Moments of truth

08 June 2007 18:36  [Source: ICB]

CHEMICAL DISTRIBUTORS and their suppliers in Europe are likely to remember 2007 as the year when all the rules were changed, or when all existing rules were fully implemented locally and globally.

The industry is still dominated by national and decentralised approaches which, in many cases, prevent local operators grasping the complex changes that affect their global suppliers and customers. In many instances, they have retained operating practices created in the 1970s.

Three fundamental aspects now face scrutiny: buy-and-build strategies, market share assessments and market information exchange policies.

Buy and build strategies

During the past 10 years, the European industry leaders Brenntag, Azelis and IMCD followed a similar model based on buy-and-build or buy-and-sell strategies. Univar, as a public company, followed a more conservative approach, relying partly on merger and acquisition (M&A) activities but mostly on organic growth.

During the period 2001-2006, Brenntag completed some 50 acquisitions in Europe alone and Univar around 10. Azelis acquired about 45 smaller companies and IMCD about 30. It is not our purpose here to describe each transaction, but rather to explain the strategic drivers that led to the creation and development of the competitive scenario in Europe today.

The private equity investors' notorious influence and sophisticated value-creation model pushed the distributors they own to buy and build in order to obtain premium sale prices at the time of their secondary or tertiary placements. Neither a trade sale nor an initial public offering could be used.

Private equity involvement has created several dynamic and entrepreneurial companies that aim only to grow their sales in order to pay back the loans their investors contracted to acquire them.

A simple question remains to be answered by the industry: should international distributors adopt an integrated model like IMCD, with single enterprise resource planning, customer relationship management platforms and pan-European industry strategies? Or, should they operate with a large number of decentralised or independent local companies with loose links among them and limited central coordination?

In the latter case, companies must be ready to cope with unexpected financial risks and unforeseen liabilities. It now seems important to give management content to chemical distribution's national and international dimensions, otherwise international companies will only remain a collection of loose-knit regional entities.

Distributors' market share assessment

Distributors' market share seems to be an innocent business dimension. In reality, it is central to distributor M&A strategies.

Distributors operate on the larger chemical markets served by producers, agents, traders and distributors. It is generally accepted that distributors in total hold a market share of 15-18% of the relevant European markets. On this basis, even the larger ones do not have an individual market share in excess of 2-3%.

At the same time, it is estimated that three companies hold 82% of the bulk chemical distribution market in France and the largest player holds a market share of around 50%. We can therefore understand better how several distributors were able to increase their market share by acquisitions without any problems from the competition agencies.

Based on recently published jurisprudence, it is now expected that distributor market shares will be based on pertinent markets and no longer on hazily defined relevant markets.

A pertinent market is based on a set of indicators, such as sales of the main distribution companies active in the sector, volume sold, respective industry sector position, supplier mix assessment, logistics capabilities measured in number of sites and tanks, position of partly or wholly owned subsidiaries and international coverage.

This new definition of pertinent markets is relevant to bulk commodity chemicals and factory-packed specialty chemicals. It is expected to allow further industry consolidation without the formation of oligopoly (where there are few sellers in the market) or oligopsony (few buyers).

In 2000, the EU competition agency published new competition laws that forbid companies from making acquisitions that give them a market share of more than 30% without formal authorisation from the authorities. Because of the confusion between relevant and pertinent markets, this ruling was not implemented on chemical distributor markets and the 30% share threshold might have been exceeded in some cases.

Information exchange policies

The 2000 European laws concerning competition and vertical restraints impose on distributors and their suppliers a new set of rules and practices.

Previously, agency agreements were nationally regulated within each member state, whereas distributor contracts were not. Since 2001, both agency and distributor agreements have been regulated at the European level and the relevant rules have been gradually implemented and enforced.

A close reading of the new laws may still leave room for some interpretation, but it is clear that the concept of supply exclusivity is obsolete and illegal, when it relates to producers seeking to impose 100% volume supply obligations on their distributors.

It is also illegal to limit the size of the resale territory or the type of customers to which a distributor is authorised to sell. Customers in Europe may order from any distributor they wish, regardless of where the distributor is located.

A sensitive aspect lies on the pricing front, where neither the prices charged by distributors to their customers, nor the names of the customers should be communicated to the supplier. From a legal standpoint, the status of distributors that take title of the goods they resell is now the status of competitors to their suppliers.

Distributors are no longer a sort of agent or an exclusive selling arm. Distributors are independent companies, the purchasing, pricing and margin strategies of which cannot be controlled by their suppliers. They may simultaneously offer similar chemicals from alternative sources to their customers. Distributors and producers can exchange technical and commercial information, but they are not allowed to talk about prices and names of customers, much in the same way as is customary between competitors.

When a producer and a distributor sell concurrently to the same customer, they are not allowed to coordinate their pricing strategies. Suppliers that are ready to transfer their small lot distribution businesses to distributors are no longer allowed to provide them with a list of customers and prices previously concluded.

The topic of direct deliveries or full-truckload deliveries is a sensitive issue in chemical distribution as it represents significant volumes. Suppliers are not supposed to know to which customers their distributors resell and at what price. To comply with this requirement, producers interested in managing direct deliveries through distributors must sell the relevant volumes on a "free on truck" basis.

The distributor takes title of the chemicals purchased at the site of the producer, organises and pays for the transport to the customers. Suppliers will no longer know who the buying customers are, since they do not deliver the goods themselves.

Another legal possibility offered is to consider distributors as agents and pay them a fixed commission on the direct deliveries. It seems also important for each producer to clearly state and publish their internal business rules and standards for the volumes and shipment size they will manage themselves and the minimum yearly revenue of the customers they will serve directly.

These aspects have already been fully implemented by some producers and distributors since 2001. Some were either not aware of the new legislation or wrongly interpreted it. In case of misunderstanding and in order to avoid possible penalties, it seems important to check these aspects with the competition agencies. In the future, shareholder value creation will be associated with vigilant respect for modern legal and ethical standards.

Comparison of revenue and asset value for major European distributors (€m)

Company	2000	2001	2002	2003	2004	2005	2006
Brenntag net revenue	2,000	2,305	2,275	2,550	2,738	2,983	3,400
Brenntag sale price* (debts included)	470		1,000		1,300		3,500
IMCD net revenue	402	421	455	469	505	530	550
IMCD sale price (including debt)**		195				320
Azelis net revenue	230	249	297	429	451	680	742
Azelis sale price (including debt)***		100		175			315
Univar net revenue	1,778	1,814	1,569	1,437	1,489	1,584	1717
Univar market capitalisation	n/a	450	170	520	780	1,000	1,230
NOTES: *Veba sale to Stinnes, Stinnes to Deutsche Bahn, Deutsche Bahn to Bain, Bain to BC Partners**Internatio Muller to NIB Equity, NIB Equity to ABN Amro Equity. *** Azelis sale to Permira, Permira to Cognetas, Cognetas to 3iSources: Districonsult Petercam

Sources: 1. European Commission site. http:// europa.eu/scadplus/leg/en/lvb/l26061.htm

2. Cour d'appel de Paris: Verdict 13.03.07 www.conseil-concurrence.fr/doc/ca06d12_ commoditeschimiques.pdf

Marc Fermont is a senior partner at specialist channel management

practice DistriConsult

mfermont@districonsult.com

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