Analysis: Funding, exit options limit financial buyers

14 March 2003 17:00  [Source: ICIS news]

NEW YORK (CNI)--Financial buyers enjoy a growing number of options in chemical assets but they remain constrained by major challenges as the lending market tightens and the door slams shut on a number of exit options.

"There are more opportunities now than there have been in many years with the tremendous amount of specialisation and narrowing of focus," said Harold Sorgenti, general partner of Sorgenti Investment Partners. "However, the issue is not one of availability, but the ability to finance and come up with a plan to get appropriate returns."

Banks continue to tighten the reins on financing with many only willing to lend up to three times earnings before interest, taxes, depreciation and amortisation (Ebitda) for a leveraged buyout (LBO) - down from up to four and one-half times Ebitda a few years back.

Said Sorgenti: "That means you have to put a lot more equity into a deal, and to get the kinds of returns the buyout funds want, the number of deals that can support those returns with a limited amount of borrowing capacity are few and far between."

Sorgenti Investment Partners' recent attempt to buyout UCB's methylamines business for Euro120m ($130.8m) in conjunction with Morgan Stanley Capital Partners fell apart late last year on financing issues.

He said: "For the time being the deal is dead, but it may resurrect itself in a different format."

Leveraged buyouts such as those engineered by financial outfits were first conceived after World War II, but they gained popularity in the 1970s and 1980s. In evaluating a target, financial buyers typically look for a combination of steady cash flow, profit improvement potential through cost cutting, the potential for follow-on acquisitions, break-up values in excess of the purchase value, and multiple exit options, according to Peter Young, president of chemicals and life science investment banking firm Young & Partners.

The first LBO may have been the purchase of a US government chemical plant by J.H. Whitney & Company in the late 1940s.

But the prominence of LBOs in the chemical industry is a relatively recent phenomenon. Financial buyers were successful in only 4-6% of all chemical deals completed in each year from 1996 to 1999, but this figure shot up to 20% in 2000, then to 23% in 2001 and 20% last year, according to Young & Partners.

Said Young: "Today a large number of financial buyers have jumped into the chemical LBO market, creating much greater competition for assets. More recently, European and global financial buyers have become the most active, in part due to the high level of M&A activity in Europe."

With chemical companies finally making tough decisions on divestments, the quality of assets for sale is on the rise, creating better opportunities for financial buyers.

"What we're seeing is generally an increase in the average quality of assets that are coming to market," said Tim Walsh, partner and head of the industrial group at JPMorgan Partners. "Companies are now making hard decisions on which businesses to keep and which ones to divest."

Walsh sees more opportunities, particularly in Europe, where portfolio restructuring is in high gear.

He said: "Take your pick of the large European companies and virtually all of them are singing from the same hymnal. They are looking to rebalance their portfolio and focus on their core areas. As a consequence, financial buyers will benefit."

Said Sorgenti: "The sluggish economy, high leverage and the problems companies are facing have put more and more emphasis on the financial buyer. And because the financial buyer is limited in the amount he can borrow and thus on the amount he can pay, that has driven multiples down."

Over the past year or so, the profile of financial deals has changed considerably, with small to mid-size deals being favoured.

While the number of deals by financial buyers remained relatively steady in 2002 at around 15, the total value of those deals fell hard to $3.6bn (Euro3.3bn) last year from $10.9bn in 2001, according to Young & Partners.

But Young expects a difficult period for many financial buyers that have completed deals in the past few years given the current limited exit options, the downturn in profitability and the high prices some firms paid.

Young said: "LBOs are inherently risky in difficult economic times, but the risks are greater now, given the oil crisis and uncertainty of future earnings. In addition, many LBO firms simply paid too much in 1999 to 2001 or put too much debt on the businesses they acquired."

Financial buyers generally aim to achieve a return on their investment in five years via exit options such as an initial public offering (IPO), divestiture or recapitalisation.

Said Young: "We saw the window on the IPO market close in the middle of last year. In addition, many of the deals by financial buyers were done with unrealistic expectations about the ability to exit via a sale or a recapitalisation. Fundamentally, all three of the financial buyers' traditional exit options have closed or diminished. This makes it more challenging to do deals or get out of existing ones profitably."

Said Walsh of JPMorgan Partners: "I don't think any private equity investor in the chemical industry is counting on there ever being a public market to support their exit."

As a result, the key exit option looms as a sale to strategic buyer.

He said: "Right now chemical companies are not active acquirers, but I fully expect that over the next three to four years that will change and they will be there to support our exit."

(For additional Chemical Market Reporter analysis visit the CMR Web site at: http://www.chemicalmarketreporter.com/.)


By: Joe Chang, Chemical Market Reporter
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