Wednesday, June 21, 2006

Hexion (HXN) -- Despite our substantial indebtedness


The more we become leveraged, the more we, and in turn our securityholders, become exposed to the risks described above under “Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from fulfilling our obligations under our existing or future indebtedness.”


Excerpt from the 168 Page Form S-1/A for Hexion Specialty Chemicals (HXN). Assuming the IPO goes as planned, there will be $3.16 Billion in long term liabilities supported by $564 million in equity capital. Lovely.

Hexion is roll up of various large chemical companies (mainly Borden Chemicals) owned by private equity firm Apollo Group. Together they form world's largest manufacturer of thermosetting resins (hard plastics) and are big and fearsome in the world of surface coatings and adhesives. Private equity groups tend to be attracted to large hard asset companies because they are can service a lot of debt.

And Hexion has alot of debt after paying out a $550 million special dividend, as well as redeeming $397 million worth of series A preferred stock, paying a floating dividend of LIBOR plus 8.0%.

Unfortunately the commodity petrochemicals business is cyclical, fiercely competitive and very sensitive to raw material (Oil, Natural Gas) costs. Combine that with thin margins, crushing debt service (fixed charges are covered 2.5x), and possible latent liabilities (from formaldehyde resins) and you have a recipe for success. Hexion would be an attractive investment if it had about a third as much debt. One would expect that Sealy's (ZZ) impressive post IPO performance would put a stop to this nonsense.

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