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Laura Thompson

Alex Manolopoulos

Luxembourg-headquartered carbon black manufacturer Orion Engineered Carbons is hammering out a dual-currency $650m refi (BB/Ba2). With margins guiding with a two-handle and rated at BB/Ba2, pricing is the deciding factor for most buysiders, who are thinking at a portfolio-level about whether they can take this rarer credit amongst the usual sea of B2s. Elsewhere, some buysiders are starry-eyed at the rapid Covid recovery on this “safe, familiar” name, while others are green around the gills in the face of ongoing environmental regulation after emission reduction upgrades at the company’s American facilities look to dampen Orion’s H2 outlook.

“Appetite for BB paper is considerable and it never goes away,” said one buysider. “Everyone makes a grab for it because it’s so helpful with your WARF (Weighted Average Rating Facility), and on a simple refi, a familiar name, this will get done easily.”

The public company, which processes carbon black (a powder or bead used primarily in rubber), is refinancing its 2024 loans: a $228m L+200 bps and a €329m E+225 bps TLB. The new euro portion guides at E+250 bps, while the dollar tranche again guides tighter at L+225 bps.

While some saw this deal as a way to offset the year’s earlier slew of lower rated names, for other buysiders, it is precisely that portfolio-wide perspective that led to them passing on the deal. “Generally, we like this business, we just don’t have space for low spread paper at the moment,” said a second buysider.

In a now common refrain, some buysiders are also uneasy about an ESG margin ratchet chiselling away at already-tight pricing. Orion’s, based on two KPIs (reductions in sulphur dioxide (SO2) and nitrogen oxides (NOX) emissions at its American facilities, according to two buysiders), could cut margins down a further 10 bps.

“That essentially makes it 240 bps,” said a third buysider. “It’s another example of how ESG margin ratchets aren’t just trendy green-signalling, though it is good that this is on emissions. Across a portfolio and, especially when you’re looking at a lower priced deal like this one, it becomes quite impactful.” A fourth buysider concurred: “How ratchets are set now, you need to haircut [margins] from the beginning.”

Only three other euro TLBs have come to market below E+250 bps this year: software company Avast’s €300m TLB at E+200 bps in March; French healthcare firm Ramsay Generale de Santay’s €700m TLB at E+225 bps in April; and pharma company Avantor’s €325m TLB at E+225 bps in May.

Founded first in 1862, Orion is split between its Rubber (tyres, conveyor belts) and Speciality Carbon (a raw material for industries including printing and coatings) divisions. The company, which went public in 2014, is largely approached by buysiders as an “unexciting, but stable” prospect, one many are pre-existing lenders into.

The global carbon black market is a consolidated market, buysiders report, where the top seven players (including Orion) contribute to about 50% of the market share. With much of this capacity in China, that gives Orion a “strong foothold” in Europe and North America, the third buysider said. Two new Orion facilities, one in Ravenna next year and a Chinese plant the year after, will bring in around $30m to $40m of extra EBITDA once at steady state.

The company is also notable for being one of the less common publicly-traded deals to grace buysiders’ desks. “Really, we prefer private equity ownership because we know that if things go wrong, the sponsors are there to step up,” said the first buysider. “But publicly owned is still better than family-owned and single ownership - the level of disclosure is excellent, the governance tends to be solid and the leverage is lower.”

Leverage is, indeed, far lower than many other loans currently in the market. As of Q2 2021, it stood at 2.4x and 2.6x on a net and gross basis respectively, after peaking at 3.4x and 3.9x in Q4 2020. Gross debt, meanwhile, stood at $714.8m in Q2 versus cash of $74.1m.

The company closed off a strong Q2 on the back of demand recovery and supply constraints following the pandemic: its $78.8m second quarter adjusted EBITDA was the second highest in its history (edged out by Q2 2017’s $127m), four times higher YOY, but also 10% higher than Q2 2019.

LTM June 2021 figures put unadjusted EBITDA at $326.6m on an EBITDA margin of 24%. The deal, however, is marketed lower at $271m adjusted EBITDA.

This is down to a one-time cash payment of €66.55m Orion snapped from former owner Evonik in June 2021. When the business was spun-out of Evonik in 2011, bought-up by Rhône Capital and Triton, the acquisition agreement provided Orion partial indemnity against costs related to any US Clean Air Act violations that occurred before the spin out. When the Environmental Protection Agency (EPA) came after both Evonik and Orion, Orion initiated arbitration proceedings to recoup those costs under the agreed indemnity.

This does not, however, leave Orion escaping the grasp of the EPA. The first buysider, who is passing on the deal, argues that orders from the agency could be too tight a stranglehold on free cash flow going forward. Moody’s estimates $220m-$240m of FFO generation in the next 12-months, which should be sufficient to cover amortisation, capex and swings in working capital.

Orion recently reached an agreement with the EPA to install pollution control technology at its four American facilities. Orion guides that Capex expenditure as €230m to €270m ($270m to $290m), with around €132m ($155m) already spent as of H1 2021.

“This could just be a taste of things to come,” said the first buysider. “We can’t be sure what other kinds of environmental regulation could be down the road for this company and what kind of Capex it’s going to take to align with that regulation.” These upgrades also mean closures of its Ivanhoe plant, the buysider added, which is expected to dampen H2 results. “There’s a picture of demand outstripping supply here anyway and the regulation is already bottlenecking it. Maybe this won’t become a big issue, but we’re in a place where we don’t need to take it, so it’s a pass.”

The second buysider, however, disagreed. “They’re already halfway through the Capex plan for the current upgrades and, really, it’s just going to make it harder for newcomers to get into the market when there’s the technological hurdle.”

As for Orion itself, the third buysider described the company as “definitely at the weaker end” of their firm’s proprietary ESG analysis, as carbon black results in incomplete combustion of heavy petroleum products (such as tar). Orion currently has $12m outstanding under a European Emission Allowance (EUA) Repurchase Agreement, with such facilities likely to become increasingly crucial for heavy emitters as the price of carbon continues to soar. Buysiders also pointed out that US competitor Monolith is further on than Orion in terms of green-ing their processes, with the third buysider labelling Orion’s advancements as “just prototypes”.

With bubbling environmental pressures, buysiders pressed the company about carbon black alternatives in the lenders’ call, such as synthetic rubber - concerns which management waved aside. “One data point neither the banks nor the company could give me was on how silicone as a replacement material is penetrating the market,” the second buysider went on. “I put it at mid-single digit CAGR, but the company didn’t seem to think it was significant.”

Environmental regulation has also been hitting Orion from another direction. In a situation its CEO dubbed a “nightmare”, demand for Carbon Black Oil (CBO), Orion’s primary raw material, has also skyrocketed due to IMO2020 regulations and by further EPA mandates. IMO2020 dictates the sulphur content of shipping fuel (read more in 9fin’s take on green regulation in the shipping industry here), forcing freight companies all into the same band of fuel with a particular sulphur content. Overall, volatile oil prices more generally drove roughly half of Orion’s increase in working capital YTD.

Like many chemicals companies, however, these costs are passed onto Orion’s customers. “We have increased prices significantly year-to-date,” CFO Lorin Crenshaw admitted on Orion’s earnings call. “But these increases have simply allowed us to hold even with rising costs, as opposed to expanding our margins.” Orion increased pricing by 20% in May 2021 due to what it described as “sharply rising” global raw material and supply chain costs, rising them again in August for the same reasons.

This proves a balm for buysiders: “Most of their revenues are from contracted customers with pass-through agreements, and there’s always the issue of the delay in passing the cost on, but it’s still good to see,” said the third buysider. The second buysider added: “The capacity outlook is good past those closures in H2, so this constrained situation isn’t set to last, and I don’t view it as a material headwind anyway.”

Goldman Sachs acts as agent, sole bookrunner and mandated lead arranger on the deal, with Deutsche Bank, ING and UniCredit as mandated lead arrangers.

Orion and Goldman Sachs did not respond to a request for comment.

Back to black - Margins make or break on Orion’s BB refi despite ESG regulation rumbles

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