INSIGHT: The time is ripe for chemical deals and refinancing

24 August 2010 15:42  [Source: ICIS news]

By Joseph Chang

NEW YORK (ICIS)--With interest rates scraping the depths and businesses hoarding record amounts of cash on their balance sheets, the time is ripe to make acquisitions as well as refinance debt to push out maturities.

While refinancing debt at low rates is a no-brainer, there are plenty of pitfalls in the mergers and acquisitions (M&A) game.

Already we are seeing M&A activity heating up, evidenced not only by more completed transactions and a higher deal backlog, but also by the emergence of hostile takeover bids.

Australia-based mining giant BHP Billiton’s unsolicited offer to acquire Canadian fertilizer major PotashCorp for $130/share, or around $39.6bn (€31.3bn), was rejected by the target on 23 August.

US-based Airgas has already rejected a revised offer by US-based Air Products to take it over at $63.50/share, or about $5.4bn.

Both companies’ share prices are trading above the bids, as investors anticipate higher offers – either from the initial bidder or from others.

In the chemical arena, there are an increasing number of assets on the selling block, but typically, the ones of the highest quality are not readily available. It may well take a hostile approach to walk away with any prized asset.

The attempted takeover examples in the fertilizer and industrial gases sectors are linked by one important quality – the assets are unique and rare.

PotashCorp is the global leader in the production of potash – an essential mineral in enhancing crop production.

The company, in its rejection letter to BHP, cited the potash industry as characterised by “substantial barriers to entry”, having “few producers” and having “no known product substitutes”.

And how many industrial gases companies are out there of any size? In the US, you’re down to Air Products, Praxair and Airgas. Outside the US, there are France’s Air Liquide, Germany’s Linde and Japan’s Taiyo Nippon Sanso.

In Airgas’ latest salvo against its pursuer on 23 August, it complained that Air Products has so far failed to offer an appropriate price – “one that compensates our stockholders for Airgas’ scarcity and synergy value”, among other factors.

PotashCorp and Airgas are no doubt rare as well as high-quality assets. And scarcity always commands hefty premiums.

But while companies with strong balance sheets that have access to cheap financing should look for synergistic deals, it’s important not to get carried away on price.

Alembic Global Advisors partner Hassan Ahmed concludes that the chemical industry has a track record of value-destroying M&A activity.

Chemical company buyers have averaged an initial three-to-six month period of stock price outperformance of around 3.3%. But over a one-year and three-year period, stock prices have declined 3.8% and 19.4%, respectively.

The key mistake buyers made was to overestimate synergies and thus overpay for acquisitions.

“Overestimating synergies leads to unattainable expectations – and stock underperformance typically results when promised synergies fail to materialise,” said Hassan in a research note.

“We have looked at operating expenses over a five-year pre- and post-deal period. The data suggest that while operating expenses as a percentage of sales fall marginally in the few years right after a deal, these savings are not sustained, with expenses reverting to historical means,” he added.

On the financing front, companies should be lining up to refinance debt and push out maturities to reduce risk.

One big lesson of the global financial crisis of 2008-2009 was that you should not wait until the last minute to refinance your debt.

Chemical companies such as US specialty chemicals firm Chemtura and Canada’s NOVA Chemicals, which were caught with debt coming due in a collapsing financial market, basically had two choices as the clock ticked away – declare bankruptcy or sell out. Chemtura chose the former and NOVA Chemicals the latter.

Today there is no excuse for a company not to push out its debt maturities. Interest rates are at record lows and financing is available – even to those companies without the most stellar credit ratings.

US specialty chemicals company Ferro in August sold $250m in senior notes due 2018 with a coupon of 7.875% to refinance debt coming due in 2013 - not the cheapest debt, but not bad for a company with a speculative ‘B’ credit rating from global credit ratings agency Standard & Poor’s.

That’s security you can take to the bank.

($1 = €0.79)

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By: Joseph Chang
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