Could life be returning to M&A in chemical distribution?

The time is ripe

23 November 2009 00:00  [Source: ICB]

The news that Brenntag owner BC Partners is seeking an IPO is a signal that life may be returning to M&A activity in chemical distribution

THE NEWS that one of the world's premier chemical distribution companies, Brenntag, is again up for sale has sent ripples of excitement through a sector that has seen very little merger and acquisition (M&A) activity since the downturn kicked in late in 2008.

UK-headquartered private equity group BC Partners is preparing a €1.5bn ($2.2bn) initial public offering (IPO) for the German-headquartered group, to be launched in the first half of 2010. Following the measure, BC's share in Brenntag is expected to fall below the 50% mark. BC acquired Brenntag in 2006 from private equity group Bain Capital.

A lot rests on the success of this venture. If it goes through, and capital markets are recovered enough to tolerate a €1.5bn IPO, then the owners of other private-equity-owned businesses, such as Azelis, of Belgium, Netherlands-based IMCD and the global Univar, might also decide to investigate the monetization of their assets.

According to Marc Fermont, founder of Swiss-headquartered specialist consultancy DistriConsult, the group is in better financial shape than might be expected for a commodity-reliant chemical distributor in the midst of the downturn.

He says clever inventory management during the downturn may have resulted in significant cash flow benefits for Brenntag and other distributors. Expensive inventory sold at a high price and replaced by lower-cost product can lead to tremendous cash flow benefits, especially for commodity players with fast stock turnover.

The positive effect should be much more pronounced amongst commodity players that turn stock over seven to nine times a year, compared with four to six times a year in specialty chemicals. "Brenntag has invested in inventory management software, which has helped it monetize its position much better than others," he adds.

Media reports suggest that before the IPO can proceed, BC Partners will need to find four or five banks to take over Brenntag's debt, which is divided or "securitized" between around 200 banks. Next, the company will conduct road shows to excite potential investors. Reports suggest shareholders will be looking for a lock-in period to prevent BC offloading the rest of Brenntag too soon with the danger of a collapse in its stock value. Asked about the likely success of the IPO, Fermont says: "It has a 50:50 chance of success. It depends on the success of the debt restructuring process and the state of the stock market and economy. There is also the wild card of the impact of any verdicts on anti-trust investigations."

Brenntag is embroiled in long-running investigations in France and Germany, as well as two minor probes in Belgium and Holland.

Fermont believes that market dominance issues will prevent any mega mergers between the big players in chemical distribution. There is too much potential for dominance either by geography or product type among players such as Brenntag, Univar, IMCD or Azelis. "Brenntag would not fit with any of the others. It will have to expand geographically, but not in Europe, where it already has a market share of 60-70% in some markets."

However, there will be M&A opportunities, though more focused on regional geographical or product expansion. Private equity players and banks will have to provide more of their own financing in the more cautious post-crisis financial environment. This means there should be more small and fewer large transactions.

"There will still be a lively market in the €10m-200m region but above that, the challenge will be higher. Financing of big transactions will be difficult, except for IPOs," Fermont says.

Azelis is reviewing the future of its European polymer operations. It may sell these to a new group, Allandis, which is due to launch in the first quarter of 2010.

Financing is in place and a series of four to five acquisitions over the next 18 months should create a major player in European polymer distribution, says Peter Fields, its creator. Fields aims for sales of €300m-400m within two to three years. Fields says Allandis has separate funding and will be independent of Azelis. Consultants at global consultancy PricewaterhouseCoopers (PwC) agree that there are significant opportunities globally for M&A in chemical distribution.

In an interview with ICIS, Mike Clements and Mark Hanrahan, said that with a very fragmented market and a recession-resistant business model, the time is right for M&A among private equity players wishing to enter the market and for existing distributors looking to expand as capital markets start to unfreeze. The consultants said their research shows that the top five distributors globally control only 15% of the market. That compares with around 70% among specialty chemical producers, 58% in polypropylene (PP) and 91% in polycarbonate (PC).

Fermont, however, disputes these figures because companies give figures for their entire portfolio rather splitting their markets to show the real situation. He insists that the top four or five companies control 70-80% of commodity chemical distribution and more than two-thirds of the markets for other big distribution markets such as food and beverage, personal care, paints and coatings and polymers. Steve Holland, Brenntag chief operating officer, disagrees with Fermont (see box). Because of this, Fermont adds: "There cannot be further big consolidation moves in Europe and North America."

Both consultancies, however, agree that the geographical split suggests that markets in Asia and Latin America are particularly ripe for M&A because they are so fragmented. PWC says in India, for example, the top five distributors control only 15% of the distribution market, while the figures for Brazil and Mexico are around 28%. This compares with 45-50% for the US and Belgium. There has been a lot of consolidation in the industry, but much remains to be achieved, Hanrahan says. "Many distributors were set up as [small] 'cottage industries' to serve small customers. As the customers have consolidated, so have distributors. But they are lagging behind. There is a lot more to do," says Hanrahan.

Clements suggests that chemical distributors can maintain profitability through a downturn. "You get a fairly fixed margin per tonne in chemical distribution. Whether prices are low or high, they can get roughly the same margin," says Clements.

Chemical distributors have low fixed costs compared with manufacturers, so profitability can be maintained even when revenues fall through a downturn, says Clements, adding: "If your cost base is small, your earnings will be stable."

A comparison of operating profits for chemical manufacturers and distributors in 2007 and 2008 showed distributors achieved an average increase of 22%, while those of bulk chemical manufacturers plummeted sharply (see graph).

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"Mergers and acquisitions within chemical distribution are still on the agenda, with continued consolidation within specialty and industrial chemicals in what is a highly fragmented market. There remain a very large number of local and regional distributors whose combined market share far exceeds that of those distributors who operate on a national or even global scale. We estimate the top five chemical distributors account for less than 25% of the market place not taking into account the huge potential in developing countries. This has been an extremely challenging year for all industries, including chemical distributors. However, what has been demonstrated is that the distribution business model is highly resilient and cash flows during the downturn remained strong because of a gradual lowering of inventory and receivables."

Distributor Owner Transaction amount (€m) Date and type of transaction
Azelis 3i 315 12.07 tertiary
Brenntag BC Partners 3,500 7.06 tertiary
DruckChemie 3i 133 4.08 secondary
IMCD ABN Equity 320 6.05 secondary
Neochimiki Carlyle 749 6.08 LBO**
Solvadis Orlando NA 6.04 LBO**
Quaron Bencis 60 6.02 LBO**
Safic Alcan ING Parcom 115 12.07 secondary
Unipex ($) AXA PE 155 ($m) 4.08 LBO**
Univar CVC 1,500 10.07 LBO**
Warwick (£) CBPE 129 (£m) 9.08 LBO**
Ethanol 60-64/HLT $3.00-3.10/gal Oct $3.00-3.10/gal
 Notes: *earnings before interest, tax, depreciation and amortization **leveraged buyout

Sales €7.4bn ($10.8bn)
Employees >11,000
Countries 64
Locations >300
Products >25,000
Customers >165,000

By: Will Beacham
+44 20 8652 3214

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