Contingent Liabilities - Ticking Time Bomb? ...... or Much Ado About Nothing?

When is the last time a specialty chemical company had a valuation that was in the range of 1 times EBITDA? That's right, a multiple of one.

As of mid-October, with its shares trading around $4, W. R. Grace had a valuation in this range.

Why? Because of contingent liabilities the company faces relating to asbestos litigation.

Are these liabilities a ticking time bomb about to go off? Or is Wall Street overreacting to the risk, thereby making Grace a bargain acquisition candidate?

In the article that follows, we will explore this subject in more detail.

Contingent Liabilities

The situation facing W.R. Grace is an extreme example of how contingent liabilities can drag down the value of a chemical business. While we do not know whether Graceís valuation today is too high, too low, or just right, it does nevertheless illustrate the risks inherent in buying a chemical business with substantial contingent liabilities. It also raises the possibility that a buying opportunity may exist if contingent liabilities are exaggerated.


Types of Contingent Liabilities - some of the more common examples are described below. Note however that there are many other types of contingent liabilities not described.

  • Litigation - Risks associated with litigation are very difficult to assess and can be very high, in some cases disproportionate to the value of the business. As mentioned earlier, asbestos litigation is putting a damper on the valuation of Grace. Asbestos litigation has forced the bankruptcy filing of Owens Corning recently and Dow Corning was forced to file for bankruptcy because of breast implant litigation.
  • Environmental Cleanups - The cost of cleaning up an environmentally contaminated site can also be very difficult to assess and as with litigation, can also involve costs disproportionate to the value of a business. The chemical industry has a long history of dealing with these types of liabilities and there are very few businesses that do not have some risks here.

  • Taxes - Contingent tax liabilities are often important when it comes to the acquisition of a closely-held business. These potential liabilities however rarely are of a magnitude that you see with litigation and environmental matters

    • Due diligence becomes critical - Because the potential costs can be so high, the due diligence review of contingent liabilities is a major undertaking in many chemical industry transactions.

Stock deal or asset deal? - One of the ways an acquirer can minimize risk is to structure a deal so only specific assets are acquired, leaving the contingent liabilities with the seller (provided the seller remains a viable entity after the deal). While this is not always a foolproof method of avoiding risk, it is an avenue that is commonly employed. Of course, when acquiring a public company, all contingent liabilities are part of the deal, making this structure perhaps the most risky from a buyerís perspective, and the most advantageous from the sellerís perspective.

Time Bomb or Much Ado About Nothing? - Back to our original question. It is common in chemical deals for buyers to focus on the worse case scenario when it comes to valuing a business that has significant contingent liabilities. This is completely normal and understandable. Nevertheless, if the risk is exaggerated and the price offered reflects this, then a deal may die because the seller wonít sell or another buyer takes a more realistic approach to measuring the risk. On the other hand, if the risks are are ignored or minimized, a valuation may be too high and a buyer may have made a major mistake.

What is clear when dealing with significant contingent liabilities is that there are opportunities for both seller and buyer. There will inevitably be examples where the risk is large and potentially crippling, as well as examples where the risk is overblown.