iosp nov 1 - 2011 - draft 2

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By Geanoo Chong [email protected] IOSP

INNOSPEC INC. (IOSP: Nasdaq) $30.20, P/E: 7.41 (ttm), P/B: 2.19

Highlights:

Company Fairly valued based on FCF Relative metrics discount illusion due to

size and inventory issues

Q3 Peek Negative EPS due to fine,how/when will market react?

Future commitments considerable inshort term due to fine

Company will either make anacquisition or begin to return cash to

shareholders share repurchase plan

Operating results in Active Chem, andupdate on new Oilfield Specialties

Segment catalysts for growth

Company Description and Recent Legal Activity

Innospec (formerly Octel) is a company that manufactures and markets fuel and specialty aroma

chemicals and solvents. Innospec was spun off in 1998 from Great Lakes Chemical Corp, as one the

leading producers of Tera Ethyl Lead (TEL), an additive in Leaded gasoline, which at the time

represented 82% of company sales.

Leaded gasoline usage in automobiles has declined dramatically around the world, due to changes in

environmental standards world-wide, declined 80% by volume. TEL is still used in Jet fuel.

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This left only a few jurisdictions to market their primary product, TEL. Their customers included Iraq,

Indonesia, and Venezuela. Conducting business in these countries would raise flags for any investor for

good reason. In 2005, Venezuela, the companys largest source of sales switched to motor gasoline,

necessitating a $134 M impairment charge, off of $200 M in gross profits. This was just the beginning of

a bad year for the company. Later in the year, Dennis Kerrison, Innosepecs CEO, was forced to resign in

2005 for misappropriation of company funds. Mr. Kerrison lent a subsdiary of the Company 50,000

pound, after which the subsidiary lent Mr. Kerrison 95,000 pound. He would be replaced by the CFO,

Paul Jennings who himself would dismissed and fined for corruption charges detailed below. A 5 year

investigation by the SEC, FOA (uk), and DOJ was launched for violations against:1

Defrauding the Oil for Fuel program in Iraq, February 2006, Violations of the US embargo on Cuba. allegations of issuing bribes to win business in Indonesia, Iraq fromm 2000-2007, or most of its

operating history.

Total fines levied for these violations were $40.2 Million on July 23, 2010 (q3). This amount was already

accrued in 2009, as an operating expense out of the Octane additives segment. Its net effect resulted in

a loss of -$44 M for the year, off a gross profit of $15 M for the segment. As at the end of Q2, June

30th, $24.5 M had yet to be paid, with $ 13.5 M due within one year.

Upon settlement with the DOJ, court documents revealed as part of Innospecs corruption practices,

they bribed Iraqi officials to ensure that a competitor, Newmarket Corporation, would fail a field test of

Lead Fuel additives.2 This case was settled of $45 Million recently, on September 13, 2011. Further

lawsuits by other competitors have not been announced. Innospec will pay $25M by September 20,

2011, $15 M annually by promissory note starting Sept 2012, and the $5 M remaining in Innospec

common stock, (195,313 shares) by September 20, 2011.3 No accrual was set up for this, so the full

impact will directly impact Q3 results. The largest earnings the company has earned in a quarter was

Q3 in F2010, $30 M, so it is likely, barring extraordinary operating results that the company will have its

first loss since Q3 and Q4 in F2009, which is when the absorbed its previous fine. The date of the

announced accrual for the DOJ complaint, the date of settlement/launch of Newmarket lawsuit, andannouncement of the settlement of the Newmarket case has drawn yawns from the market.

- July 23rd, 2010 Newmarket case launched. Same day as final settlement of DOJ settlement.Stock up 2% next trading day.

- September 12, 2011 Case settled. Stock up 3.5% Keep in mind, the company gave noguidance to the extent of loss, and as of Q2, were still defending it.

It would appear that a) the market assumed a much larger settlement, b) the fine itself is immaterial,

or, on a related note, c) the market did not care.

For a) I am not aware of a consensus market settlement, but given the timeline, there was no

disclosure of Newmarket filing a suit till the announcement date, and no range of potential settlement.

The range for the DOJ settlement was $18-$63 M as of 2009, so assuming the market anticipated the

high end of the estimate, there is still $25 M unaccounted for.

1http://www.corruptionwatch-uk.org/cases/innospec/index.html

2http://www.downstreamtoday.com/News/ArticlePrint.aspx?aid=23636&AspxAutoDetectCookieSupport=1

3September 14, 2011 8k, -http://www.innospecinc.com/financial-information/sec-filings.html
http://www.corruptionwatch-uk.org/cases/innospec/index.htmlhttp://www.corruptionwatch-uk.org/cases/innospec/index.htmlhttp://www.corruptionwatch-uk.org/cases/innospec/index.htmlhttp://www.downstreamtoday.com/News/ArticlePrint.aspx?aid=23636&AspxAutoDetectCookieSupport=1http://www.downstreamtoday.com/News/ArticlePrint.aspx?aid=23636&AspxAutoDetectCookieSupport=1http://www.downstreamtoday.com/News/ArticlePrint.aspx?aid=23636&AspxAutoDetectCookieSupport=1http://www.innospecinc.com/financial-information/sec-filings.htmlhttp://www.innospecinc.com/financial-information/sec-filings.htmlhttp://www.innospecinc.com/financial-information/sec-filings.htmlhttp://www.innospecinc.com/financial-information/sec-filings.htmlhttp://www.downstreamtoday.com/News/ArticlePrint.aspx?aid=23636&AspxAutoDetectCookieSupport=1http://www.corruptionwatch-uk.org/cases/innospec/index.html

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As for b) the fine being immaterial, the company generates approximately 30-40 M in FCF, averages $50

Mill in operating income, $82 M in the last 12 months. I would suggest that the charges are very

material.

C) Indifference of the market. The stock is covered by one analyst. Its market cap is less than 1 billion,

meaning it is off the radar. The company does not provide guidance on the stock. Recently, the stock

has been tightly correlated to the Russell 2000, .8, in the last 100 days, .92 in the last 50 days, which

would suggest for the most part, there is no analysis done on the stock, beyond membership of its

index. Due to lack ofcoverage, I dont think the market is aware of the fine, but will it care when the

company reports a YoY decline in EPS?

How will this hamper performance in the future? Im not a legal expert, but the specific nature of the

charges in the Newmarket case, may limit future lawsuits by other competitors, as Newmarket was

named as being a direct victim of Innospecs corruption practices. Also, given the small number of

competitors, there is a smaller potential number of potential companies that would file suit. If a

company felt they had a claim based off the settlement with the DOJ, I would presume would have

launched a lawsuit around the same time as Newmarket but that does not eliminate the risk of further

legal contingencies given the large settlement. It is also pure conjecture to assume such practices exist

are ongoing. The CEO and CFO during the times of the violations have been removed, but, severaldirectors remain on the board throughout this. The worst is over, but risk of further litigation remains,

due to the global nature of their operations with varying standards of ethics.

Naturally, to disassociate with its scandalous past, the company changed its name from Octel to

Innospec in 2005. It was part of a reorganization, diversifying the business and concentrating growth

away from the declining lead fuel additives market.

Commitments:

Before fine due in 1 Q3* Due in 1 yr 2010 2009 2008 2007 2006 2005

Long-term debt obligations 33 33 15.00$ 47.00$ 51.00$ 73.00$ 81.00$ 148.00$ 140.00$

Interest payments on debt 1.155 1.155 2.5 3.10 5.70 2.00 6.10 11.00 36.1

Planned funding of pension obligation 9.1 41.5 9.1 50.60 37.20 28.80 35.70 28.30 15.5

Remediation payments 3.6 25.90 3.6 25.90 23.70 21.10 23.80 23.70 23.2

Severance payments 0.5 0.50 0.20 0.50 2.40 3.80 7.8

Raw material purchase obligations 5.2 15.8 5.2 18.30 2.60 7.40 7.00 0.30 2.3

Operating lease commitments 1.3 5.2 1.3 5.50 6.50 6.90 9.40 6.10 2.7

Capital commitments 1.4 1.4 1.4 1.40 1.70 1.40 1.60 3.10 2.6

Legal fines @q2 F2011 10.9 24.5 10.9 24.50 40.00

Legal fine - Newmarket 25 40

Share repurchase plan 45 45

Total 90.66 188.46 49.50 176.80 168.60 141.10 167.00 224.30 230.20

Cash and short term investments 103.40 111.30 68.60 13.90 24.30 101.90 68.90

Due in 1 yr 90.66 49.50 29.30 93.80 47.50 37.60 42.40

The table shows an estimate of the financial commitments of the company prior to the payment of the

Newmarket fine. The impact of the fine is significant, raising commitments to $190 M. Cash, at the end

of Q2 was 103 M, with $25 M remaining on the term loan, due within 4 months. They also have a share

repurchase plan in place for the rest of 2011. This is not included in the total commitment, as it is up

the companys discretion, while all the other commitments are not.

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They are restricted by covenants, Debt/Ebitda, > 2.5, and EBITDA/net interest > 4.0, measured

quarterly. If the EBITDA calculation counts the legal fine, the company would likely violate a quarterly

test of the ratios, as there they would have to earn at least $46 M before the fine in order to meet the

coverage ratio, so Id assume it is not included. They have just enough cash to meet financial

commitments due in one year, and assuming FCF is $15-20 M in Q3, they can draw on their credit facility

to a maximum of 100M till February 2012 to meet their working capital needs and provide a cash

cushion.

The size of debt financing could dictate the strategic direction of the company. An increase in term debt

could be the resource to fund a large scale acquisition that the company has repeatedly stated as its

growth strategy, despite not making a meaningful acquisition since 2005. A modest or lower debt

financing may mean that the company is maintaining its businesses, and using its strong recent free cash

flow generation to build up a cash base. In spite of comments on the Q2 conference call, if we do not

make any acquisitions by year end, we will review our options for returning cash more aggressively to

our shareholders4 I would expect this any decisions to be moved to next year. An acquisition by year

end is unlikely due to their resources. In theory, they could use equity to finance an acquisition, but that

would be contradictory to the recent announcement of a $40 M share repurchase plan which may be a

way to appease current shareholders and revist an acquisition next year.

Aside from the fine, the largest source of cash outlay is the Defined Benefits plan, for the UK employees.

The company has worked to control a once ballooning PBO by closing the plan for future service accrual

in March 2010 and reducing the uncertainty in future benefit increases through a plan that would give

the option of taking a one increase to future benefits in exchange for future non-statutory raises.

Finally, they gave the option of exchanging the pension for another non-DB vehicle.

Q2

2010 2009 2008 2007 2006 2005

PBO 684.00$ 796.00$ 571.20 854.30 897.90 909.50

Fair value 672.30$ 671.80$ 557.40 889.10 875.40 872.90

Funded status (11.70)$ (124.20)$ (13.80)$ 34.80$ (22.50)$ (36.60)$

Amount recognized in OCI -129.20 -249.10 -124.30 83.50 138.50 179.60

These steps have served to reduce the amount and uncertainty of future pension obligations and offset

the reduction in equity. Since the application of FAS 158 in 2006, book value has eroded by $152 M, due

to the funding deficit. In the beginning of 2006, equity swung several times from $170M, to as low as

$22M, and now back on track at $180 M as of June 30, 2011. These changes serve to reduce PBO, but

the company will still have to contribute for the alternative pension plans, obligations that have not

been disclosed.

At the end of F2010, the funded status had deficit of $11 M. The plan assets are heavily weighted in

fixed income securities (73%), so the steep decline in worldwide equity indices should be offset by the

performance of bonds. Future cash contributions have been budgeted at about $ 9.1 M annually.

Plan assumptions

42011 Q2 conference call transcript, page 6

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Q2

2010 2009 2008 2007 2006 2005

Plan assumptions (%):

Discount rate 5.40 5.60 6.50 5.80% 5.10% 5.00%

Inflation rate 2.80 3.60 3.00 3.95% 3.55% 3.55%

Rate of increase in compensation levels - 3.60 3.75 3.95% 3.55% 3.55%

Rate of return on plan assets - overall 5.45 5.75 6.20 5.45% 5.25% 5.30%Rate of return on plan assets - equity securities 7.70 7.20 7.80 7.50% 7.60% 8.50%

Rate of return on plan assets - debt securities 4.50 5.80 5.10 4.60% 4.60% 4.60%

Plan asset allocation by category (%):

Equity securities 27 26 22 29% 32% 29%

Debt securities 73 74 76 71% 67% 70%

Other - - 2 1% 1%

Above is the list of pension assumptions for the Company, and asset allocation. The biggest change was

the lack of change in compensation levels, as further wage increases will be frozen in the pension, which

contributed in reducing PBO. For plan assets, the rates of return have been reduced over the years in

line with the performance of financial markets.

Operating Segment Results:

SixMonthsEnded

June 30

2011 2011 - ttm 2010 2009 2008 2007 2006 2005

Fuel Specialties

Sales 240.4 481.5 458.1 422.7 440.9 374.6 311.3 257.1

% of total sales 64.7% 66.6% 67.1% 70.6% 68.8% 62.2% 58.5% 45.5%growth - yoy 10.8% 5.1% 8.4% -4.1% 17.7% 20.3% 21.1% 23.1%

Gross margin 28.1% 30.1% 32.1% 34.8% 33.0% 33.3% 34.1% 32.5%

Operating Margin 14.4% 15.2% 16.9% 19.3% 18.1% 17.0% 14.7% 10.2% The company invested into growing their auto fuels additives business, basically unleaded fuel additives

business, named in filings as Fuel Specialties. In 2004, perhaps anticipating the smell of legal trouble

ahead, they launched an active chemicals business, focusing on household products and aroma

chemicals. Throughout all this, the company has never generated negative Free Cash flow, and with the

exception of big bath of 2005, has posted positive net income. The annual growth rates for both

segments have been 9% for Fuel, 6.75% for Active annually

As per the most recent corporate presentation, the company treats the whole oil barrel. Customers in

this segment consist of major integrated oil and gas conglomerates. Royal Dutch Shell has been their

largest customer, making up more than 10% of sales since 2007. Included in this segment is Avtel,additives for jet fuel. Based off of refinery utilization rates, oil comsumption, and jet fuel demand, Id

expect stronger quarter to quarter sales growth, with possible gains in their oil field services business.

Margins remain threatened by rising commodity costs. As per the CEO, 5 there are 5 large competitors

and several mid-sized , with Innospecs focus on Fuel Additives, as opposed to refinery process

chemicals and lubricant oil additives. Some of these competitors are Lubrizol, recently acquired by

5Wall street transcript, March 21, 2011www.twst.com, reposted on Innospec website
http://www.twst.com/http://www.twst.com/http://www.twst.com/http://www.twst.com/http://www.twst.com/

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Warren Buffet, and Infineum International, a joint venture between Exxon and Shell. Given the healthy

30% gross margins, competition should be expected to increase, and may have already as margins have

declined, from as high as 35% in 2009 to 27% in Q2.

SixMonthsEnded

June 30

2011 2011 - ttm 2010 2009 2008 2007 2006 2005

Active Chemicals

Sales 95.2 172.4 152.7 130.2 138.3 133.8 120.4 109.4

% of total sales 25.6% 23.8% 22.4% 21.8% 21.6% 22.2% 22.6% 19.4%

growth 26.1% 12.9% 17.3% -5.9% 3.4% 11.1% 10.1% 125.1%

Gross margin 26.7% 25.2% 22.3% 20.6% 9.0% 18.4% 18.9% 16.1%

Operating Margin 17.5% 14.9% 10.9% 6.8% -3.6% 4.6% 4.8% 0.9%

The Active Chemicals segment, was born out of acquisitions made in 2004 and 2005. It is a point inpride in that the 35%-45% of sales have originated from R&D efforts within the last 5 years. Its

customers range from la P&G to small labels. Its strategy is to operate in niche markets. As the

company is still gaining a foothold in this market, growth projections are highly speculative. Margins

have increased to 28%, from a low of 9% in 2008. Consumer demand, and commodity prices, namely

vegetable oils are the drivers for growth.

SixMonthsEnded

June 30

2011 2011 - ttm 2010 2009 2008 2007 2006 2005

Octane Additives

Sales 36.2 69.20$ 72.40 45.60 61.30 94.00 100.40 198.30

% of total sales 9.7% 9.6% 10.6% 7.6% 9.6% 15.6% 18.9% 35.1%growth -8.1% -4.4% 58.8% -25.6% -34.8% -6.4% -49.4% -17.2%

Gross margin 49.7% 49.9% 49.7% 33.6% 46.2% 51.2% 57.6% 49.9%

Operating Margin 28% 26% 36% -98% 2% 21% 34% 35%

Op margin net of fine 28% 26% 36% -8% 2% 21% 34% 35%

TEL, the legacy lead fuel additive that was the cause for the legal troubles of the past, is still alive. Sales

have actually grown in 2010, and continue that trend although, declined in 2011. Their current market

is in the middle east and Africa, which has been the subject of political instability this year. Gross

margins north of 50% is good reason for the company to maintain this business, and Operating margins,

net of the fines, have also been strong. Prospects for this segment will continue to weaken, but as long

as it remains, legal and regulatory risk looms due to the markets and customers it does business with.

Moat exists in TEL, but in a declining business.

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2010 2009 2008 2007

Change (%)

Fuel Specialties

Volume 15.00% -1.00% 10.00% 14.00%

Price and product mix -4.00% -2.00% 7.00%

Exchange rates -3.00% -1.00% 1.00% 6.00%8.00% -4.13% 17.70% 20.33%

Active Chemicals

Volume 7.00% -3.00% 2.00% 4.00%

Price and product mix 12.00% 5.00% -1.00% 1.00%

Exchange rates -2.00% -8.00% 2.00% 6.00%

17.00% -5.86% 3.36% 11.13%

Octane Additives

Volume 45.00% -23.00% -35.00% -5.00%

Price and product mix 14.00% -3.00%

59.00% -25.61% -34.79% -6.37%

Growth:

Since 2006, 82% of growth related to volume. There is little ability to drive pricing within Fuel specialties,

given the size of the customers and competitive nature of the market place. Pricing appears to flow

with the price of oil. Active chemicals has shown less price sensitivity especially in recent years, where

sales grew 12% based on changing the product mix to higher priced products and increasing prices. I

would guess that the easy growth within the Fuel Additives industry is over while Active Chemicals

should show volatile growth as the company continues to ramp up its presence in the industry. To

continue growth, they are leveraging their integrated oil producers by selling products on the upstream

of the oil barrel. They are adding new markets geographically, opening offices in Singapore, Russia, and

Brazil. These markets are still in the early stages. Margins have ranged between 29%-35%, mainly due

to the shift from high margin octane additives to Active chemicals. Further margin compression is likelyas high margin Octane Additives continues to phase out at a faster clip than Active Chemicals can gain

traction in the market.

Cash flow analysis

Free cash flow, defined as CFO, less capital expenditures, was $40, $49 and $80 in the last three years.

While the remainder of the year will be hampered by the fine, I would expect $40M in FCF per year

going forward Sales growth, and reduced future legal expenses, would provide upside. There may be

opportunity to better manage inventory. Raw material prices have gone up, but this also coincides witha large raw material purchase obligation ($18M at F2010 year end) which may be a way of securing

materials for future demand, rather than on a JIT basis, reducing future inventory purchases.

FCF will further be reduced by $25 M in term debt, any remaining amount on the credit facility ($8 M at

the end of Q2) a $15 M note payable to settle the fine, due in 3 years, and a $45 Million share

repurchase plan, which would eat up most of FCF from Q3 and Q4.

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Free cash flow has a volatile history, mirroring the many changes occurring in the company since

inception, in 1998. The trend was initially, negative, declining from 214M annual FCF to 52 M in 2004.

The results from 2005, since the reorganization are below.

To better understand the volatility behind FCF, the number is broken down into xx components. 1) Net

income, + Depreciation/Amort and Impairment, 2) Working Capital, 2) Other non-cash charges to

operating income, 4) Capital expenditures.

Net income + depreciation/amort and impairment is 118 M for the last 12 months, the highest it has

been, since inception. Results in 2009 declined because of the SEC settlement of $42 M, and 2008 can

be explained by general downturn in the economy. Otherwise, a minimum amount generated can be

assumed to be 40 M.

Working capital has largely been negative annually. The cash collection jumped 54 days from F2010, due

to lower inventory turnover, which dropped 25%. A/R and A/P turnover was largely flat. This was the

second highest it has been since the impairment write down in 2005. Adding changes to CFO, ignoring

working capital, gives a clearer picture. Working capital resulted in net cash outflows in every year but

2009, where it actually served to benefit the company, due to an increase in A/P and reduced inventory

purchases, to help offset the fine. Capital expenditures have ranged between $7- $12M a year, which is

below depreciation, and well covered by Free cash flows.

Valuation

Net assets

Net Working capital after deducting total commitments, is about $17M assuming 100% liquidation

value. After meeting all its commitments, the pension, environmental fees, operating leases, etc, there

is $17M to fight over. At the end of F2010, Innospec owned 7 facilities worldwide, with land at $7 M,

and the building, at gross value, of $4.7 and equipment, at $110M. The gross value of this total went up$7M by June 30, 2011, likely due to the construction of a new building. Land likely would get a larger

value in a liquidation, buildings and equipment would be more difficult to assess. Assuming a steep

discount on the equipment, offset by the discount on the building, and 100% of the land, we can assume

$13M for total fixed assets for a grand total of $30M. No matter how you change the appraisal values of

the individual components, the market capitalization is at a steep premium.

After settling its legal matters, and no other lawsuits announced on the horizon, I can safely assume the

company will continue to operate in the future. Cash, after paying for commitments due in one year, is

about $12M. To meet the rest of the commitments and earn a tidy profit, the company will have to

continue to generate free cash flow.

Discounted Free Cash Flow Analysis

Any forecasting is usually folly, even a forecast of 0% growth, which could be as wrong as 8% growth per

annum. One way to approach it is to begin by assuming zero growth, and add growth up to a

maximum of average ROIC, of 12%. Key assumptions are a starting base of $40 M in 2012, and a

required return of 10%. Starting FCF is estimated for 2012, as gains for FCF for the second half of 2011

will be impacted by remaining fine payments.

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A constant stream of $40 M in FCF (average FCF generation over the last 6 years), assuming zero growth,

with a required return of 10% is about $400M, or about $16.74 per share which would indicate that the

stock is considerably overvalued.

What growth rate would the current stock price imply? Lets look at a two stage process, growth of 10

years, after which constant growth of 1% to keep up with worldwide gdp.

If first stage growth is 8.3%, we get a discounted value of $747 M, which is the current market price. If

we are more optimistic, lets try a growth ceiling of 12% of 10 year, which is average ROIC. This results

in an intrinsic value of $974M, or 41.03 a share. At 8.3% growth, the company will generate 89 M in FCF

in 2021. The highest FCF level generated by the company was $80 M in 2009, and as Octel, in 2002

$88M. 2009s results were benefited by positive working capital cashflow, an outlier from a generally

negative working capital. Growth levels of 8.3% are close to historical ROIC, of 12%, which I would place

as a historical growth ceiling. At this ceiling, intrinsic value would be a 30% discount to current market

price. But that is if everything goes right. I believe the company could potentially reach its historical

ROIC, but Id rather not have to pay for the pleasure. This would make me conclude that based on FCF

analysis, and factoring a marginal benefit for its tangible assets, that the stock is not at a discount.

Implied growth is at a reasonable rate however, so it doesnt appear to be overvalued. All the aboveanalysis leads to a fairly valued conclusion.

I would be buyer of the stock at the right price. Given the volatile operating history, and past corporate

governance short sightedness, Id demand a 40% margin of safety. With an assumption of 2% growth ,

with an intrinsic value of $500M, that translates to a target price of $12.63, around the stock price one

year ago. I apologize for the report being one year too late.

Why I may be wrong

In a bear/bull case, the stock would have to perform differently from the Russell 2000 first of all,

otherwise, just buy the index for the diversification, likely through more sell side research or more

awareness of the company, outside of legal briefs. Assuming that, Ive listed a few bear/bull scenarios:

Bull case:

The legal problems plaguing the company have been resolved and have allowed the company to

concentrate on executing its growth strategy, through a cheap acquisition. The acquisition is

immediately cash flow accretive, with minimal integration headaches. Octane Additives continues to

serve the few remaining markets, and these markets are slow to change to environmental standards ofdeveloped nations. Their entrance to Oilfield specialties gains traction at minimal cost, utilizing existing

contacts in their core Fuel Specialties business. The world economy stabilizes, and fuel usage remains at

high levels, or the company is able to successfully gain market share in renewable fuel additives. This

results in 10%+ free cash flow growth. Most importantly, the changes mandated by the settlement of

their DOJ fines result in no future corporate malpractice. The company continues to have low capital

charges.

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Bear case:

Octane additives continues to give the company problems, with possible future litigation. More

countries change away from lead-based fuels, with the TEL business being written off in a few years The

company make a substantial, costly acquisition. The world economy slows, with less fuel usage

worldwide. Growth is stagnant or negative. Active Chemicals, and Oilfield business do not growmeaningfully, and more cash is invested in these businesses without returns. Capital charges skyrocket

as capacity is added.

Relative Analysis

In Millions NEU n/a IOSP

Company Newmarket Lubrizol Innospec

Exchange NYSE sub of BRK Nasdaq

as at 31/10/2011 09/07/2011 31/10/2011

Market Cap (intraday)5: 2,690 8,684 717.22Enterprise Value (Oct 31, 2011)3: 2,980 9,248 677.48

Trailing P/E (ttm, intraday): 13.89 11.91 7.41

Forward P/E (fye Dec 31, 2012)1: 12.01 na 8.16

PEG Ratio (5 yr expected)1: 1.45 na N/A

Price/Sales (ttm): 1.36 1.48 1.03

Price/Book (mrq): 4.87 3.22 2.19

Enterprise Value/Revenue (ttm)3: 1.48 1.58 0.94

Enterprise Value/EBITDA (ttm)6: 8.55 7.35 6.59

For comparison purposes, Ive added two competitors, Newmarket, the plaintiff, and more famously,

Lubrizol, Warren Buffets latest acquisition. Innospec would appear cheaper than both companies,which at first glance, would question Warren Buffets deal making. A further look below at operating

statistics gives a clear reason for the discrepancy, size and inventory turnover.

Innospec, for its size, would compare nicely on profitability and return ratios. Leverage usage is the

lowest for Innospec as well. Looking at the difference between Operating and Free cash flow, they have

low capital costs as well. The problem is inventory turnover, which is almost 3x its competitors. Factor

in size as well, this would explain the cursory value discrepancy.

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Newmarket Lubrizol Innospec

Profitability

Profit Margin (ttm): 9.76% 12.46% 13.89%

Operating Margin (ttm): 15.24% 21.48% 12.25%

Management Effectiveness

Return on Assets (ttm): 17.26% 14.00% 10.02%

Return on Equity (ttm): 39.37% 29.37% 38.14%

Income Statement

Revenue (ttm): 2020 5854.8 723.1

Revenue Per Share (ttm): 143.44 90.83 30.47

Gross Profit (ttm): 515.46 1850.4 217.2

EBITDA (ttm)6: 348.51 1257.8 102.8

Net Income Avl to Common (ttm): 196.98 729.3 100.4

Diluted EPS (ttm): 13.98 4.08

Balance Sheet

Total Cash (mrq): 60.89 793.00 103.4

Total Cash Per Share (mrq): 4.4 12.30 4.35

Total Debt (mrq): 298.26 1,357.00 33

Total Debt/Equity (mrq): 0.53 0.50 0.10

Current Ratio (mrq): 3 3.53 1.96

Book Value Per Share (mrq): 40.67 41.81 14.35

Cash Flow Statement

Operating Cash Flow (ttm): 130.47 637.6 49.3

Levered Free Cash Flow (ttm): 46.85 386.6 45.5

FCF yield 0.02 0.04 0.06

Stock Price History

Beta: 1.71 na 2.37

52-Week Change3: 66.87% na 0.86

S&P500 52-Week Change3: 8.61% na 0.0861

52-Week High (Oct 27, 2011)3: 198.38 na 38.2452-Week Low (Oct 29, 2010)3: 115.12 na 15.4

50-Day Moving Average3: 163.8 na 26.39

200-Day Moving Average3: 164.83 29.95

A/R 313.80 921.00

Turnover 7.07 7.12 7.81

Collection (days) 51.63 51.25 46.74

INV 327.80 917.00

Turnover 5.01 4.61 1.56

Conversion (days) 72.90 79.21 233.96

A/P 127.10 468.00

Turnover 17.10 13.99 13.99Payment (days) 21.35 26.09 26.10

Cash conv cycle 103.19 104.36 254.61

iosp nov 1 - 2011 - draft 2

Documents