International Flavors and Fragrances (IFF) – Update on Dupont Nutrition & Biosciences merger

Stone Run Capital |

9.25.20 – International Flavors and Fragrances (IFF) - $115 – Update on Dupont Nutrition & Biosciences merger
• Thesis: IFF is consolidating the flavors and fragrances industry and adding adjacencies in health and nutrition ingredients. This is an attractive stable growth oligopolistic industry. With the completion in Q1, 2021 of the IFF + Dupont Nutrition and Biosciences merger, the company will have $11+ billion in revenues competing in a consolidated and disciplined $50 billion flavors, fragrances, and ingredients industry. Dupont brings #1 or #2 positions in nutrition, cultures, enzymes, probiotics, and soy proteins. The combined company provides its customers critical ingredients that provide significant characteristics and differentiation to the end product but make up a relatively small amount of the cost of goods sold. CEO Andreas Fibig stated: “We will drive greater R&D discoveries and expand our customers’ opportunities by creating the industry’s first truly integrated solutions.” With limited cyclicality and relatively predictable revenues, IFF can grow organically in the low to mid-single digits—management believes there are $400 million in revenue synergies—and with cost synergies of $300 million from the Dupont acquisition, and stable industry pricing, the company can grow adjusted EBITDA at a high-single digit CAGR from $2.6B proforma total in 2020 to $3.2B in 2023. At 15x TEV/EBITDA three years from now, this drives a $150 share price for a 9% stock CAGR.

• Business: At present, IFF has a total enterprise value of $17.3 billion with just over $5B in revenues, $1B in EBITDA, and nearly $500M in free cash flow (2020E). With the $26.2B merger announced on 12/15/19 to merge IFF with Dupont’s Nutrition & Biosciences (N&B) business in a Reverse Morris Trust transaction, IFF shareholders will own 44.6% of the combined business and Dupont shareholders will own 55.4% of a ~~$42B TEV business with about $11.4B in debt. The combined business will have over 40,000 customers, 9,000 patents, and be #1 or #2 across taste, scent, nutrition, cultures, enzymes, probiotics, and soy proteins. The business is very global with ~68% of sales outside the U.S., and ~50% of sales to local and regional customers—as opposed to the global customers like Nestle, Proctor & Gamble, and Pepsi. With the provided $50 billion TAM, IFF will have a roughly 20% share. Givaudan, the next largest company at ~$7B revenues has 14% share. This is now a very complex business with high growth areas, GDP areas, and likely, shrinking revenue areas. R&D will be over $550M—perhaps the largest in the industry—though at 5% of revenues, this is lower than IFF’s spend at 7% (8% five years ago). The business has four segments: taste, food, & beverage (55%), scent (18%), health & biosciences (21%), and pharma solutions (7%).

• Risks:
o Acquisition integration risk. IFF stumbled with Fruatrom, and so investors have limited reasons to be confident on the major DD integration. It will take two years to fully assess integration success. The stock should be volatile during this period and likely offer good entry and exit points for trading.
o This business has gotten quite complex in terms of product sets—not just the traditional F&F segments. This is a lot to keep track of in terms of competitive understanding. How much is closer to commodity? Closer to the threat of Asian competition and the active ingredients capacity there?
o Competition: Givaudan is the superior company based on fundamentals. IFF growth has underperformed the comparables at times. The following slide from their recent deck highlights their view of capabilities.

• Fundamentals: While the forward business will be much different than the history, the trailing fundamentals include 5-year CAGRs of: 11% revenue (4% organic), 10% EBITDA, 4% FCF. Our initial investment on the business was based on an improving profit profile based on rationalization of product sets. The business then priced this in and the investment has stagnated while management has made aggressive capital allocation decisions. Gross margins did indeed improve from 40% in 2011 to 44.5% in 2014. EBITDA margins improved from 20% to as high as 22.7% in 2016. Proforma adjusted EBITDA margins for IFF+DDNB are about 23% in 2020 and expected to go to 25% by 2023. The combined business will have leverage at ~4.0x net debt/TTM EBITDA and management targets 3x by year two post close. GAAP ROC was as high as 16% in 2014 and 2015 and declined with the $7.1 billion Frutarom acquisition in 2018. It is a long road back to mid-teens return on capital. Management has not indicated a ROC target, while they have committed to the current dividend policy.

• Management: CEO Andreas Fibig has been with IFF for 9 years. His background includes leadership positions in the healthcare area: Pfizer and Bayer. The new executive committee includes 18 members, with half from IFF and half from DD. Notably, both Andreas and CFO Jilla Rustom come from IFF. They continue to name new board members, with John Davidson (board member at FMC and TEL) named recently, among others.

• Consensus outlook: Published consensus does not include the merger and so is not relevant.

• Valuation and share price: On the 2021E merged business, the stock trades at about 15.5x TEV/EBITDA, 35-40x FCF, and about 18x P/E (adjusted proforma EPS of $6.50 to $7.00). More work is required on this over time.

• Stock: IFF has underperformed the S&P 500 by 10% YTD and by 35% during the last five years. This followed strong outperformance of 40% from 2012-2016. IF the team executes well the next three years, IFF stock is poised to outperform. A downside estimate based on 25-times TEV/FCF on 2021E of $1B in FCF, we get a ~$65 stock. For comparison, Givaudan trades at 44x 2021E FCF. 30-times TEV/FCF on IFF would be ~$85.

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