David Einhorn
I want to thank the Sohn Investment Conference for inviting me to speak. Thirty years is an incredible achievement. Congratulations.
A fellow comes home from work early and finds his wife in bed with another dude. He gets really upset, obviously. He goes to the drawer, takes out a gun, and points it at his head. The wife starts laughing hysterically. He says, “What’s so funny? You’re next.”
That’s pretty much our tariff policy as of a couple of weeks ago. Subsequently, he took the gun away from his head and started waving it around the room. He’s maybe pointing it at his knee or his foot. That’s kind of where we are today.
The last 2 years, I’ve given presentations on European companies that most of you had never heard of. Maybe it’s because we’re finding more value in unloved European companies. But this year, I will present you another European company that most of you have never heard of. We’re on a streak.
Last year, I presented Solvay, which has since returned 25%, including dividends. 2 years ago, I presented Vitesco, which went up about 50% in the next 6 months before eventually being taken over at a discount to that by the controlling shareholder. In case you’re curious, the year before that was gold at 1,850 an ounce, and the year before that was Teck Resources, which returned about 58% the following year. Let’s see if we can get this streak going.
Here are our disclosures. I’d like to remind everyone that the idea I’m about to present is in our portfolio. We may change this position at any time.
The cartoon says, “Hey, I’m a big boy. I can accept that bad things sometimes happen to good people. What drives me nuts is how all the good things always seem to happen to people I can’t stand.”
Today, I’m presenting a company where the management has made excellent strategic decisions, but the stock has suffered due to a lot of bad luck. Our idea is Lanxess. It’s a German chemical company.
This is Matthias Zachert. He’s the CEO. We met him in 2004 when Lanxess was spun out of Bayer. At the time of the spinout, he was the CFO. In 2011, Matthias left to become the CFO of Merck KGaA, which had a strong run under his leadership, and he returned to Lanxess as CEO in 2014, when the company was a mess.
At the time of the spinout, Lanxess was a hodgepodge of noncore chemical businesses. When we sold it in 2010 in the low 40s, it had been the second-most-profitable investment in Greenlight’s history. With 15 years having passed, the stock is about one-third lower today than where we sold it and just over half of where it was when Matthias returned in 2014. Suffice it to say, this company has not been a compounder.
The cartoon says, “What if we don’t change it at all and something magical just happens?”
Matthias has transformed Lanxess through divestitures and acquisitions, and the company today looks completely different from when we owned it 20 years ago. Lanxess has shed highly cyclical commodity businesses and replaced them with more stable, higher-quality specialty chemicals in attractive global niches. In theory, this should have led to more stable returns, higher margins, and a higher multiple. In practice, the progress was temporarily derailed by a slew of unfortunate developments.
The opportunity today is to realize that the troubles have largely passed and that the company is likely to be on a successful path to realizing the benefits of its transformation. In 2016, about half of Lanxess’s sales were polymers from Arlanxeo and Envalior. Arlanxeo was sold in 2018. In 2020, Lanxess sold Currenta, and in 2021 it sold its organic leather business. In 2023, Lanxess sold the majority of Envalior to a joint venture in which it retains a 41% interest. This year, it sold its last commodity business, Urethane Systems, in a deal that just closed.
I think it is interesting that the market likes to value Lanxess at around 5 to 6 times EBITDA, even though it has sold its bad businesses at multiples that are much higher than that.
During this time, Lanxess made 4 key acquisitions. It bought Chemours’ Clean and Disinfect business in 2016, Chemtura in 2017 with a focus on flame retardants and lubricant additives, Emerald Kalama in 2021, which makes preservatives and aroma chemicals, and IFF’s microbial control business in 2022, which made Lanxess one of the largest suppliers of microbial control products.
The cartoon says, “What are you going to be when you grow up? A butterfly or a moth?”
Transforming a business is no easy task, and Lanxess has now done all the heavy lifting of repositioning its portfolio of businesses. Lanxess owns a strong portfolio with reduced complexity, lower asset intensity, and a focus on cash generation. We think we are left with a butterfly that is being perceived, for the moment, as a moth. The quality of Lanxess has improved, but its value has not been unlocked yet.
1. Lanxess Builds A Specialty Portfolio
Let’s observe what Lanxess looks like today. Lanxess is organized into 3 segments. The first segment is Consumer Protection, which has 4 separate business units. All the business units are top-3 players in niche markets.
Like me, you probably have no idea what biocides are. They are products intended to destroy or control harmful organisms to protect humans, animals, and materials from harm. Think of items like disinfectants, preservatives, pesticides, and antimicrobials.
While Saltigo doesn’t immediately strike you as a consumer protection business, most of its business is focused on crop protection chemicals. The acquisition of Emerald Kalama in 2021 made Lanxess a global champion in flavors and fragrances.
The second segment is Specialty Additives. The cartoon says, “But if we remove all the attitude additives, there’ll be nothing left.” It’s really hard to find a good additives cartoon. True story. My cartoon person—yes, apparently that’s a job at Greenlight—said she fell asleep finding a good additives cartoon.
Specialty Additives has 3 business units, which are all top-3 players in their markets. The Polymer Additives business unit operates a bromine well in Arkansas, which has a 70-year reserve and is vertically integrated for the whole bromide value chain, which is mostly used in flame retardants. Rhein Chemie is the world’s largest rubber additives manufacturer.
The third segment is Advanced Intermediates, which has 2 business units. Unfortunately, Advanced Industrial Intermediates is abbreviated AII, which is probably one I too many to get a good multiple. It makes all kinds of intermediate chemicals for many industries. The unit has a unique integrated manufacturing network in Germany with a lean cost structure.
Inorganic Pigments is the leading global manufacturer of iron and chromium oxide pigments. Even I can understand this one. It has over 40% market share in Europe. These are used in things like coloring, making red bricks red and green bricks green. It’s like synergy in our portfolio.
The caveman says, “You found another pigment. Hallelujah. I’m so tired of my blue period.”
Lanxess today is a top-3 leader in each of its business units globally, and it has a balanced portfolio that is not overly reliant on a single industry. The M&A activity has given Lanxess a much larger U.S. presence than it had historically. Sales are 35% in the Americas, of which 28% is the United States, nearly doubling in the last 8 years.
European sales are 46%, and Asia-Pacific is the remaining 19%. The business 8 years ago was much more heavily weighted toward the automotive industry, which made up almost 40% of sales. Today, it’s much more balanced, with mobility at only 10% of sales.
2. The Crisis Hits Lanxess
Despite a thoughtful business plan and excellent execution of acquisitions and divestitures, Lanxess ran into problems over the past few years. It’s critical to understand what happened in order to get comfortable that the future likely has clearer skies.
Since the month before Russia invaded Ukraine, Lanxess shares have been cut in half. During that same period, the STOXX Europe 600 Index returned 9%. The Russian invasion of Ukraine triggered a European energy crisis, and energy is one of the main inputs for all chemical-product producers, including Lanxess.
European natural gas prices increased drastically from 2020 base levels. To give you a sense of how bad things got, European gas went from 12 per megawatt-hour in 2020 to a peak of 339 per megawatt-hour in August of 2022, an increase of over 27 times. Europe basically had no energy substitution during this crisis. The average price in 2022 was 13 times higher than in 2020.
Competitors in China and India didn’t have this problem and sharply undercut Lanxess on pricing. This caused Lanxess to suffer both a margin squeeze and share loss.
The cartoon says, “Let’s say you want to save millions of dollars. You just push this button here.”
Starting in 2021, Lanxess began implementing SAP software, an enterprise resource planning, or ERP, system. Most ERP systems will lead you to believe in great stories like this cartoon. But this is more like the reality.
The cartoon says, “Dilbert, I want you to integrate our sales database with our inventory and finance systems. The managers of those systems are a nitwit, an ogre, and a word that is unspeakable at this family gathering, and they know that 2 of them will be fired when it’s complete.”
Dilbert replies, “I can get that done in 30 years.”
Lanxess’s implementation of SAP turned into the usual nightmare. With the bulk of the work done in 2022 and 2023, Lanxess expects it will complete the full SAP implementation this year.
During this period, Lanxess has had to build buffer inventories on its balance sheet to ensure delivery reliability to its customers. It increased its inventory buffer in 2021 and ramped up significantly in 2022, as shown here. This increase happened precisely when energy and raw material prices were exceptionally high due to the energy crisis.
When demand fell off a cliff, Lanxess had to sell its high-cost inventory into an environment of falling prices. This crushed profits in 2023, as we can see from the significant drop in gross margins.
In the second half of 2023, Lanxess had to prioritize free cash flow generation over profitability, given its high financial leverage. Capacity utilization dropped from 79% in 2021 to 69% in 2022, to 58% in 2023, before rebounding to a still-low level of 67% last year. The cartoon says, “Unfortunately, the consumer was not as demanding as we hoped.”
European industrial production had been recovering since the 2008 financial crisis, and then COVID hit. COVID had a significant impact. Initially, there was a burst followed by a sharp recovery. However, customers built inventories in late 2021 and early 2022 based on fears of missing out on profitable sales due to shortages of key inputs.
This was a period when just-in-time was replaced by just-in-case. But that proved to be short-lived, and a large destocking cycle began. You can see that European industrial production has seen a multiyear slowdown cycle from 2022 through the present, and chemical production decoupled due to the destocking effect, falling to levels not seen before. Even with a large amount of destocking, demand is more stabilized than recovered.
This is the chemical industry chart of capacity utilization by geography. We are at recessionary levels, or even worse. Overall, European capacity utilization dropped below 65% for most of 2023 and early 2024, well below the rest of the world. It has begun to recover from a very low trough.
From a longer-term perspective, Lanxess had stable EBITDA until 2022, in the range of €800 million to €1 billion annually. Due to the larger acquisitions, debt rose significantly in 2021 and 2022, which left Lanxess at peak leverage just before its troubles emerged. In 2023, due to the crisis we just discussed, EBITDA dropped by 45% to just €512 million. The leverage ratio jumped to nearly 5 times, and Moody’s downgraded the company to Ba3 with a negative outlook.
Lanxess was forced to cut its dividend by 90%. Leverage has come down since, and Lanxess is using the proceeds from the sale of its urethane systems business to further delever. Pro forma net debt should be down to €2.1 billion, and pro forma net debt to EBITDA will drop to a more normal 3 times by the end of this year. Management is committed to reducing the leverage ratio to below 2 times over the long term.
3. Lanxess Enters A Recovery
Despite all the hiccups, the transformation is now complete. The new Lanxess is a higher-quality business with lower asset intensity. Capacity utilization, while beginning to improve, remains depressed. As a result, Lanxess does not need a lot of growth capex and should be able to manage with only €300 million to €350 million in total annual capex for the next few years.
Lanxess’s goal is now to maximize the performance of the existing businesses. For 2025, Lanxess is guiding to €600 million to €650 million of EBITDA pre-exceptionals, which is about 10% higher organically than 2024, given the divestiture of the urethane business. Lanxess will also complete its ERP system implementation and cost-cutting plans this year. The strategy appears to be de-risked.
4. Tariffs Could Boost Lanxess
Lanxess could actually be a tariff beneficiary. When everyone thinks about the inflationary aspects of tariffs, they seem mostly focused on how much higher import prices will be passed on to consumers. There is relatively little discussion about the inflationary impact from domestic manufacturers raising prices. Almost 30% of Lanxess’s manufacturing capacity is in the United States.
In some areas, such as parts of its Advanced Industrial Intermediates business unit, Lanxess is the sole remaining U.S. producer and faces Chinese competition. The Chinese tariffs create a pricing umbrella where Lanxess can either raise prices, gain share, or both. Further, some of the European-manufactured products, including agrochemical precursors, have no alternative to a U.S. domestic supplier. Lanxess also competes in the U.S. with Chinese imports, which may be tariffed at a higher rate.
As you know, the tariff situation is extremely volatile. It is impossible to quantify the benefit or even know if it will materialize. However, there is certainly the possibility that tariffs could create upside potential to Lanxess’s guidance, which was provided before Liberation Day.
There are several other tailwinds that should help improve Lanxess’s bottom line over the next few years. First, the inventory destocking cycle is nearly done, and end users will start to increase purchases, leading to improved capacity utilization. Second, Germany just passed a significant infrastructure stimulus package of €500 billion over the next 10 years.
All things being equal, it should increase Lanxess’s baseline volumes by about 6% in 2026, and by more than that in 2027 and 2028. Third, a number of end markets, particularly agriculture and European construction, are operating at cyclical trough levels. And finally, if Russia and Ukraine agree to a peace deal, there will be significant reconstruction that should be a tailwind for a lot of European industrial demand.
2025 marks what should be the early stages of a multiyear recovery. The market is not giving Lanxess credit for this yet. Now, you can invest in a de-risked situation as management focuses on executing and further streamlining the business in order to improve earnings and margin potential. It is a compelling story.
5. Envalior Becomes A Hidden Asset
But wait, there’s more. In 2023, Lanxess contributed its High Performance Materials business to a joint venture with the private equity firm Advent International. The joint venture was named Envalior, and it is a global leader in nylon and other engineering plastics. Lanxess retains a 41% stake, and it has a put option back to Advent starting next year.
So, how much is the 41% stake in Envalior worth? The cartoon says, “Well, we’d value the company at either $2.4 billion or less than $100,000 or somewhere in between, but we wouldn’t want you to hold us to that.”
Next year, Lanxess has the right to put its remaining stake in the joint venture back to Advent at about 12 times trailing EBITDA. Lanxess chooses when to exercise the option, so it can select a time when EBITDA appears to have reached a cyclical peak. This is a very valuable option.
Envalior is levered and has about €3.9 billion of debt. S&P Global Ratings has published a credit analysis showing that Envalior is expected to have between €475 million and €525 million of EBITDA in 2026. We believe that this estimate is below the company’s internal forecast. Assuming Envalior simply hits the midpoint of that estimate, Lanxess could sell its stake in early 2027 for about €860 million, which is over one-third of Lanxess’s current market cap.
If it appears that there will be further EBITDA growth, Lanxess might choose to defer a sale. Every 100 million of extra EBITDA is worth $500 million to Lanxess. As Envalior has negative net income, partly due to amortization of goodwill created by its formation, it does not contribute to Lanxess’s current results. Some bearish sell-side analysts value the Envalior stake at zero.
6. Lanxess Reclaims Its Earnings Power
We think Lanxess is set for success. Assuming Lanxess uses its free cash flow to pay down debt and sells the Envalior stake for €860 million, by 2027 the company would have relatively little debt. Contribution margins on incremental volumes should be quite high as capacity utilization improves. An eventual demand recovery, with capacity utilization rising from 67% in 2024 to a more typical level, could see Lanxess generate over €900 million of adjusted EBITDA in 2028.
This would not even fully return the company to pre-COVID profits and margins. A 6x multiple on €900 million of EBITDA in 2028 would be worth around €50 per share at the end of 2027. If the market rerated Lanxess to a higher-quality specialty chemicals company with a 7x or 8x EBITDA multiple, which is still a discount to where peers like Akzo Nobel and Croda trade, it would imply a share price between €60 and €71.
Alternatively, if Lanxess decided to repurchase shares when it gets to 3 times debt to EBITDA before the Envalior sale and 2 times debt to EBITDA after the sale, the company could buy back a lot of stock. At the same EBITDA multiple, we would estimate that buybacks could add another €15 per share of value. This assumes the stock price goes up 20% per year. Obviously, if the stock went up faster, the buyback would have a smaller impact. We could live with that.
We think Lanxess is set for success and will surprise the market. It’s always an honor to be here. Thirty years is quite an accomplishment. Greenlight will turn 30 right about when I hopefully present another idea here next year. Thank you. [Applause]