(Bloomberg Gadfly) -- The probable sale of Akzo Nobel NV's specialty chemicals unit is a test of private equity's ability to show a little restraint. The tension in the auction seems to be tightening, while the pressure on the Dutch paint-maker to sell is arguably easing. It's a recipe for someone ending up with buyer's remorse.
Akzo's own investors, and potential bidders, had been eyeing a carve-out long before it was announced almost a year ago, after PPG Industries Inc. made an unsolicited takeover proposal for the whole company.
The attraction to private equity is a strongly cash generative business that looks more resilient than commodity chemical production. The deal math is seductive. Bernstein Research estimates a purchase price of 10 billion euros ($12 billion), equivalent to 10 times this year's expected Ebitda. Assume the unit can sustain net debt of 6 times Ebitda and you'd only have to pay 4 billion euros for the equity.
A buyer might potentially double their money. Ebitda could plausibly be lifted to 1.3 billion euros through cost savings and natural growth, Bernstein reckons. Use cash flow to pay down 700 million euros of debt, sell the business on the same 10 times multiple, and the equity at exit would be nearly 8 billion euros.
Over three years that's a tasty 25 percent internal rate of return. Might some bidders be willing to settle for lower returns to win the auction? The temptation must be there, given that private equity firms have abundant funds and targets like this are few.
The snag is that returns may fall off sharply in a bidding war above 10 billion euros. The first problem is that it might not be possible to add much more than 6 billion euros of debt to the deal. That means putting in extra equity as the price rises. To achieve a 20-percent-plus return on a higher initial price would put additional demands on the exit, requiring either a quicker expansion of the business or selling it on a higher valuation. That's a tall order.
Given that most bidders probably have access to the same financing packages, some other kind of edge will be needed to win. Apollo Global Management LLC appears to be showing some cunning here. Having enlisted the support of an industry partner in German chemical maker Lanxess AG, it's now roping in a financial partner in Dutch pension fund PGGM, according to the Financial Times. The former should give it more confidence in finding industrial synergies while the latter should make it look like a more politically palatable private equity owner.
A three-way industrial-financial consortium may be better placed to win. But it's potentially cumbersome, and may still not be enough to see off a desperate private equity firm willing to put returns second to winning the deal.
Akzo is, of course, still maintaining that a demerger is possible. Given the feeding frenzy, it will have to come up with a good explanation as to why today isn't the time to sell.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.
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