Analysis: Financial buyers still active in chemical M&A

26 November 2003 17:00  [Source: ICIS news]

NEW YORK (CNI)--Financial buyers continue to play an active market-maker role for chemical assets, acting as a "way station" for unwanted businesses. Although some private equity firms are seeking to exit, the interest level in chemicals remains high.

"Financial buyers have played a significant role in deal-making, and they continue to display a vibrant level of activity," said Gary Denning, director of chemical industry practice at Houlihan Lokey Howard & Zukin.

"The activity level continues to confirm the fact that the private equity community is the most active player in the merger and acquisition (M&A) marketplace in the chemical space," said Telly Zachariades, senior managing director and head of global chemicals at Bear Stearns.

Despite the fact that the economic recovery is still in its infancy, two fundamental factors have shaped the toning up of the market.

On the one hand, "financial buyers are slowly inching up in their willingness to pay more than was previously the norm," said Alex Markin, M&A specialist at First Analysis Securities.

He said: "They're starting to view things on a proper cost of capital basis (in the 9-10% after tax range rather than 12-13%), assuming low interest rates, the increased availability of credit, and greater leverage enticement for equity. They have to meet certain expectations on equity, cash on cash return, but not in terms of return on assets since money is available for borrowing."

Said Omar Abboud, managing director at Morgan Joseph & Co: "Compared to six or twelve months ago, the market has certainly improved in terms of offering different options to sellers."

He said the financial sponsor community was able to buy reasonably attractive businesses during the past two to three years at very attractive multiples. And given the more favourable lending market available to buyers, they can easily translate that upward in disposing of the asset.

Abboud cited the Kraton Polymers transaction is an example.

This more sanguine outlook, which has led to a lot of money chasing deals and the banks becoming more aggressive, is a function of the belief that the economy has indeed bottomed out and is in recovery mode, however snail-like in pace.

Peter Young, president of Young & Partners, points out financial buyers, though active, still represent only 20% of the chemical M&A market.

"While equity firms have substantial amounts of unused funds and have been methodically adding to their portfolios during the past three years, many have experienced poor results from the investments they made," said Young.

In some cases, these disappointments involve bankruptcies or failed exit attempts.

He said: "Also, keep in mind that there were only seven public chemical equity offerings in the first nine months of 2003 worldwide, raising only a modest total of $700m (Euro593m)."

But there remains a somewhat pent-up supply situation with the growing inventory of assets for sale, notes Houlihan Lokey's Denning. Private equity funds are seeking to lock in gains, particularly if they plan to raise a new fund in the near future and need to trumpet their success.

The exit strategy often depends on where the firm is in its fund cycle-"how old the investment is or whether the fund has since closed," said Bear Stearns Zachariades. Private equity funds operate on their own timetable and have their own view of the asset.

A successful exit strategy is ultimately a measure of the acquisition price, and the subsequent financial performance and attractiveness of the asset, according to Young.

Strategic buyers have yet to return to the M&A market in full force.

"Many of the non-financial buyers are still hesitant to make a big splash in the M&A marketplace, either because they haven't quite completed their own restructurings or they recently completed them and it's just a little early to start spending serious dollars," said Zachariades.

Strategic buyers remain in the nibbling phase.

"Since they're still aligning their own internal cost structures with the current level of demand for their products, they're gingerly looking at assets, but haven't got to the finishing line as frequently as the large universe of financial buyers, who are sitting on an extensive pool of capital which they need to put into play," said Houlihan Lokey's Denning.

Now that cash flow and credit emergencies have been largely staved off, chemical companies can begin to address the portfolio issues presented by non-core assets. With strategic buyers and sellers, "it depends on the scenario they're looking at - where they realise synergies, and to what extent they're willing to pay up front for the potential synergies they envision," said First Analysis' Markin.

He said: "Today, those assessments are based on integration plans that are tempered by past experience, drawing important lessons from several of the better known calamitous deals."

Said Zachariades: "The prime motive of strategic sellers is shifting slightly - away from the pressures of financial necessity and in the direction of strategic considerations. Certainly, DuPont's recent sale of its textiles business Invista to Koch Industries for $4.4bn falls into the strategic category, whereas the unloading of any businesses by Rhodia and Clariant would appear driven primarily by balance sheet considerations."

Leland Harrs of Dresdner Kleinwort Wasserstein (DrKW) said: "We're starting to see companies make decisions based more on long-term portfolio optimisation criteria."

The General Electric-Crompton organosilicones deal had a mixed flavour with the seller, Crompton, shoring up its balance sheet and the buyer, GE, paying a healthy premium for its own strategic reasons.

The sole purpose of financial buyers is to do deals, while a chemical company first and foremost must protect and grow the enterprise, said Denning.

Also, strategic buyers don't have giant pools of capital at their disposal and need to pay attention to their own internal operations.

(For additional
Chemical Market Reporter analysis visit the CMR Web site at:

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