Renewed Global Restructuring Driving Chemical Mergers and Acquisitions

20 October 2003 00:00  [Source: ICB Americas]

Mergers and acquisitions activity in the global chemical industry is finally starting to pick up with a healthy flow of small to midsize deals as well as a few blockbusters announced or in the works. A new round of restructuring is sweeping across the global chemical industry, driving deal activity as European companies continue their portfolio shuffling and US companies join the trend once again after four consecutive years of difficult market conditions. Financial buyers continue to be active, valuations are edging up and bankers are looking towards greater activity in 2004.

Through the first three quarters of 2003, the global chemical industry completed $11 billion in deals versus $18 billion in the year-ago period and $23 billion for all of 2002, according to New York City-based investment bank Young & Partners. However, $3.1 billion in deals closed on October 1, the day after the close of the third quarter.

"The chemical industry faces many roadblocks that are getting in the way of improved earnings," says Peter Young, president of Young & Partners. "This is affecting the view and confidence of senior chemical executives and will make it difficult for the M&A market to claw its way out of the current valuation hole and the shift away from larger deals."

While the dollar volume of deals is nothing to write home about, the number of deals continues at a robust pace with 49 deals over $25 million in size closing through the first three quarters versus 50 deals in the year-ago period, according to Young & Partners.

"Deal activity is strong because in many instances, companies have no choice but to sell, either because they are up against the wall financially or are committed to a strategic direction to achieve growth or rationalize their portfolios and cannot turn back," Mr. Young says.

Small to midsize deals continue to account for the bulk of M&A activity. Transactions over $1 billion have fallen to 33 percent of total dollar volume so far this year versus 65 percent in both 2001 and 2002.

"Compared to a year ago, there are more assets that are making their way into auctions and one on one discussions-not just large businesses but a lot of smaller assets," says Christopher Iannaccone, managing director and head of the global chemicals group at JPMorgan. "The pace of activity in 2003 has clearly picked up, and I think you'll only see that accelerate as the months unfold. I'm pretty optimistic on transaction activity."

Mr. Iannacone notes that some deals may not even require the aid of bankers. "You'll see some portfolio trades companies will do between themselves or find ways to exit on their own because they have enough sophistication to do it themselves." For example, Celanese AG recently sold its acrylates business to Dow Chemical Company for around  150 million without the help of a banker.

"Looking at the global picture, quite a lot of restructuring of chemical activities is happening," says Ulrich Geld-macher, global head of chemicals at Deutsche Bank Securities. "Across the board in polymers, petrochemicals, specialty chemicals and industrial gases, we see more restructuring coming, driving more deals in 2003 and beyond."

Packing the Pipeline-Europe Leads

The steady stream of assets hitting the selling block is quickly packing the M&A pipeline. Europe is leading the pack with 37 percent of the target businesses sold through the first three quarters versus 35 percent for the "Rest of the World" category and 29 percent for the US, according to Young & Partners.

Most recently, German conglomerate MG Technologies AG decided to rid itself of chemicals and focus solely on engineering. For sale are its specialty chemicals subsidiary Dynamit Nobel with around  2.5 billion in sales and its distribution arm Solvadis with sales of  1.5 billion. MG Technologies has retained Dresdner Kleinwort Wasserstein and Lazard as financial advisors.

"There are a lot of chemical assets coming to market, particularly out of Europe," says Leland Harrs, director of the chemicals practice at Dresdner Kleinwort Wasserstein. "Excluding DuPont Textiles & Interiors, Nalco and Eastman, I don't see a lot happening in the US. Europe is definitely more involved in restructuring right now."

After the ousting of its chairman and chief executive Jean-Pierre Tirouflet in October, Rhodia announced it will divest unspecified businesses by the end of 2004 for expected proceeds of at least  600 million to reduce its hefty debt load.

"With some of the changes going on at the senior level at companies such as Rhodia, that's going to result in more major portfolio restructuring in Europe," says Paul Collins, managing director and head of global chemicals at Lehman Brothers.

Akzo Nobel has put its catalyst, resins and phosphorus chemicals businesses up for sale. The divestitures are expected to raise  1.1 billion and represent 22 percent of Akzo Nobel's chemicals revenues. The company plans to pay down debt and focus on its core coatings and pharmaceuticals operations.

Three years after its ill-fated acquisition of fine and specialty chemicals producer BTP for $1.8 billion, Clariant is undergoing a massive portfolio adjustment, putting $1.5 billion worth of businesses on the block, including electronic materials and cellulose ethers. Other operations earmarked for disposal could include textile dyes and custom synthesis, pharma chemicals and specialty fine chemicals that are part of its life sciences division.

US Revs Up

While Europe still accounts for most of the portfolio restructuring activity, the US appears to be starting another round of reorganization as businesses continue to struggle in the face of high energy and feedstock prices.

"If you look at where North America is from a cost perspective with oil and gas prices at elevated levels and unlikely to go down much in the future, companies are going to have to rationalize and consolidate more to improve earnings," says Lehman Brothers' Mr. Collins. "With projections for the petrochemical cycle peak being pushed out, companies are either going to have to raise equity such as Lyondell has done, or sell assets to get through the trough."

In the US, Eastman Chemical Company is reviewing options, including divestiture, for certain units in its CASPI (coatings, adhesives, specialty polymers and inks) segment. With $650 million in sales, it includes acrylate ester monomers, liquid resins, composites (unsaturated polyester resins), powder resins, raw materials for inks and graphic arts, and textile chemicals. The businesses generated an operating loss of around $75 million in 2002 and are on track for higher losses in 2003. Eastman has retained JPMorgan to assist in evaluating strategic alternatives for the units.

Other assets for sale or in the process of being sold include DuPont Textiles & Interiors, BP's performance chemicals business, Alcoa's specialty chemicals operations, Air Products' European methylamines business, $1.5 billion in unspecified businesses of Dow Chemical, Goodyear's synthetic rubber unit, Kraton Polymers, Brenntag and most of the businesses of Rtgers. Sources say FMC Corp.'s ag chemicals business is also up for grabs.

"Some companies are just focusing their portfolios while others are being forced to exit businesses because of the need to pay off liabilities," says Telly Zachariades, senior managing director and head of global chemicals for Bear Stearns. "But I'd say the balance is moving more in favor of strategic portfolio restructuring."

Asset sales that were held off in earlier years because of low valuations may also be coming to the fore. "There's still a lot of overhang from 2001 and 2002 where there were a number of deals that came to market but couldn't get done because the valuations weren't sufficient for sellers to part with the assets," says Gary Denning, director of chemical industry practice at investment bank Houlihan Lokey. "While these businesses have been sitting on the sidelines, companies have been restructuring them and will likely bring them to market in 2004 with more competitive cost structures."

"Coming off the back of a really difficult 2001 and 2002, a lot of companies are just resigning themselves to the fact that they'd rather have the cash than keep a particular business. That's the biggest driver of deals," says JPMorgan's Mr. Iannaccone. "However, on the buyer side, I would not characterize the current time as one where folks feel so good about their own prospects and are eager to make acquisitions."

Lehman Brothers' Mr. Collins sees more sale announcements coming from the US chemicals sector, adding that there are still too many small cap chemical companies that need to get bigger to capture investor interest. "Some companies are just too small," he says. If they don't start to differentiate themselves either through growth or scale, they will be left by the wayside."

Asia-the Next Frontier?

A relatively new feature of the global chemicals M&A market is the emergence of significant deal activity in Asia. Through the first three quarters of 2003, the "Rest of the World" category, which in-cludes Asia, accounted for 35 percent of the target businesses sold, according to Young & Partners.

"Just as chemical manufacturing is slowly shifting to Asia, so is the M&A market," says Young & Partners' Mr. Young. "Companies are now more developed, and Japanese and Korean companies are increasingly seeking M&A solutions to their strategic or financial woes.

In Korea this year, LG Chem and Honam Petrochemical acquired financially troubled Hyundai Petrochemical for $1.51 billion. LG Chem plans to use Hyundai's ethylene capacity to expand in downstream areas throughout Asia.

The rise of China as a major industrial power is forcing Asian chemical companies to renew their focus on long-term strategic plans to compete and participate in the region's powerful growth.

"Japan is starting to wake up and think about the structure of their industry and what they need to do to fix some problems and be competitive," notes Lehman Brothers' Mr. Collins. "They've tried some mergers and JVs, but I really think they're only beginning to chisel away at what needs to be done. So activity will pick up there."

Big Deals Fuel Optimism,But Strategic Buyers Remain Cautious

The announcement of a couple of billion dollar deals this year is giving rise to optimism in an M&A market that is miles away from its heyday in 1999. In July, General Electric Company's acquired Crompton Corp.'s organosilicones business for up to $1.05 billion in cash, future payments and GE's plastic additives business.

In the largest announced deal in chemicals this year, private equity firm Blackstone Group recently agreed to acquire Nalco Chemical from Suez for $4.2 billion in the third largest LBO (leveraged buyout) in US history, behind RJR Nabisco and TRW. Blackstone then sold equity stakes in Nalco to Apollo Management and Goldman Sachs Capital Partners, who had jointly bid on Nalco. The financial consortium will put up $1.1 billion in equity and finance the rest of the purchase with debt (sidebar, above).

"Larger transactions are starting to go through. Things are picking up and there are a lot of discussions going on," says Tim Wilding, managing director and head of the global chemicals practice at CIBC World Markets. "There are a lot of deals that have been dragging on for awhile and they are finally starting to come to a head. So I think we'll see more deals being closed."

However, the industrial recovery has yet to manifest and companies are still struggling to maintain profitability in the trough of the cycle, making this a tough time for strategic buyers to be aggressive.

"Those big headline deals generated a lot of excitement, and some people are jumping up and down saying: The market's back!," says Mr. Denning of Houlihan Lokey. "But many of our clients are still a bit tentative because energy prices remain high and they lack pricing power. Many companies are worried about their own future rather than going out and seeking large acquisitions, so a lot of the activity has been concentrated in the middle market."

Competitive pressure from China also appears to be a factor causing industrial buyers to be cautious and keeping a cap on valuations. "A big factor that keeps coming up is a sense of tremendous pressure from China-not only in chemicals but downstream in converting as well," says Mr. Denning. "That's causing people to reduce the terminal multiple they apply in a DCF (discounted cash flow) analysis. It's hard to justify a big exit multiple on a business if you're concerned that the economic results are subject to erosion from import pressure."

Valuations Edge Up

Although faced with an eleventh consecutive quarter of trough valuations, industry multiples are starting to pick up slightly. Through the first three quarters of 2003, specialty chemical transaction EBITDA (earnings before interest, taxes, depreciation and amortization) multiples averaged 8.8x compared to 8.2x in 2002 and 7.9x in 2001, according to Young & Partners. Back at the 1991 M&A trough, valuations averaged 8.2x. While specialty valuations are edging up, basic chemicals EBITDA multiples have fallen to an average of 6.3x versus 6.6x in 2002.

While most valuations have been modest, others have attracted attention and spurred hopes of better days ahead. "If you look at some deals, valuations are pretty attractive now," says JPMorgan's Mr. Iannaccone. "If you have strategic interest and financial sponsors involved, I think there are some attractive valuations that could come about right now. I don't know if there's a lot more upside to multiples in the industry."

General Electric's acquisition of Crompton's organosilicones business represented a multiple of between 9.5x and 11.5x EBITDA, depending on the amount of future payments to Crompton.

While the Blackstone/Nalco deal was done at a reported 8.1x EBITDA, Chinh Chu, senior managing director at Blackstone Group, says it actually went off at under 7.5x EBITDA after some contract adjustments.

Financial Buyers Take Their Seats at the Table

Financial buyers remain a formidable presence in the chemicals M&A market, accounting for 20 percent of the number of completed deals and 21 percent of dollar volume through the first three quarters. Private equity firms have accounted for two of the top six transactions completed or announced this year (Blackstone/ Nalco and Bain Capital/SigmaKalon). The $4.2 billion Nalco deal, which has yet to close, will ratchet up the market share of financial buyers.

The favorable high-yield debt market, driven in part by low interest rates, has made financing deals easier today than in the past.

"Financial buyers are leveraging off the fact that the lending market has improved greatly. The high-yield and senior debt markets have improved tremendously this year, allowing financial buyers to compete very effectively," says Tim Walsh, partner and head of the industrial group at private equity firm JPMorgan Partners.

"There continues to be a substantial amount of funds available and financial sponsors continue to focus on the sector," says John Anos, managing director at Deutsche Bank.

Many private equity firms are also flush with cash, ready to pick up the pieces where strategic buyers are handcuffed by operational issues. "It's pretty amazing how much capital is sitting in the hands of financial buyers. They continue to be aggressive about getting deals done," says Mr. Denning of Houlihan Lokey. "Most chemical companies have announced their own internal restructuring where they are cutting costs and pruning non-core businesses, so they've kind of removed themselves from the auction process. In a typical auction, by the second round, financial buyers are taking up half if not more of the seats at the table. Their presence is substantial."

Right Time in the Cycle?

While financial buyers remain relatively active in the market, many that made acquisitions in 2000 and 2001 have stumbled in the face of declining business conditions and valuations. Industrial buyers that were aggressive in their acquisition strategy years ago have also dearly paid the price.

With weaker cash flows and more modest transaction multiples following years of difficult market conditions, could this be the ideal time to buy chemical assets?

"When you invest in chemicals, the cycle and timing are essential to success, and this is almost an ideal environment due to the confluence of three events-we're coming out of a recession, strategic buyers are not in the market, and raw material prices have depressed profitability, leaving lots of room for improvement," says Black-stone Group's Mr. Chu. "That makes for an ideal environment that presents us deals at reasonable multiples at close to the trough of the cycle."

Blackstone looked at numerous chemical assets in recent years, but has chosen to hold off until now. "Nalco is the first chemical investment we've had in several years. We track the market and felt that in the past we had two things going against us-the prices of deals were too high and we thought the cycle was going through a downturn. So we didn't pull the trigger until now," says Mr. Chu.

Mr. Chu believes the "ideal" conditions will last for another 12 to 24 months and says Blackstone is gearing up for additional acquisitions. "We think there will be a flood of opportunities, and this is a great time to buy," he says. "Nalco was a unique situation given its size, but we think there will be a number of $1 billion to $3 billion deals in chemicals that we'll consummate in the next 12 to 18 months."

But Some Financial Buyers Look to Exit

While financial buyers are on the prowl for acquisitions, some are also seeking to exit positions after owning chemical assets for several years.

"These financial buyers are struggling to find attractive ways to exit their investments with the returns that they target," says Mr. Young. "This could eventually create a dilemma with industrial guys restructuring and selling assets, and financial buyers also wanting to get out."

"With strong financing markets and the perception that strategic players may finally be back on the acquisition trail, it could be time for financial sponsors to exit," notes Mr. Anos. "There has been much more dialogue with financial sponsors seeking to monetize their assets."

Ripplewood Holdings LLC, which bought Kraton Polymers LLC from Shell Chemicals in 2001 for somewhat over $500 million in March 2001, or a little over 5x EBITDA, has put the company up for grabs, with CS First Boston and Morgan Stanley handling the sale.

"If you paid a high multiple of EBITDA as a financial buyer-say over 7x EBITDA-such as Morgan Grenfell did for Vantico, or Cinven/Investcorp did for Avecia, or AEA did for Sovereign and Noveon, then unless the quality of the business and the growth prospects are significantly above average, it will always be challenging to generate an acceptable equity return upon exit," says Bear Stearns' Mr. Zachariades. "However, if you buy at a more modest multiple of say 5x to 6.5x, you should be able to exit profitably even when EBITDA growth may have been held back by a weak economy."

"Anyone who paid top dollar-9x EBITDA, which some financial sponsors did, is finding that it takes longer to generate an acceptable return on equity," says Dresdner Kleinwort Wasserstein's Mr. Harrs. "They're finding that the exit takes longer."

Vulture FundsAnd PIPE Dreams

Aside from the traditional routes to M&A, the chemical industry has seen the emergence of two relatively new phenomena-vulture funds and PIPEs (private investments in public equities). These deals usually involve struggling companies that are unable to raise financing from traditional routes.

In the vulture arena, MatlinPatterson Global Opportunities Partners acquired struggling epoxy resins maker Vantico in July by scooping up the company's distressed bonds for an estimated 15 cents on the dollar. MatlinPatterson negotiated with Vantico to swap the bonds for a majority equity stake in the company, then combined Vantico with the Huntsman companies, in which it had already taken a 49 percent stake in 2002.

In one of the rare PIPE deals, Warburg Pincus Private Equity acquired a 26 percent stake in publicly traded Wellman Inc. in June through the purchase of convertible preferred stock and warrants for $126 million in cash. Warburg Pincus' stake in Wellman has the potential to rise to 49 percent over the next five years under certain conditions.

Wellman chose to sell a large equity stake because it was unable to raise funds via the traditional route. The company had been hampered in its refinancing efforts by tough market conditions as well as an ongoing investigation into the polyester staple fiber industry by the US Department of Justice since 2001.

Last March, a group of investors comprised of Berkshire Partners, Greenbriar Equity Group and Goldman Sachs paid a total of $125 million for convertible preferred stock in Hexcel Corp., an $850 million producer of advanced composite materials for the aerospace, electronics and other industries. Goldman Sachs had already been a shareholder in Hexcel after acquiring shares in 2000 from Ciba Specialty Chemicals.

As a result of the latest deal, the ownership structure stands with Goldman Sachs having 37.8 percent, Berkshire and Greenbriar 35.2 percent, and the rest in public hands. Hexcel used the proceeds to pay down debt.

"There is clearly interest in PIPEs from private equity firms, but the question is: Does management want to share control?" says JPMorgan's Mr. Iannaccone, who represented Wellman in its PIPE transaction. "I don't know if there's the same interest on the corporate side."

Return of theStrategic Buyer?

While business remains challenging, chemical companies are still willing to make bolt-on acquisitions to boost their core market positions. There is the sense among bankers that strategic buyers are starting to feel more confident in stepping back into the M&A game.

"I don't anticipate many major acquisitions from strategic buyers in this environment, but things are moving in the right direction," notes Dresdner Kleinwort Wasserstein's Mr. Harrs. "Some strategics have been willing to get back in the M&A market for assets that are very close to their core businesses."

Indeed, a number of decent sized strategic deals are still getting done. Air Products and Chemicals Inc. recently completed its acquisition of Ashland Inc.'s electronic materials business for $300 million, while BASF AG and Honeywell engaged in an asset swap involving BASF's nylon business and Honeywell's engineering plastics unit.

"Last year I didn't see strategic buyers at all, but now we're starting to see them more and more. It feels like business confidence is returning," says JPMorgan Partners' Mr. Walsh. "We're not seeing a dramatic improvement in financial performance, but we are seeing more of a willingness to take risk inside the board room. So companies are having the courage to make decisions to get out of non-core businesses. Likewise, they are also becoming more active as buyers as well, and that's a good sign."

"Many companies have cleaned up their balance sheets and with a modest improvement in earnings, we're starting to see more confidence among CEOs to act more aggressively," says Greg Kelly, director at Deutsche Bank. "This is a sector where a little bit of positiveness goes a long way in improving CEO confidence," adds Deutsche Bank's Mr. Geldmacher.

"M&A activity has fallen off in the past two to three years, but the basic underlying factors that drive M&A haven't really changed," observes JP-Morgan Partners' Mr. Walsh.

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