Covestro to Cut Its Teeth on Small M&A Before Unlocking Billions

(Bloomberg) -- Covestro AG, the German chemical maker with roots dating back more than 150 years, is acting like a young upstart as it considers its first acquisitions after former parent Bayer AG completed cutting ties this month.

Covestro wants to add polymer technology and broaden its coatings, adhesives and specialty-products offerings, said Patrick Thomas, who steps down as chief executive at the end of this month. The manufacturer will focus initially on bite-size deals rather than any large purchase to avoid excessive risk to its business, Chief Financial Officer Thomas Toepfer said.

“The limiting factor is not so much financing” given the company’s leverage at just 0.4 times earnings, Toepfer said in a joint interview with CEO Thomas in London. Instead, Covestro should “get some experience and build some capability, and go from walk to run to fly.”

After profiting in the 1990s from demand for basic plastics used in TVs and compact disc cases, Leverkusen-based Covestro is turning its attention to new polymers and composites as industrial customers seek lightweight materials for cars, top-end laptops, sport shoes and planes. Rather than battle Chinese commodity-chemical producers on price and volume, it’s focusing more on innovation to improve the performance of polyurethane foams and polycarbonates for replacing heavier metal parts.

The company has yet to make a major purchase since drugmaker Bayer began selling shares in the business in October 2015. Net income more than doubled in the past two years, and free operating cash flow surged 35 percent in 2017 to 1.84 billion euros ($2.2 billion).

Markus Steilemann, a long-time Bayer and Covestro employee, will take over from Thomas in June. The start of his tenure coincides with investor concern that the run of record profits, inflated by high prices, will end with a bump as competitors encroach on its main markets. Huntsman Corp., Wanhua Chemical Group and BASF SE are among manufacturers to announce factory expansions. Covestro shares have dropped 10 percent this year, valuing the business at 15.6 billion euros.

For the time being, the chemical industry can absorb any new capacity that comes on stream, and there’s no need for any dramatic departure from Covestro’s current strategy of low-cost manufacturing coupled with an expansion into derivative products, said Thomas, who has spent the past year in a gradual handover of responsibilities.

“There will be some decline” in margins as chemical prices recede, “but maybe the market is getting a bit overly nervous about how steep that decline will be,” Toepfer said. “People might be thinking that we are approaching a peak. We might be less nervous than the market, in that sense.”

©2018 Bloomberg L.P.