Is the deck stacked in Europe's favour?

01 December 1997 00:00  [Source: ICB]

The past year has been one of mergers, joint ventures and sell-offs, but Europe is still saddled with old and inefficient plants. Producers have hesitated to take the plunge, shut down old capacity and invest in new world-scale facilities. But, as Marjorie Walker reports, the climate in European industry has never been so ripe for change.

It was the best of times. It was the worst of times. The worst of times because, at least on the surface, nothing has really changed in Europe. The cards have merely been reshuffled. Each player appears to be entering 1998 with a different hand to the one he began the year with, but fundamentally the same old problems remain.

The European industry is saddled with old and inefficient plants. Actual investment on the ground in Europe continues to be limited, with players still opting for capacity creep and debottlenecking rather than risk new world-scale projects, and capacity closures remain few and far between. The Asian petrochemical industry has grown faster than anyone could have predicted earlier in the decade and a new wave of Middle East capacity is coming onstream. Europe will inevitably lose export markets and face stiff competition in its own home markets.

Upping the ante

But if ever the time was right for the European petrochemical industry to put its house in order it has to be now. The single market has opened up borders, and the single currency is on track for 1 January 1999 - with a few notable exceptions - further breaking down trade barriers. National ties and considerations, which have so hampered restructuring, are being loosened by privatisation. Even the German industry, once the bastion of conservatism, is actively restructuring, prompted partly by the internationalisation of the country's financial sector.

The European Commission has amply demonstrated that it accepts restructuring of the industry is essential, and appears ready to take a more encouraging and enabling role than in the past. With the single market has come the appreciation that competition comes from both inside and outside Europe and without mergers and joint ventures the European industry would be incapable of investing for the future.

Now that the EC views its role somewhat differently, the industry has surged into action. Mergers, joint ventures, product swaps, flotations and outright sales have taken place at an alarming rate, aided by global stockmarkets pushing onwards and upwards to new highs. Few companies will end 1997 with the same portfolio of businesses they had on board at the beginning of the year and some, like ICI, which acquired the Unilever speciality businesses for £4.9m ($8.3m) earlier this year, are radically different. Others, like Hoechst and Rhône-Poulenc are well on their way to being radically different.

Everyone has reservations about the scale and rapidity of change. But one thing is certain, the industry in Europe cannot survive without it. So change, too, contributes to 1997 being 'the best of times'.

Growing competition in export and home markets, global overcapacity in many sectors, and the financial chaos in Southeast Asia could provide the impetus required for Europe to bite the bullet and close old and uneconomic capacities, the hardest part of Europe's restructuring.

The APPE ethylene initiative foundered back in 1994, but the joint ventures set up over the past few years: Montell, Polimeri Europa, Borealis/OMV-PCD, Marlene, Targor, Basell, DSM-BASF Structural Resins, DSM/Veba, to name just some of the significant ones, do not just create stronger players. They enable the closures of uneconomic capacity and the investment in new world class capacity which will push European petrochemicals into the 21st century.

The worry is that with everything happening so quickly it is almost like throwing all the cards in the air with a mad scramble to grab the face cards, those desirable speciality businesses with high returns and low cyclicality that are so in vogue just now. The competition is keen and prices are being bid higher and higher - so high that several analysts have begun to question whether some of the acquisitions actually contribute to shareholder value.

Healthcare and life-sciences are the ace cards on anyone's valuation and whereas ICI floated Zeneca, Hoechst and Rhône-Poulenc now see healthcare as their core business. Hoechst chairman Jurgen Dormann announced in March that Hoechst Marion Roussel would not be floated as a separate company but would instead form the core business of the new Hoechst, a pure life-science company. In the middle of the year, Rhône-Poulenc announced a share issue to finance the purchase of the remaining shares in Rhône-Poulenc Rorer, and announced that the company would split into two separate entities: the life-science businesses and the speciality chemicals and services division which would be floated next year.

Building a strong suit

An alternative strategy is building up a long, strong suit of commodity businesses which will guarantee the owner a leadership position in a particular global market. Purchasing commodity businesses is only attractive to the strongest players - those with market, technology and financial strength.

In September, Shell announced the $2bn purchase of Montedison's stake in Montell, the 50:50 PP and PE joint venture formed in 1995. Shell obviously sees full control as an essential part of its attempt to create 'a global sustainable petrochemical business'. However, completion of the PE joint venture with BASF and ROW, codenamed Marlene, has been unexpectedly delayed with further information required by the EC, cited as the reason for the holdup.

DuPont's purchase of ICI's polyesters businesses and of Tioxide also comes into the category of a strong player becoming even stronger. DuPont's existing strong market positions in the global polyester and titanium dioxide markets are further enhanced. The addition of ICI's fast growing PET business and its strong European and Asian PTA market position are a perfect fit with DuPont's existing strengths and the transaction, already cleared by the EU, should be completed before the year end. ICI's Tioxide business reinforces DuPont's global leadership position in titanium dioxide and makes DuPont the clear leader in all three major global markets.

TOP WEST EUROPEAN COMPANIES BY 1996 TURNOVER ($M)
Company	Country	Sales	Change	Profit	Change
Hoechst	Germany	33 072	(2.4)	3428	(0.6)
BASF	Germany	31 675	5.5	3181	6.9
Bayer	Germany	31 566	9.0	3520	17.1
Novartis	Switzerland	27 059	0.8	4317	1.2
ICI	UK	18 016	2.4	1445	27.1
Rhône-Poulenc	France	16 537	1.2	2012	(4.8)
Shell 1.2	UK/Netherlands	15 375	(2.8)	1865	(33.5)
Akzo Nobel	Netherlands	12 888	4.4	1167	2.9
Roche	Switzerland	11 919	8.4	4260	13.3
Elf Atochem 1	France	10 367	(3.1)	713	(26.0)
Zeneca	UK	9184	9.5	1850	15.1
Solvay	Belgium	8890	3.2	721	(7.1)
Hüls	Germany	6847	(3.7)	484	(2.1)
EniChem	Italy	6735	(26.6)	151	(89.5)
Norsk Hydro 1.2	Norway	6653	7.0	458	(23.9)
Air Liquide	France	6625	6.8	924	3.8
BOC 4	UK	6291	7.1	867	8.5
Henkel 2	Germany	5941	7.5	343	nc
DSM	Netherlands	5895	4.5	600	(34.2)
BP 1.2	UK	5667	(17.5)	815	(44.3)
Unilever 2	UK/Netherlands	5052	3.7	711	18.2
Montell	Netherlands	3785		334*
Total 1.2	France	4734	13.6	369	14.7
EMC	France	3472	7.0	79	(30.6)
Courtaulds 3	UK	3442	(7.1)	282	(0.3)
Schering	Germany	3424	13.4	425	2.8
Degussa 2.4	Germany	3422	0.4
Petrofina 2	Belgium	3411	(1.3)	383*	(41.3)
Rutgers	Germany	3164	(2.2)	121	5.7
Kemira	Finland	2923	1.4	288	(6.6)
Borealis	Denmark	2685	(11.2)	150	(71.1)
Montecatini	Italy	2583	(13.2)	477	(15.7)
Wacker-Chemie	Germany	2260	4.6	219	(13.0)
Perstorp 5	Sweden	1955	(0.6)	231	2.6
AGA	Sweden	1866	(3.1)	323	(14.5)
Laporte	UK	1821	(0.4)	234	8.2
Tessenderlo Chimie	Belgium	1638	5.9	131	(10.1)
UCB	Belgium	1603	(6.1)	206	25.1
Polimeri Europa	Italy	1581	(9.5)	71	(61.9)
Dyno Industrier	Norway	1508	(6.7)	87	(8.1)
Erdöl Chemie	Germany	1477	(5.7)	109	(77.0)
Messer	Germany	1427	3.2	153	8
Repsol 2	Spain	1328	(15.2)	186	(61.7)
Lonza 2	Switzerland	1304	(1.5)	163	(0.5)
OMV	Austria	1302	(16.0)	93*	+44.3
ROW	Germany	1282	(11.4)	66	(76)
Albright & Wilson	UK	1205	0.0	112	13.6
EVC	Netherlands	1199	(17.6)	9	(91.8)
Neste 2	Finland	964	(15.3)	72	(43.0)
Croda	UK	761	(2.4)	73	70
1. excluding intersegment transfers 2. chemicals only through company analysis 3. year to March 1997 4. year to September 1996 5. year to August 1996 * Earnings before interest and tax. SOURCE: CHEMICAL INSIGHT

Solvay's purchase of a 67% stake in Sodi, the Bulgarian soda ash business, put together Europe's strongest soda ash producer with one of the strongest east European players, substantially strengthening Solvay's position in the southern European and Middle East soda ash markets. Heavy investment and dropping the anti-dumping complaint against the US natural ash producers was not seen as too high a price, especially as the strong dollar has kept US soda ash uncompetitive in Europe.

Millennium's purchase of Rhône-Poulenc's TiO₂ business is another example. US-based LaRoche and Rhône-Poulenc recently announced the formation of Chloralp, a 50:50 joint venture taking over Rhône-Poulenc's existing chlorine, caustic and bleach activities in France LaRoche and has enhanced further its exposure to the European chlorine market with the purchase of Hoechst's remaining chlorine exposure through Celanese's Frankfurt-based business.

However, 1997 has seen many players seeking to lessen their exposure to the commodity sector.

Hoechst has been heavily involved in spinning off businesses and several have moved into joint ventures, the compromise or interim solution. Targor, the PP joint venture with BASF, was completed in the third quarter, but talks with BP for a joint venture in hdPE appear to have stalled. The Hoechst/Bayer joint venture in textile dyestuffs, Dystar, appears now to be interested in the Clariant dyestuffs business. One of the most interesting deals must be Hoechst's sale to Indonesian investor Multikarsa of a majority stake in its European textile polyester and polyester staple businesses. Hoechst will hold a minority stake in the new joint venture company.

TOP TEN WEST EUROPEAN COMPANIES BY 1996 TURNOVER
Company	Sales	Sales/   employee	Pre-tax/   employee	Pre-tax     margin	Sales as %     assets	Capex as %      pre-tax
Hoechst	33 072	223 668	23 185	10.4	60.2	72.5
BASF	31 675	306 318	30 766	10.0	6.6	74.3
Bayer	31 566	221 983	24 757	11.2	57.2	69.8
Novartis	27 059	232 908	37 161	16.0	na	32.5
ICI	18 016	284 605	22 833	8.0	78.1	115.9
R-P	16 537	219 763	26 737	12.2	45.5	68.5
Shell	15 375	697 211	81 083	11.6	59.7	83.0
Akzo Nobel	12 888	182 297	16 501	9.1	na	90.7
Roche	11 919	243 376	86 979	35.7	33.6	28.5
Elf Atochem	10 367	308 430	21 212	6.9	na	145.9

Messer, the industrial gases business and Herberts, the paints business, are effectively being prepared for full market listings as separate entities. The Trevira polyester business, the Celanese base chemical businesses and Ticona technical polymers have become stand-alone companies - almost certainly a prelude to sale or joint venture.

Neste finally divested its 50% stake in Borealis to the International Petroleum Company of Abu Dhabi and OMV, of Austria. The deal not only considerably strengthens Borealis' position in European polyolefin markets, but also brings to Borealis the benefits of a link with a low-cost Middle East producer, almost certainly in polyolefins for the long term. OMV/Repsol merger discussions obviously came to nothing.

Akzo Nobel announced in October that it would joint its industrial fibres with the Turkish player Sabanci, but the company has denied that it is the first step of a complete divestment.

Showing their hands

Petrochemicals had a difficult year in 1996. Everyone expected new capacity to take its toll on commodity prices in 1997, but few expected the first effects on pricing would be seen as early as 1996 when operating rates on the whole remained at reasonably high levels. Although many chemical majors returned an overall strong performance in 1996, results from plastics, fibres and chemical commodities were bad enough to plunge the industry into another round of restructuring. Since then there has been little improvement in fibres, the polyester chain and in styrene and its derivatives. So for many companies the poor performance continues into 1997. Outside Europe, PP and PS prices are under considerable pressure and new PE capacity in the Middle East looks likely to extend the pressure to that sector too despite strong European markets in the second half of 1997.

Conglomerates were already out of fashion in financial circles when 1996 began. They are difficult to value and financial results impossible to predict.

Unbundling picked up pace in 1996 and 1997 and the pressure continues to build with many of the commodity businesses reporting poor results over the period.

The German majors all managed to report very respectable sales and profit performances in 1996 - not the dazzling profit surges of 1995, but maintaining 1995 profit levels and in Bayer's case moving even higher. The improved performance has continued for BASF and Bayer. Results for 1997 have benefited from the weakness of the deutschmark which appears to have kickstarted the German economy into life mid-year courtesy of an export boom, although domestic sales are still lacklustre.

However, BASF, reporting strong overall 1996 results boosted by a strong performance in health and nutrition and oil and gas, admitted: 'The market for polyolefins and PVC was influenced by keen competition and earnings were significantly lower than the previous year. We aim to put our business on a new basis and are preparing cooperations.' Plastics and fibres sales fell by 3% and earnings dropped from DM1.5bn ($86.7m) in 1995 to DM997.4m.

BASF reported record profits for the first nine months of 1997. Much of the plastics and fibres business has shown considerable improvement and sales were up 19.5%, reflecting the Targor joint venture, but profits fell DM203m to DM534m as a result of the very poor performance of the styrene and engineering polymers businesses. Even health and nutrition suffered a profit downturn as a result of new product launch costs and the Synthroid settlement, mainly in the US.

Bayer also achieved record results in 1996. Sales growth during the year was driven by acquisitions and the US operations, while business conditions in Europe - especially in Germany - were disappointing, said chairman Manfred Schneider.

Bayer is once again setting new records in 1997 with sales for the first nine months of 1997 up 13% and operating profits up 11% to DM4.2bn. The Americas are doing very well, both in local currency terms and even better when translated into deutschmark. Even Europe did well, although German domestic sales are still disappointing.

Bayer, like BASF, has no radical change in structure in the offing. Early in 1997 Schneider spoke of Bayer's 'balanced risk structure and a considerable potential to gain competitive advantage through synergies'.

Life-sciences is, as in Hoechst, the main focus for growth. Schneider also spoke of massive price erosion in some sectors of the polymer market, probably ABS and synthetic rubbers, yet overall, the operating result for polymers was only 5% below last year because of cost savings. Bayer's TiO₂ business is still believed to be up for sale or joint venture.

Hoechst, too had a good year in 1996 - a very strong performance from Hoechst Marion Roussel where the integration of Hoechst, Marion and Roussel began to pay off as the number of production and R&D locations were reduced and the sales and marketing organisations were streamlined. AgrEvo increased sales and operating profits despite further restructuring charges. However, a truly awful result from Celanese, where operating profits fell from DM1495m to DM728m and Trevira, where operating profits of DM530m in 1995 were virtually wiped out at only DM84m dampened the performance of Hoechst and led to a marginal decline in sales and pre-tax profits in 1996.

Hoechst delivered a profit warning at the interim stage in 1997 and a 54% slump in pre-tax profits was reported. Although adjusted for extraordinary gains in the first half of 1996, profits were 10% ahead of 1996. The half-year figures included the speciality chemicals business, and the polypropylene business, transferred to Clariant and Targor on 1 July. Trevira's operating profits fell to DM89m from DM133m last year.

ICI put in a strong performance in 1996 which continued into 1997, aided by good performances from the ex-Unilever businesses. In terms of continuing businesses, coatings and materials saw sales dip with trading profits flat and down respectively.

Industrial chemicals saw earnings disappear as PET and PTA suffered from the global capacity build and Tioxide continues to suffer from low, albeit improved, global titanium dioxide pricing. The combined businesses being sold to DuPont lost £2m. Further divestments are on track.

The energy companies, with chemical businesses concentrated in petrochemical commodities, suffered dramatic earnings falls in 1996. Shell's profits fell 33.5%, Elf Atochem's fell 26%, EniChem 89.5%, Norsk Hydro 23.9%, DSM 34.2% and BP 44.3%. The falls must be seen in the light of the extraordinary run up in prices and profits in 1995.

CAPITAL EXPENDITURE 1996
Company	$m	Change, %
Hoechst	2485	13.4
Bayer	2456	19.3
BASF	2363	20.3
ICI	1675	52.6
Shell	1548	14.7
Novartis	1402	1.4
Rhône-Poulenc	1379	16.7
Roche	1212	9.0
Hüls	1199	101.9
Air Liquide	1122	61.8

Pre-tax margins among this group vary widely from companies like BP where the chemical business earns pre-tax margins of 13.7% of sales, reinforcing BP's assertion that sites integrated back to feedstock and forward to derivatives provide the best results.

Shell and Petrofina come in at 11.2% and Elf Atochem and Norsk Hydro at 6.9% and 6.8% respectively, falling to 0.7% at EVC where a combination of weak demand, low PVC prices and high feedstock costs slashed margins. However, there were signs that the PVC market was improving by the 1996 year-end.

These commodity-orientated margins are not too out of line with those of the more widely based conglomerates like BASF, Hoechst and Bayer where the inclusion of the healthcare and speciality businesses of coatings and other such choice consumer-orientated products still resulted in margins in the 10.4-11.2% range. The highest margins were earned by Roche, Zeneca and Novartis.

German and French companies still complain of high labour costs and rigid employment laws which prevent change and certainly companies contemplating acquisitions in these countries are said to considerably reduce offer prices to take account of high labour costs and the potentially immense costs of redundancies.

BASF employee numbers rose by 913 since the end of 1996, partly the result of consolidating Targor. Bayer also reports rising employee numbers - up 2400 by the end of September on the year end 1996. In both cases they reported only a token reduction in workforce in 1996 whereas Hoechst cut numbers by 8.5% and Novartis by 13.3%

The biggest percentage reduction in Europe was at BP where there was a 27.7% cut in the workforce in 1996, at Borealis where numbers fell 24.7% and at Enichem where numbers dropped 21.0%. BP's sales/employee ratio rose 14.9% and Borealis' by 17.9%, lifting them into the top ten on a global basis. Total increased its workforce by 15.9%.

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