Market Intelligence: Dow and Ashland deals are not a signal for Europe

Europe may not follow US specialty deals

18 July 2008 15:16  [Source: ICB]

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Nigel Davis/London

SPECIALTY CHEMICALS are back in vogue. Dow Chemical's agreed offer for Rohm and Haas, followed rapidly by Ashland's bid for Hercules have seen to that. These US transactions prove that deal making in troubled times for the chemical and financial sectors is possible and desirable.

It is desirable particularly as the sector heads for a downturn. Specialties, or what Dow sometimes likes to call "market-facing businesses," provide a haven from cyclicality, although not necessarily margin pressure.

The businesses that Dow is buying into, and the water treatment market that is the main attraction for Ashland, bring with them the prospects of steady growth and safer margins.

Specialty assets, though, do not come cheap, with the multiple that Dow is prepared to pay for Rohm and Haas being 11.1 times the enterprise value (EV) to earnings before interest, tax, depreciation and amortization (EBITDA), according to global investment bank Credit Suisse. Ashland's bid for Hercules is valued at 8.4 times on the same basis.

The attraction of specialty assets is clear. Upstream, the sector is heading for a supply-driven downturn, but the tough times have come early as oil prices have nudged past $145/bbl and close to 50% above prices at the turn of the year.

Producers have been squeezed hard by rapidly rising feedstock and energy costs. The battle has been joined to push price increases down the chain to compensate.

Specialty chemical makers have not been immune to rising costs and the need to pass on costs to retain margins. Evonik Industries says it will apply a surcharge on its specialty polymers and monomers from August 1 to cover the rapid increase in feedstock, energy and transportation costs.

But these things are relative. And, as Credit Suisse has pointed out, the appetite for downstream assets is different in different parts of the world. The bank suggests that the Dow and Ashland deals represent a regional, rather than a global, trend - or at least one that might not affect Europe in a significant way.

European chemical companies are more focused on share buybacks and digesting recent deals than medium-sized to large specialties acquisitions. Dutch chemical firms like DSM and AkzoNobel have significant buyback programs in place, following wide-ranging portfolio reshaping.

Chemical companies may never say never, but a reality check suggests that the Europe-based firms might be more likely to be happier with small bolt-on deals in specific market segments, rather than portfolio reshaping in a more drastic way.

Two announced deals in as many days reflects the industry landscape in the US as much as anything else. And it comes as no surprise, given currency movements, that deals appear to be region-specific, Credit Suisse suggests.

The two deals have prompted a review of sector firms and the suggestion from US bank Citigroup that even the mighty US chemical giant DuPont may be vulnerable to break-up. Mighty the company is not from a shareholder perspective, with the shares having been essentially flat between 1998 and 2007, the bank suggests.

Just how do DuPont shareholders feel seeing Rohm and Haas holders being offered a 74% premium? It calculates a break-up value for DuPont of around $60/share - around one-third higher than last week's prices.

But, do broken-up companies, or those that attempt to push further away from commodities into specialties, work? If the European experience is anything to go by, the answer has to be no. Where did the specialty assets of the once-mighty German company Hoechst go to? Think of the way value was ultimately destroyed by the breakup of UK specialty group ICI. DSM is still trying to find its way following the divestment of petrochemicals. Germany's Evonik Industries has followed a similar path, but successfully divested a number of upstream businesses to focus on specialties.

Europe's specialty chemicals sector companies are currently under-performing against their peers in the US. Some of this is currency-related, but Credit Suisse notes that they are perceived as lower-quality assets.

Europe has probably experienced its great wave of specialties merger and acquisition activity. The time now is largely for bedding in recent buys or making forays into more attractive markets, such as those in the East and in Latin America.

By: Nigel Davis
+44 20 8652 3214

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