The Beautiful Market

In the words of Jerry Maguire "we work in a business of tough competitors" and that makes it hard for investors to find sustainable returns on invested capital (ROIC). Companies like Amazon keep everyone on edge.

A few years ago I was just pondering products that are important and can be differentiated AND account for only a small % of the cost of the final good. Paint came to me right away and more generally coatings. You might spend millions on the end product and the paint and coatings would be only a few percentage points.

In addition, the labor required to apply paint is considerable and often greater than the cost of the material. That's yet another reason to insist on quality and be fairly price insensitive - at least for professional jobs.

These types of structural economics are good for investors and they can be great during periods of growth and expansion. The ability to increase units and raise prices is an ROIC elixir. Initially this brought us to Valspar (VAL) and Sherwin-Williams (SHW). They both performed well and then SHW acquired VAL to make it a giant in the space.

Venator the Company

That brings us to Venator (VNTR) which is doing an IPO to spin off from Huntsman (HUN). Venator is a $2B (sales) maker of Titanium Dioxide (TiO2) and "performance additives." TiO2 is the key ingredient in paint and is used in a variety of other end markets.

Consolidation has been underway in the market which has gone from a dozen global suppliers to five. These companies are all competing but the last thing they want is a price war. TiO2 prices have been recovering steadily during the last 18 months and remain below where they were in 2014.

While TiO2 prices were low in 2015 Venator went through a restructuring and embarked on a program to streamline the business and reduce their cost base. As a result, their profit margins are already double what they were when TiO2 prices were higher. Thus the company is poised to enjoy robust profit growth as TiO2 prices remain firm and volumes continue to grow with GDP.

Although TiO2 is a commodity there are grades and higher quality means less price competition. About 1/2 of the VNTR TiO2 business is in high quality which ends up in things like cosmetics, plastics, films, food, and speciality inks.

Besides TiO2, Venator gets about 25% of their revenue from "performance additives" which are things like different color pigments, additives that effect gloss, flow and drying and treatments for timber to make it last longer.  This is also a more differentiated, hence higher margin part of the business.

As a spinoff from Huntsman the management team has been in place for some time and generally have decades of experience in the industry (each) so they have the team to run a $2B enterprise and deliver results.

The Deal

The offering consists of 22.7 million shares at $20-22 all coming from Huntsman. The company won't receive any proceeds from the IPO. After the offering, there will be 106 million shares outstanding which equal a market capitalization of $2.2B at the mid-point. Add to that pro-forma net debt of $738M and the EV reaches $3B.

Venator has about $1.2B in tax loss carry-forwards which are certainly valuable and position them to return more cash to shareholders during an extended period of profitability.

This is a smart move for Huntsman. Chemical companies typically trade at less than 1x sales while paint and coatings can trade at 2-3x sales.

If we saw a similar EV for VNTR, let's say 2.5x sales then the shares would be about $45/share. 

One big question here is what is Huntsman going to do with the rest of their holdings (over 83 million shares) post the IPO.