GERMAN SPECIALTY CHEMICAL company Lanxess recently announced a JV with Saudi Aramco to help its challenged synthetic rubber business bounce back from high costs and industry oversupply. In return for fully contributing two underperforming divisions to a newly-formed 50:50 JV, Lanxess is receiving a cash payment of $1.3 billion from Aramco and a promise that Aramco will provide cost-advantaged access to feedstock, additional investment in technology, and access to capital to pursue industry consolidation (see Exhibit below).
On paper, it looks like a win-win for both parties. Lanxess frees up capital to invest in better-performing businesses and pay down debt, while improving returns on the retained 50% as cost and scale improvements are generated. Meanwhile, Aramco gains access to a captive user of its feedstocks, and pushes downstream into higher-margin chemicals products. But while Lanxess shareholders and market analysts have responded positively to the JV, they might want to think about how much money was left on the table – because as we’ve written in the past, a joint venture like this has all the warning bells of being a sale in disguise.
Aramco and Lanxess are already a study in opposites, pairing the world’s most valuable company generating almost $400 billion in annual revenue (Aramco), and a $9 billion firm with a rocky performance history and a clear desire to limit its exposure in a challenged and cyclical business (Lanxess). In our experience working with hundreds of JVs like this, the asymmetries tend to get worse when it’s time for the JV to pursue the technology investments and consolidation opportunities talked about at the time of the deal, as they require ongoing shareholder funding to execute. What might look like a rounding error on the Aramco balance sheet will have the size of critical strategic investment decision for Lanxess. There is a fair chance that, at some point, Lanxess will prefer placing its capital in the same businesses getting a share of today’s $1.3 billion from Aramco, and the formal countdown to exit will begin.
A question that strikes us: Why isn’t Lanxess selling the entire business now for a full acquisition premium generated by a competitive public auction? If we were talking to Lanxess (which we haven’t), we would preface that question with the following: Aramco will now spend years learning the financial and operational details of the business, making it harder to extract a valuation premium through shrewd negotiation. It will become inextricably linked to the success of the business, as the guaranteed supplier of cost-advantaged feedstock to the business. And as a result, it will be in the driver’s seat at the time of an exit, because this relationship turns Aramco into the natural buyer – if not the only buyer – for the assets.
That doesn’t mean a JV like this is the wrong choice. On the contrary, it’s fair if management is not fully convinced that exiting is the right strategic path and views a JV as a way to maintain optionality, or believes that it can secure more value by waiting for the industry to improve. But these options need to be balanced against a full recognition of the downside risk that this path could be leaving money on the table.
The good news for Lanxess shareholders is that the near-term risk of Aramco using its leverage to force a buyout is limited by the five-year lockup negotiated by the parties. Unknown, however, is whether Lanxess management used the single best tool it has to defend the value of its stake: Negotiating an exit clause with an approach to valuation that explicitly defends against the negotiating power Aramco will hold at the time of exit (for example, by stipulating a valuation process or a purchase price that will fairly reward Lanxess).
Absent that, Lanxess shareholders may find themselves kicked to the curb in five years and a day for less than the business is worth in a sale today.