Sale of Valvoline’s ‘Global Products’ to Aramco – A Rare Win-Win M&A Transaction (NYSE: VVV)
Last year in October 2021Valvoline Inc. (NYSE: VVV) announced plans to separate its two business units, Retail Services and Global Products, to better position the group for growth and more deliberate capital allocation process. Retail Services, being the largest contributor to the company’s revenue and EBITDA with a strong brand presence in North America, seemed like the most likely choice for management monetize the Global Products activity and make the group a pure play Retail Services. According to latest company newsthe intended use of the product is: majority for shareholder returns, remainder for debt reduction, including 2030 bonds, and reinvestment.
Aramco’s interest in global commodities was reported on May 22 by WSJ. This follows their entry into the motor oil business through the Orizon brand which was launched in december last year to meet the needs of the domestic market. The acquisition of the Valvoline brand marks the oil giant’s entry into the global lubricants club, where all the other major oil players compete for market share.
For Valvoline, this is a synthetic sale-leaseback of the lubricants business, as the company would continue to get the proceeds of its divested business to serve its customers. However, he is coming out of an industry that has an uncomfortable exposure to gross margin volatility that cannot be easily mitigated without executing a successful and costly upstream integration. As a result, the company does not have the luxury of competitive pricing for raw materials and is also exposed to supply chain challenges.
With this sale, the risk is essentially ceded to Aramco, which can manage it relatively easily, given its presence across the entire value chain in the downstream segment. This sale also binds the two parties through a long-term product supply agreement, which should mitigate supply risk for Valvoline and revenue risk for Aramco.
On the other hand, the Retail Services activity enjoys a very comfortable market position and is set to develop even further. For fiscal year 2021, the company recorded “a rate of more than 50 oil changes per day throughout the system, significantly exceeding the industry average, which is in the low 30s.“This would encourage any management to allocate more resources to this side of the business, where it holds a strong competitive advantage over other players in the market.
Valvoline is largely comfortable with its debt position due to maturities having been extended to the years 2030-2031. The company has been very careful in managing debt issuance, and currently 87% of outstanding borrowings had fixed rates (Source: Fiscal 2021 – 10K Filing). The net proceeds of the sale of 2.25 billion dollars are intended by the management to pay a good dividend (cash and/or buyback of shares), to repay the long-term debt (2030). It also plans to increase its market share in retail services by opening new locations and expanding existing facilities. After all, the company is bragging about fiscal year 2021 as 15e consecutive year for same-store sales systemwide, having added 132 additional stores.
For the acquirer, Saudi Aramco (ARMCO), this allows them to better establish themselves in the lubricants industry, where the major global players are already competing through their strong brands. According to the latest 10K record (fiscal year 2021), Valvoline currently ranks third among passenger car motor oil brands in the US DIY market by volume. The long-term product supply agreement to be signed by both parties would also set a volumetric floor for the buyer. If Aramco could improve product pricing, given its natural cost advantage, and inject enough capital to expand its footprint globally, it might be able to gain more market share. There is a strong possibility of adding at least $400-500 million in annual sales from the EMEA push that Aramco can easily handle over the next two years. With the tailwinds of cost advantage and proximity to location, margins are expected to improve further, accelerating the recovery period.
EBITDA generated by the Global Products segment last year was US$327 million, which was achieved thanks to the 160.9 million gallons sold by the company in 2021 (2022 projection – 169 million gallons). The business generated more than $200 million of discretionary free cash flow, implying a reasonable valuation multiple, despite margin pressure during 2021. Improvements in key performance indicators should unlock even more value from Aramco with strong monetary support and relatively better distribution channels available to them.
Valvoline shareholders are the most obvious beneficiaries on two fronts: 1) a one-time high potential dividend; and 2) company orientation shifted to a less volatile business segment. The higher dividend would certainly be a relief in the inflationary environment as well as continued participation in a business that is free to focus on core competency with key risk mitigated.
It is rare to find such a transaction where the stakeholders are ready to benefit in their respective fields. The key that could ruin everything for Valvoline and Aramco, however, is poor business performance, with management unable to take advantage of the strong hand they have been offered. However, shareholders can at least preload their returns with the cream to be received as well, should the Retail Services business continue on its current growth trajectory.