at $4.7 billion, when counting its debt.

"The acquisition of Solutia is a significant step in our growth strategy," said Eastman Chemical Chief Executive Jim Rogers in a statement.

On news of the deal, Solutia shares surged nearly 40% to $27.27 in early afternoon trading, while Eastman Chemical shares also rose over 6% to $49.95.

Content on this page requires a newer version of Adobe Flash Player.

Get Adobe Flash player

For Eastman Chemical, which missed fourth quarter earnings estimates on Thursday on rising materials cost and a drop in operating income from its plastics division, the deal is expected to help the company show earnings improvement in 2012.

On Thursday, Eastman Chemical bumped up its first quarter earnings per share estimates as high as $1.15, while it forecast $4.64 in 2012 earnings per share, a boost from 2011 EPS of $4.56.

The merger carries high expectations for Eastman Chemical's top line growth and its bottom line costs. With Solutia, Eastman Chemical will boost its Asia Pacific revenue by over 33%, helping to diversify the balance of its earnings from the U.S., where roughly half of its sales occur. "By leveraging infrastructure in the region, Eastman expects to have a compound annual growth rate in Asia Pacific approaching 10 percent for the next several years," said the company in a statement.

Because of the emerging market growth, the deal will immediately add to 2012 earnings per share and will help lift 2013 EPS above $6. Meanwhile, the tie-up may also wrench out $100 million in cost synergies, the company said.

Calling the deal price of 9 times Solutia's enterprise value to earnings before depreciation and amortization "reasonable at first blush," Wells Fargo analysts noted that the specialty nature of Solutia's operations, the two companies shared automotive and architectural end markets and Eastman Chemical's balance sheet make the tie-up strategic, even at a post-crisis stock price high.

Solutia was spun off from Monsanto in 1997, but filed for bankruptcy in 2003 as a result of crippling debts and legal problems. The company emerged from bankruptcy in 2008. Meanwhile, Eastman Chemical was a spun from recently bankrupt Eastman Kodak ( EK) in 1994, creating the 10th largest independent chemical company in the U.S. The next year, the company began an international expansion, especially in Asia, which has helped to offset falling U.S. revenue and bolster profit margins.

To learn more about corporate spins, see 5 short sighted stock spinoffs. For more on Eastman Chemical and Solutia see, 10 buy rated dividend stocks to buy today. See Morningstar's top 10 M&A stock picks for more deal stocks to watch in 2012.

-- Written by Antoine Gara in New York

If you liked this article you might like

The Really Big Money Rushes to Super Bowl

The Really Big Money Rushes to Super Bowl

Market Recon: The Tax Reform Is Just Ordinary Negotiation on Steroids

Market Recon: The Tax Reform Is Just Ordinary Negotiation on Steroids

Are Trump Stocks a Crowded Trade?

Are Trump Stocks a Crowded Trade?

Avangrid Chart Shows Good Fundamentals Not Everything in Trading

Avangrid Chart Shows Good Fundamentals Not Everything in Trading

Here's Why These 3 Stocks With Alluring Dividends Are Strong Buys

Here's Why These 3 Stocks With Alluring Dividends Are Strong Buys