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3M Potential Ear Plug Settlement:
Word started leaking today (August 27) that 3M (NYSE:MMM) was nearing a potential settlement for the class action litigation over its ear plug liability stemming from its Aearo Subsidiary. The settlement calls for $5.5 billion paid out over 5 years. This number is near the low end of the range that sell side analysts had speculated and which I discussed in my initial write up on the company “3M: Catalysts for a Potential Bankruptcy”. I have remained strongly bearish of the company since then.
We will have to see if the settlement does indeed come about and is blessed by the judge assigned to the MDL (multidistrict litigation). If it becomes official, I think some people will consider it a win for the company. I’m not going to get too excited. For starters, $1.1 billion per year for five just for this liability is an over 10% drag on the company’s EBITDA and a 20-25% drag on free cash flow for five years. The cash flow drag is more important than EBITDA as the drag from these payments will mean that the company is no longer organically covering its dividend.
Small Compared to PFAS:
Moreover, this ear plug liability is and has always been far smaller than what I believe the company will ultimately pay for its PFAS liability. Reminder, the company announced a settlement for its water utility PFAS pollution MDL for between $10.3 and $12.5 billion in June. That settlement has not been blessed by the judge overseeing the MDL yet, has been challenged by state attorney generals, and has yet to reveal the size of opt-outs. It was my contention at the time of the settlement that it was a small part of what the ultimate liability for PFAS will be. I stand by that. The issues still outstanding, beyond the opt-out water utilities, are property damage, personal injury, lawsuits from state attorney generals, and (most importantly in my opinion), the Superfund (Cercla) risks posed by the EPA which will come if the EPA gets PFAS designated as a hazardous material. Starting at a base of $10.3-12.5 billion, the total costs for PFAS could dwarf this, still consider $5.5 billion for the ear plugs.
However, even if we’re just discussing the PFAS mdl and the ear plugs, we’re still talking about $15.8-$18 billion of liabilities in the context of a company with negative total and organic revenue growth and compressing EBITDA margins that are driving EBITDA to $8 billion or lower. At best, just these two settlements added two turns of leverage to the company and drop credit metrics to 3x leverage, implying a far lower credit rating than A from S&P.
Sell the News:
I think the low end of sell side analyst estimates might lead the stock to bounce a little. As I said with the PFAS settlement, I would sell that spike. These settlements are still quite large and taken together cause considerable damage to the company’s credit metrics, cash flows, and ability to service its dividend. Given the terrible operating performance and still lingering liabilities, I believe that many people own this stock simply for its dividend. If that is cut, look out below.
Risks:
As with any short, your downside is theoretically unlimited. MMM has underperformed the indices this year so you could see catch up. Size any short to be able to absorb a move higher or use put options to cap your downside.
Conclusion:
I still think this company faces major threats posed by its residual PFAS liabilities and its deteriorating core businesses. These settlements alone cause considerable damage to its balance sheet and dampen its ability to service its dividend. Much larger liabilities loom and are not far off in the future. I continue to believe this company faces potential bankruptcy risk at some point and even if it survives, the bulk of its cash flows will go to servicing these liabilities.
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