Brenntag: Implications Of General Meeting Results On Investment Case (Rating Downgrade)

Activist investors PrimeStone Capital and Engine Capital suffered a defeat at Brenntag SE's (BTNGF; BTNGY) annual general meeting this Thursday. The candidates for the company's supervisory board proposed by PrimeStone and supported by Engine Capital, former Goldman Sachs MD Joanna Dziubak and Geoff Wild who served as CEO of chemical companies Atotech and AZ Electronic Materials, lost to Brenntag's preferred candidates. The activists are calling on the company to separate its specialties and essentials divisions. As previously stated, I concur that a separation of the two units has the potential to create significant shareholder value.

Unfortunately, Brenntag's executive management and supervisory board are not convinced of separation being the best way to create value. Thursday's voting results, while far from a slam-dunk, ultimately strengthen the pro-unity camp for the time being. Below, I will give an update on how that changes the investment case.

The Case For Separation Remains Unchanged

The case for separation remains unchanged. There is significantly higher valuation potential for the specialties business as a standalone entity. The considerably higher multiples that listed pure play specialty distributors like IMCD N.V. (OTCPK:IMDZF; OTCPK:IMCDY) and Azelis Group NV (OTCPK:AZLGF; OTC:AZLGY) trade at underline this.

At the same time, being part of a group that also deals in essentials still may be detrimental to Brenntag Specialties' access to customers and/or acquisition targets who prefer to associate themselves with specialized distributors, thus hindering growth potential. As I have explained before, I believe a stock price of around €120 in the medium term to be realistic if the group were to be split in two.

However, as long as the business remains integrated, I have doubts that the stock price will reach those levels in the foreseeable future. Let alone the targets envisioned by Engine Capital (€140 within 24 months) and PrimeStone (€170 within 3 years).

Election Results

For investors rooting for a spin-off, the annual general meeting produced bad news. Brenntag's candidates, Richard Riedinger and Sujatha Chandrasekaran, were elected with a majority of 62.71 percent and 61.79 percent, respectively. Those are fairly weak results, but a majority still is a majority. Turnout was slightly below 80 percent of outstanding shares, in line with what I expected.

Votes appear to have been somewhat split by geography more than anything else. International institutional investors presumably followed the recommendations of proxy advisors Glass Lewis and ISS to vote for the alternative candidates. German institutional shareholders, on the other hand, voted for Brenntag's candidates. The day before the general meeting, Deka, DWS and Union Investment answered a request for comment by German newspaper Handelsblatt declaring their intention not to support the activist slate. Flossbach von Storch, after speaking to all candidates individually, also sided with the company's candidates. Before, Kühne Holding AG, which owns between 5 and 6 percent, had already come out in support of Brenntag's candidates and the company's integrated strategy.

The voting results also show a high approval rating for the supervisory board given the circumstances. 95.12 percent of votes cast were in favor of ratification ("Entlastung"), which is in fact above the 2022 numbers (93.98 percent). PrimeStone and Engine Capital control about 2 and one percent of the voting rights, respectively. Add to that the usual handful of disgruntled retail shareholders, and it is clear that the vast majority of investors, even those voting in favor of Mr. Wild and/or Ms. Dziubak, are not willing to apply maximum pressure as of now.

What Comes Next?

The supervisory board in its old composition recommended that the general meeting vote against PrimeStone's candidates and motions. Former chair Doreen Nowotne did not stand for reelection. That strongly indicates that at least two members of the new board are opposed to the activist proposals. Add to that the newly elected member, Ms. Chandrasekaran, who (at least implicitly) ran against the proposals. With Mr. Riedinger as the new chairman (who has a tie-breaker vote), the majority for the existing strategy seems firmly secured for at least two years.

No board seat is up for reelection in 2024, while the members serving through 2025 are Ms. Stefanie Berlinger (whom I identified as probably the member most likely to be able to see the benefits of a separation given her background) and Dr. Andreas Rittstieg (who I think is likely to retain his seat, if he wants to, given his association with Klaus Michael Kühne and his various companies, including Kühne Holding AG).

It should be noted that the position of shareholders relative to executive management is comparatively weak under German corporate law. Most importantly, the general meeting does not have the right to issue instructions to management or to appoint management. Appointment, dismissal and oversight over management fall exclusively within the responsibilities and power of the supervisory board. The premature dismissal of an elected member of the supervisory board, meanwhile, requires a qualified majority of at least 75 percent of votes cast.

The only direct way of showing shareholder disapproval would be the annual vote on ratification of the management's and/or supervisory board's acts. Denying ratification - or even an approval rating below 90 percent - is a strong symbolic measure. The practical importance of a vote of ratification, however, is fairly limited. Notably, the last case of withheld ratification for a representative of a DAX constituent was then Bayer AG (OTCPK:BAYZF; OTCPK:BAYRY) CEO Werner Baumann in 2019. He nonetheless remained in office until about two weeks ago.

So all in all, a continuation of the recent course appears overwhelmingly likely for the next month and years. Management has so far paid lip service at best to the exploration of strategic alternatives. After the general meeting's voting results, the imminent pressure has arguably somewhat decreased.

Conclusion

The election of PrimeStone's candidates for Brenntag's supervisory board could have been the catalyst for the creation of significant shareholder value through a strategic overhaul resulting in a spin-off of the specialties' division. With the company's candidates elected, and no election scheduled until 2025, the likelihood of this coming to pass has decreased. Neither will there be imminent need for measures such as more aggressive buybacks from management's point of view. In theory, the company could, of course, improve growth and profitability of its divisions regardless of their independence. But this has been promised for some years now, with lackluster results so far.

I, therefore, feel compelled to change my assessment from a buy to more of a hold for the time being. While I still see the potential for a value in the range of €120 per share, I would expect the stock to move sideways for the foreseeable future absent a catalyst. Looking further ahead, the relatively weak election results of the company's candidates may offer a glimpse of hope, as this at least puts a certain degree of pressure on the company to show tangible results. Brenntag certainly remains a name worth keeping an eye on. But for the time being, I will remain on the sidelines until a catalyst in the form of either an openness to structural change or improvements in terms of growth and profitability relative to competitors emerges.

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