W.R. Grace Corporation's Investment Thesis [Slides]VW Staff
Mitesh Amarthaluru (Duke ’17), Venkata Amarthaluru (Wharton ‘15, Engineering ‘15), Nicholas Liu (Wharton ‘15, Engineering ‘15), John Lu (Wharton ‘15, Engineering ‘15), Anubhav Maheshwari (Wharton ‘15, Engineering ‘15)’s investment thesis on W.R. Grace Corporation from the IRA Sohn Conference 2015.
W.R. Grace Corporation – Company Overview
- Industrials Company operating in catalyst technologies, materials technologies, and construction products
- Exited Chapter 11 on Feb. 3, 2014 after 13 years in bankruptcy due to asbestos litigation
- Management has announced plan to spin-off Grace’s construction products business in 2016 with New Grace retaining the catalysts technologies and materials technologies businesses
- Idea Generation: Circle of Competence -> 1. Industrials Sector 2. Special Situations 3. Engineering Expertise
- Catalyst Technologies: Largest player (33% share) in oligopolistic industry with secular tailwinds
- Construction Products: 2nd largest player (8% share) for concrete admixtures industry, Largest player (18% share) for cement additives; industry fragmentation resulting from localized monopolies
II. Investment Thesis
W.R. Grace is a recession-resistant cash compounder with clear paths to value realization.
- Grace operates in an oligopolistic industry with high barriers to entry, market share stability, and high ROIC levels.
- Grace maintains a deep competitive moat and recession resistant business due to customer captivity, specialized products, and technical expertise.
- Consensus mispricing exists in the marketplace because of Grace’s post-bankruptcy status, understatement of excess assets, and overlooked margin improvement potential.
- There are clear pathways to value realization from the upcoming spinoff, effective capital allocation, and increased investor transparency.
Recommendation: Buy Grace stock pre-spin with the intention of selling Grace Construction Products stock following its spin-off in 2016 and hold New-Grace over at least a 3 year period to realize a projected asymmetric equity upside of 40.08%.
III. Industry Overview: Catalyst Technologies
Oligopoly with high barriers to entry
- W.R. Grace is the market leader in an oligopolistic industry where the top 4 players have 89.2% market share
Barriers to Entry
- Economies of Scale: 45% of cost structure is fixed, providing high operating leverage
- Demand Side Barriers: Customer specific products create high switching costs
- Technology Barriers: Specialized technology with continued R&D investment necessary
Pricing discipline in oligopoly
- Catalyst technologies companies limit capacity expansion to 1-2% per year with a focus on value accretive pricing
- Increasing pricing allows a more effective EBITDA lift increasing volume
Evidence of barriers to entry
- Market shares for oligopolistic players have shifted by less than 5% since 2010
- Adj. ROIC (5 year average) of 31.5% for Catalyst division consistently exceeds 8.5% cost of capital
- Value enhancing pricing industry structure where price is not sacrificed for market share increase
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