OMV AG: There May Be The Chance To Make A Deal With ADNOC

As I have previously discussed, reports emerged that Abu Dhabi National Oil Company ("Adnoc") is interested in a takeover of Covestro AG (OTCPK:CVVTF, OTCPK:COVTY). As I explained before, while certainly not ruling out the possibility, I am at least doubtful regarding the success of such undertaking. At the same time, I believe that there is another, maybe more obvious, potential takeover target. Adnoc already owns a 25 percent stake in Austrian base chemicals producer Borealis AG.

Naturally, that has implications for my view of the company that controls the remaining 75 percent, OMV Aktiengesellschaft (OTCPK:OMVJF, OTCPK:OMVKY). Notably, Adnoc is OMV's second largest shareholder, owning a 24.9 percent equity stake which has been transferred from Emirati sovereign wealth fund Mubadala. Following, I will explain why I believe Borealis to be a potential target for Adnoc to acquire and what that means with regard to the investment case as far as OMV is concerned.

The Business Rationale

Adnoc is owned by the government of Abu Dhabi, the largest of the emirates that make up the UAE. Therefore, a wider strategic context must be considered. Notably, Adnoc's CEO H.E. Sultan Ahmed al-Jaber is also a UAE cabinet minister, responsible for industry and advanced technology.

The oil-rich states of the Persian Gulf such as the UAE face the long term challenge of preparing their economies for the possibility of a future in which the role of oil as an energy source will be diminished. Adnoc, being a main source of state revenue, is key in this pursuit. While smaller Dubai has established itself as a tourism destination and a financial hub, Abu Dhabi's economy has historically been overwhelmingly dependent on its natural resources.

Adnoc will certainly remain a producer of oil and natural gas, but the company is diversifying its asset base. Besides hydrogen and solar projects, (petro-)chemicals are a focus of Adnoc's strategy. One can think of neighboring Saudi Arabia's Aramco (ARMCO) as a blueprint. Aramco acquired a majority stake in petrochemical company Sabic - which in turn had acquired General Electric's (GE) plastics division a few years earlier - as part of a push for vertical integration and diversification.

Borealis, I believe, is an obvious target. Borealis holds a minority stake in Emirati chemical company Borouge plc which, in turn, is majority controlled by Adnoc. There is also a certain aspect of vertical integration, given that oil is an important base product for a significant portion of Borealis' product line-up. In so far, increased diversification into the petrochemical field somewhat hedges against Abu Dhabi's massive oil exposure, as the sector naturally profit from lower commodity prices. Long term, vertical integration also helps to secure a customer base for oil, once it is no longer relevant as fuel due to an increasingly electrified transportation sector.

Notably, a takeover of Borealis would make sense even if, and arguably especially if, a bid for Covestro were successful (which I view as far from certain). Covestro's product line-up consists primarily of polycarbonate plastics, insulation chemicals and upholstery foams. Borealis, on the other hand, deals in polyolefins and base chemicals as well as fertilizers. The respective product portfolios are rather complementary. In fact, Covestro is a customer of Borealis.

Mubadala also owns Nova Chemicals, a Canadian producer of Polyethylenes and Olefins. This asset could be transferred to Adnoc as well. Grouped together with Borouge, Borealis and possibly Covestro, Adnoc could become one of the largest vertically integrated petrochemical companies in the world.

The Political Angle

A large takeover by a state owned foreign entity inevitably has political implications. Yet, while in the case of Covestro I believe the political situation to be stacked against Adnoc, it could play out in its favor as far as a Borealis transaction is concerned.

First of all, it should be noted that the Republic of Austria, through state holding company Österreichische Beteiligungs AG ("ÖBAG"), controls 31.5 percent of OMV. There are indications (though not yet proof), that the Austrian government would be willing to explore lending its support to a transaction. Austrian newspaper "Der Standard" quotes parliamentary sources that there may be LNG supplies in return. According to these sources, discussions have been held during a visit of the country's minister of finance, Magnus Brunner, to the UAE at which he was accompanied by ÖBAG's CEO Edith Hlawati and chairman Günther Ofner. That kind of gas deal would make sense, as Austria is under increasing international pressure to replace Russian gas (which still accounts for a majority of the country's consumption) following the latter's continued war against Ukraine. On a side note, former OMV CEO Rainer Seele now works for Adnoc in an advisory role.

An interesting possibility is that Adnoc could, in turn, give up its ownership interest in the remaining OMV. That would make strategic sense within the broader context of diversification away from oil. It would also strengthen ÖBAG's influence on OMV, especially, if the shares were to be cancelled or held in treasury by the company itself.

All in all, while there is, of course, a high degree of uncertainty (politics, after all, can be among the most irrational things on earth sometimes), I think that a Borealis takeover would have better chances of success than a Covestro buyout.

Price Implications

Austria is a Western democracy and, as such, the rule of law applies. Hence, the remaining shareholders would naturally have to be compensated fairly, which in practice means a fair price for the assets in question. In terms of a hypothetical takeover price, the €11.5 billion valuation at which OMV acquired the last tranche of its current stake in 2020 may serve as a starting point. Anything below that would probably be a non-starter, politically speaking. At the time, that sum represented a (trailing) earnings multiple of around 13 and a revenue multiple of about 1.2. Of course, revenue has grown since. Borealis reported revenue of €12.2 billion and a net profit of €1.6 billion (excluding discontinued operations) in 2022. Based on these figures and at multiples comparable to the 2020 transaction, I believe that a valuation between €15 billion and €20 billion may be likely. To be conservative, I will base further calculations on the lower figure (although I would not rule out an additional premium if a formal offer would indeed be made). From a purely business driven point of view, that sum would probably be considered too much. However, one has to keep in mind that the Emiratis are playing the (very) long game. Adnoc's financial firepower is not at all in question, it can afford to overpay.

Adnoc already owns a quarter of Borealis, so based on a valuation of €15 billion, the acquisition price would be around €11.25 billion. That is not far off OMV's current market capitalization, which is just shy of €13 billion. The rest of the company (oil and gas exploration, refining, trading) together account for around €2.4 billion's worth of net earnings in 2022. Even when applying a multiple of just 3 - which is not only below OMV's current trailing P/E ratio but also well below the multiples of (admittedly far larger) companies such as Shell plc (SHEL), BP plc (BP) or TotalEnergies SE (TTE) - that would still represent a value of €7.2 billion. Adding a hypothetical cash consideration of about €11.25 billion, one would arrive at a valuation of close to €17.5 billion. Of course, net debt of currently €639 million (as of March 31st) must be taken into account as well. So all things considered, the company might reach a value of slightly below €17 billion, translating to a share price of around €52 (a little over $57 at current exchange rates). This, in turn, represents about 30 percent upside from the current stock price.

As I alluded to above, a possibility that I could imagine is that Adnoc's OMV shares could play a role. I am thinking (and I should note that this is speculation on my part) about, for example, a payment in kind for part of the Borealis stake. Based once again on a total valuation of €15 billion and a resulting acquisition price of €11.25 billion, a payment in kind would represent a value of about €3.2 billion. That would still leave a cash component of around €8 billion. All else equal, the total valuation of the company would thereby be closer to €15 billion. However, the number of outstanding shares would be reduced by just shy of a quarter. Therefore, the share price would be in the range of a little over €60 in this scenario, representing an upside of more than 50 percent.

The above calculations are, admittedly, of a rather theoretical nature. In practice, one would have to assume that the company might sink significant portions of a hypothetical cash consideration into some form of alternative long term decarbonization strategy (renewable energy comes to mind). The fact that the Austrian government is the largest shareholder makes that possibility even more likely, in my opinion. Nonetheless, I believe that shareholders would at least somewhat participate in the sale proceeds, either via dividends (most likely though a special dividend) or via buybacks. Notably, OMV has one of the highest dividend yields as is, with a dividend yield above 6 percent on the basis of the regular dividend of €2.8 per share - the company's explicit intention being to at least maintain the previous level every given year - and a special dividend of an additional €2.25 per share for FY2022.

Conclusion

All in all, I believe that regardless of the outcome of a potential Covestro bid, Borealis could become a takeover target for Adnoc. A transaction definitely has the potential to create significant value for OMV shareholders, in my opinion. Crucially, the political environment in Austria appears more favorable with regard to a takeover by Adnoc than in the case of Covestro, from my point of view. To be clear, this is not a risk-free investment. However, I believe that given OMV's cheap current valuation, there is a certain margin of safety. It is my belief that the stock is worth keeping an eye on in the near term.

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