Survival of the fittest

08 June 2007 18:36  [Source: ICB]

MERGER AND acquisition (M&A) activity is making its impact on the North American chemical industry's distribution network.

The previously fragmented market by which companies distribute the chemicals needed to run the US economy may soon give way to a more streamlined set of entities, as smaller distributors are swallowed up by larger ones.

In the past 10 years, the number of national distributors has decreased from six or seven to three - Univar/CHEMCENTRAL, Ashland and Brenntag, says Chris Jahn, president and CEO of the National Association of Chemical Distributors (NACD), an industry group that he says accounts for 80-90% of industry revenues and has lost 48 members over the past 14 years, due to M&A activity alone.

Not surprisingly, large and small companies involved in distribution are putting their best feet forward to operate in this changed environment. The larger ones tout the synergistic opportunities involved in M&A, while small and medium-sized enterprises say they welcome the competition. The only question mark remains the health of the US economy, which has seen growth hampered by weakness in the housing market and downstream consumer demand.

The most recent mark of this consolidation was the $650m (€484m) acquisition of CHEMCENTRAL, a privately held US company, by Univar, a Netherlands-based distributor. Univar, which had already been recognised as the largest chemical distributor in the US, according to information published by NACD, closed the deal by which it acquired CHEMCENTRAL, the No 4 distributor, in April.

The transaction is the first major instance of a large distribution company changing hands since last year's purchase of Germany's Brenntag by BC Partners for $3.8bn, or about 8.5-9 times earnings before interest, tax, depreciation and amortisation (EBITDA). It marks a major expansion into the US market for the acquirer and one that comes at a slightly more costly multiple. At $650m of cash and assumed debt, the buy would cost Univar about 9.3 times CHEMCENTRAL's 2006 EBITDA of $70m.

More to the point, the new combination will place Univar squarely in an expansion mode in the US, consolidating its leadership position. CHEMCENTRAL was already getting about 90% of its sales revenues from inside the US, and Univar projects that the acquisition will "instantly" increase the size of its US business by about 40%. The new combination should account for about 15-20% of the US market, according to Terry Hill, senior vice president and chief commercial officer at Univar's headquarters in Rotterdam, the Netherlands.

John Yanney, the former CHEMCENTRAL chief executive, took Hill's place as president of Univar's US business on the closing of the acquisition.

Yanney and others at Univar are also unconcerned about the extent to which the new combination will alter the competitive landscape. There are fears that the deal may create a monopolistic presence that may ultimately have a negative impact on the broader chemical sector. "I know people fear the Wal-Marts of the world," says Yanney. "But this is not going to be very disruptive... I'm really excited about everything we have to offer.

"If anything, it should up everybody's game," he says, arguing that the difference in products and markets handled by the two companies - with Univar's business centered in inorganics, while CHEMCENTRAL is mostly a solvents house - will enable them to maximise business growth without resorting to personnel cuts or facility closures. "Right now, we feel that we have a tremendous foundation.

"In North America, the numbers speak for themselves. We are definitely the No 1 distributor [there] and, with the new combination, Univar will also become the No 1 distributor [for Canada]," he says. Univar is also in a commanding position in eastern and western Europe, and the company should also see its market share rise in Mexico.

US ECONOMY QUESTIONS

But rising North American market share or not, Univar and other chemical distribution companies ought to be prepared to slog it out, at least for the short term, given the lacklustre outlook for the US economy. Sluggish growth is forecast to continue throughout most of this year.

With that slowdown, industry watchers expect distribution to follow suit. "Chemical distribution is a good proxy for the US economy, because our members sell into all industries," says Jahn, noting that "things are good now, but not as good as they've been for the last two years", which saw revenues of $20bn-30bn, "the best the industry has seen in years".

The outlook is similarly murky when it comes to individual companies and deals.

With about one-third of CHEMCENTRAL sales revenues coming from the housing-sensitive paints and coatings business, ING analyst Quirijn Mulder openly expressed scepticism when its acquisition by Univar was announced in March, citing doubts about the US economy.

"We believe this is an interesting deal but not without risk given the complications, the state of the US economy and the price which is being paid," he said, maintaining that the purchase price represented a premium "compared to [CHEMCENTRAL's] own evaluation of 32% of sales and seven times EBITDA".

Elsewhere in the distribution sector, Jefferies & Company analyst Laurence Alexander notes that Ashland, a diversified company that derived 56% of its 2006 sales revenues from distribution, will see continued weakness from that part of its business throughout much of this year. Ashland's distribution business, suffering from deteriorating margins, will deliver $15m in earnings before interest and tax in the third quarter, down by 54% year-on-year.

SMALLER FIRMS HOLD OUT

In the meantime, the chief of at least one smaller, regional distributor, says he is so far uninterested in the M&A offers he has been receiving and is committed to keeping his $50m company independent and growing through acquisition of smaller companies.

"Sure, there are lots of challenges, but that's what keeps us going," says Chuck Kellogg, the 75-year-old chairman and chief financial officer of Hubbard-Hall, a family-owned company founded more than 150 years ago in Waterbury, Connecticut, US. The company, which ranks 64th on the list published by NACD, derives about 80% of its revenue as a regional distributor for such top producers as Dow Chemical, handling more than 5,000 commodity chemicals. This distribution network has been buttressed since the late 1990s through a series of acquisitions of small owner-managed firms in key geographic areas.

While he says he has managed to knock back acquisition offers from bigger players, largely on the basis of a well-established "family succession plan", he says he is "looking to buy some of these smaller companies that are still around".

"These [M&A] pressures are really going to help us," he says. "You have to have a certain size to stay in business these days, and companies with less than $20m of revenues will be finding it harder to stay independent."

Also looking ahead to the next deal is Univar's Yanney.

He admits that he is firmly focused on the Univar/CHEMCENTRAL integration at this point, hoping to soon grow his company, which had combined pro-forma North American revenues of $4.6bn-4.8bn last year, to at least $5bn for the region.

In the meantime, "it's not that you don't continue to look at something if it adds value", he says. "We're not just sitting there like the Maytag [refrigerator] repair man, waiting for something to happen."

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