Monday, November 19, 2018

A Current AIM Program Small Cap Equity Holding: KMG Chemicals, Inc. (KMG) by: Cole Froemming. "Cabot Wait to Merge"

KMG Chemicals, Inc. (KMG, $76.43): “Cabot Wait to Merge!”
By: Cole Froemming, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.


KMG Chemicals, Inc. (NYSE:KMG) Produces and distributes specialty chemicals and performance materials for the semiconductor, pipeline, and industrial wood preservation markets.

• KMG entered into a merger agreement with Cabot Microelectronics (CCMP) on August 14th, 2018, resulting in the acquisition of KMG by Cabot for 1.6 billion in cash and stock.

• This company operates internationally, with 55.5% of revenues from the Americas and 43.3% coming from Europe.

• In FY2018, net sales in the performance materials segment increased 187.9%, largely due to the recent acquisitions of Flowchem and Sealweld.

• Demand for high purity electronic chemicals, such as those manufactured by KMG, has been driven by a 9% CAGR in semiconductor units worldwide.   

Key points: 

KMG entered into a merger agreement with Cabot Microelectronics that will result in the acquisition of KMG by Cabot. The deal is expected to close near year end and is valued at $1.6 billion in cash and stock. This strategic acquisition is synergistic with CCMP and their existing product line of chemical mechanical planarization slurries and pads, which are also used in the manufacturing of semiconductors.

For FY18, KMG experienced record results, with growth in both operating segments. Income from operations in the electronic chemicals segment, which primarily supplies the semiconductor market, increased 32.0% from FY17. This growth is also due to increased volume globally, and increased operating efficiencies after the restructuring of their electronic chemicals segment in Asia. The performance materials segment faired even better, with income from operations increasing 298.6% in FY18 over FY17. This was largely due to contributions from the recent acquisitions of Flowchem, in June of 2017, and Sealweld in February of 2017, but was also attributable to their legacy businesses within the segment.

In October of 2017, KMG completed a public offering of ~3.5 million shares of common stock priced at $54 per share. KMG used all of the proceeds to pay down their outstanding $550 million term loan that was taken out in the acquisition of Flowchem. This equity offering took their D/E ratio from 3.56 in FY17 to .96 in FY18, a much more manageable level of leverage for KMG.

What has the stock done lately?

One day prior to the announcement of the merger with Cabot, KMG was trading at $66.84. Once announced, KMG quickly jumped to $76.97. This was on target as shares of MKG will have the right to receive $56.65 in cash plus .200 shares of Cabot common stock. This equated to an implied value of $78.65 based of CCMP’s closing price that day. Since then, the stock has hovered right around $76. It is important to note that the .200 ratio is fixed for the stock portion of the merger and that the market price of CCMP will continue to fluctuate until the completed merger date.

Past Year Performance: 

Today, the stock is trading at $24 more than a year ago to date. Prior to the merger announcement, KMG was on the rise, with large spikes after both Q2 and Q3 earnings reports. We saw a spike of ~$8 from $61.92 to $70.04 after Q2 earnings were announced and a spike of ~$9 from $70.51 to $79.26 when Q3 was released.
These spikes of more than 10% post earnings are largely standard as a small cap stock.

Source: FactSet

My Takeaway:

The merger agreement with Cabot Microelectronics confirms that KMG is a solid player in the specialty chemicals and performance materials space. With the semiconductor industry booming, KMG benefited from the continued increase in demand for their electronic chemicals used in the manufacturing process. The acquisition makes sense for Cabot as they will further increase their semiconductor product offering and establish themselves as a leader in the industry. KMG receives a “hold” as the acquisition is expected to close near year end.

Source: FactSet