Chemical mergers and acquisitions set to rise in 2011

02 December 2010 19:41  [Source: ICB]

Correction: In the article headlined "Chemical mergers and acquisitions set to rise in 2011," in the 76th paragraph, please read: "'Asia is rearing its head and targeting Europe, with Reach compliance being a key factor,' says Constantine Biller, director and senior analyst at US-headquartered professional services group IMAP's UK office, Clearwater Corporate Finance," instead of: "'Asia is rearing its head and targeting Europe, with Reach compliance being a key factor,' says Constantine Biller, director and senior analyst at UK-based Clearwater Corporate Finance." A corrected story follows:

Merger and acquisition activity is set for another strong year as private equity seeks exits and strategic buyers look to deals as a key part of their growth strategies

With the economic and financial crisis easing off, the chemical industry is wheeling and dealing again. Global chemical merger and acquisition (M&A) activity has shot up in 2010 from depressed 2009 levels, and all indications point to a strong 2011.

"The current M&A market is strong and the outlook is very positive for 2011," says Peter Young, president of US-based investment bank Young & Partners. "Only a drop into another economic recession or a major hit to the financial system will prevent this improvement in chemical M&A in 2011."

Already through the first three quarters of 2010, the global chemical market closed $32bn (€23bn) in deals on an equity basis, exceeding the $25bn for the whole of 2009, according to Young & Partners. And the number of completed deals over $25m in size through the third quarter (Q3) rose to 32, exceeding the 25 booked for all of 2010.

"M&A activity through Q3 has jumped far beyond last year's totals in both dollar volume and number of deals, and may, by the end of the year, equal or exceed the totals for 2008," says Young. "This is supported by the fact that there is a strong backlog of deals that have been announced and are moving to a close. Confidence has returned to the market."

The threat of a double-dip recession has subsided, company earnings have been solid and debt markets have been strong, all leading to a spate of dealmaking.

Recent notable deals yet to close include:

Thailand-based polyethylene terephthalate (PET) producer Indorama agreeing to buy US-based INVISTA's PET assets in the US and Mexico for $229m;

"M&A activity through the third quarter has jumped far beyond last year's totals in both dollar volume and number of deals, and may, by the end of the year, equal or exceed the totals for 2008"
Peter Young President, Young & Partners
Mexican industrial conglomerate ALFA (through subsidiary DAK Americas) buying US-based Eastman Chemical's PET business for $600m;

US-based private equity firm TPG Capital acquiring US-based Ashland Distribution for $930m;

US specialty chemicals firm OMNOVA Solutions buying France-based specialty polymers and chemicals company Eliokem for €227.5m from France's AXA Private Equity.

In the US, sellers of chemical assets are rushing to close deals by the end of the year to avoid potential tax hikes.

"There's a big glut of deals waiting to get done by year end in the US - it's a tax situation driving these deals," says Chris Cerimele, director and head of chemicals at US-based investment bank Houlihan Lokey. "Because of that focus on closing deals before the end of the year, the near-term pipeline of new transactions for next year is relatively soft. Activity in Q1 2011 is likely to be lower than in Q1 2010."

The former US Bush administration's tax cuts are set to expire at the end of 2010. While these cuts could be extended, sellers aren't taking any chances, notes the banker.

For 2011, Cerimele expects a solid year for chemical M&A. "2011 has the potential to be a better year because corporations have a lot more cash from solid operating performance, and there are no indications that the financial markets will worsen," he says.

In addition, chemical companies will continue to divest non-core assets.
"The interest, appetite and financial capability of strategics to do deals is high, but they are not looking to diversify - they are looking to find accretive bolt-on acquisitions"
Leland Harrs, managing director, PrinceRidge Group

"There is still plenty of room for companies to consider divestitures. That kind of activity will remain steady," says Cerimele. "Many corporations would have liked to trim their portfolios in 2008-2009, but weren't able to, and are now trying to take advantage of the improved market."

Private equity buyers have made a comeback as financing has become more available and at cheaper rates.

Through the first three quarters of 2010, private equity firms completed 12 transactions of more than $25m, representing 26% of the total number of deals, according to Young & Partners. This was a huge improvement on 2009, when the financial crisis shattered the debt markets. Last year, private equity buyers were crippled, completing only four deals, comprising 14% of the total.

"The greater availability of financing was particularly beneficial to the financial buyers, who have come back strongly, starting in the second quarter of this year," says Young.

Much of the private equity deal activity has taken place in the US. Notable deals this year include:

Bain Capital's $1.63bn acquisition of US-based Dow Chemical's styrenics assets (Styron);

New Mountain Capital's $280m buyout of US specialty chemicals firm Mallinckrodt Baker

Graphite Capital's £130m ($209m, €156m) acquisition of UK-based automotive refinish products producer U-POL.

 "Foreign - especially Asian buyers - will increasingly look at US assets"
Philip Kassin, senior managing director, Evercore Partners
Private equity can also wind up with a majority stake through the bankruptcy process. Earlier this year, a consortium of Apollo Management and Access Industries gained control of Netherlands-based chemical major LyondellBasell Industries in the US bankruptcy process.

Private equity will be a big force on the sell side as well. More of these companies will seek to exit their chemical investments in 2011 on improved M&A market conditions and the initial public offering (IPO) market.

"There is a pent-up supply of assets in financial sponsor hands - long-in-the-tooth investments - that need to come out, so there will be pressure to sell or exit," says Leland Harrs, managing director at US-based investment bank PrinceRidge Group. "And on the buy side, the money's out there. Strategic buyers and sponsors have lots of cash, lenders and lending and the high-yield market is on fire, so that will drive activity."

The banker expects more private-equity sales of chemical assets to private-equity buyers, as strategic buyers are being very selective, mainly looking for bolt-on acquisitions that fit their existing businesses.

On November 30, US-based Royal Adhesives & Sealants was sold by US private equity firm Quad-C to the global Arsenal Capital Partners, another private equity firm.

"This transaction highlights the fact that sponsor-to-sponsor transactions can still get done in the current M&A market," says Houlihan Lokey's Cerimele, who advised Royal Adhesives & Sealants on the deal.

Other recent sponsor-to-sponsor deals include Rhone Capital selling a 75% stake in US-based pine-chemicals producer Arizona Chemical to American Securities and CVC Capital Partners selling a 42.5% stake in US chemical distributor Univar to Clayton, Dubilier & Rice. Both sellers pursued a parallel exit track - Arizona Chemical and Univar filed for IPOs as well.

An IPO would make sense for larger businesses, notes Harrs. "Especially for multibillion-dollar chemical assets, there are only a handful of buyers that could do it and not that many will, so an IPO is the logical exit."

The banker sees a flurry of sponsor-to-sponsor deals closing before the end of the year, as sellers aim to avoid potential US tax increases in 2011.

Telly Zachariades, partner at US-based investment bank The Valence Group, expects stronger chemical deal activity in 2011 as strategic players seek growth and private equity firms both look to spend money raised in recent funds and sell off assets that have been held for several years.

"Private equity firms are hungry for deals in their more recent funds, and also looking to exit assets in vintage funds since they were not able to do so during the financial crisis of 2008-2009," he says.

Many chemical companies are flush with cash, with solid balance sheets. Through the financial and economic crisis, they cut costs, sold assets and shut down inefficient plants.

Some, such as LyondellBasell and US-based specialty chemical firm Chemtura emerged from bankruptcy where they shed a great deal of debt and other liabilities. US-based titanium dioxide (TiO2) producer Tronox is next up to emerge from bankruptcy.

"Post-bankruptcy, companies' balance sheets have been cleaned up," says Philip Kassin, senior managing director at US-based investment bank Evercore Partners. "These types of companies will explore both acquisitions and divestitures as they seek to reoptimize their portfolios."
"Asia is rearing its head and targeting Europe, with Reach compliance being a key factor"
Constantine Biller, director, Clearwater Corporate Finance

LyondellBasell, with annual sales exceeding $40bn, had just $2.5bn in net debt at the end of Q3 and could be net debt-free within a year. US-based DuPont sports one of the strongest balance sheets in the industry, while Belgium's Solvay sits on a cash pile exceeding €5.0bn ($6.5bn) - much of it from the sale of its pharmaceutical business in February 2010.

Chemical companies are under increasing pressure to make acquisitions as cash builds on their balance sheets, according to Zachariades. "The pressure to do deals has become even more acute in the past few months as strategic buyers have generated more cash," he says. "However, corporate buyers and private equity firms aren't running around spending money like drunken sailors - they are being very disciplined and selective."

Chemical companies are looking for "strategically relevant" businesses, rather than assets that would take them into completely new sectors, notes Zachariades.

"The interest, appetite and financial capability of strategics to do deals is high, but they are not looking to diversify - they are looking to find accretive bolt-on acquisitions," says Harrs.

And a number of once-leveraged companies are finding themselves leveraged no more, and ready to make deals. In this category are US-based specialty chemical companies Solutia and Rockwood Holdings. Both companies will employ M&A as a tool to advance their ambitious growth plans.

Solutia emerged from bankruptcy in February 2008, shedding billions of dollars in debt and environmental liabilities after an arduous, almost five-year process. It then sold its nylon business in June 2009 and made several acquisitions.

Led by chairman, president and CEO Jeffry Quinn, the company today sports a very reasonable net debt/earnings before interest, tax, depreciation and amortization (EBITDA) ratio of under 2.5 times, and will look to make bolt-on acquisitions, as well as potentially adding another leg to its core businesses of advanced interlayers, performance films and technical specialties.

Rockwood Holdings, led by chairman, president and CEO Seifi Ghasemi, went public in 2005 as a highly leveraged company with a net debt/EBITDA ratio of around 5 times. Before its IPO in 2004, it was levered up to 7 times. It has since paid down debt with its strong cash flow, and today has taken down leverage to below 2.9 times.

Rockwood, a producer of specialty TiO2, pigments, lithium compounds, advanced ceramics and surface treatment chemicals, is targeting 8% average annual sales growth through 2015, with organic growth accounting for 5% and bolt-on acquisitions for 3%.

In many cases, deals beget more deals. US specialty chemical company Ashland agreed to sell its chemical distribution arm, Ashland Distribution, to TPG Capital for $930m in cash in a deal that is expected close in Q1 2011. The proceeds will likely be used to make bolt-on acquisitions.

"Going forward, our primary reinvestment plan will be to make bolt-on acquisitions in the $100m-300m range in the Aqualon and Water Technologies businesses," said Ashland chairman and CEO James O'Brien in an interview with ICIS in November.

Ashland's Aqualon Functional Ingredients business makes products that manage physical properties in aqueous and non-aqueous systems. Its products are used in diverse end-markets such as paints and coatings, personal care, construction materials, food and pharmaceuticals. Ashland's Hercules Water Technologies business makes industrial water-treatment chemicals, many of which are based on acrylic acid.

"We see a decent [M&A] pipeline. We are evaluating several opportunities and discussions are taking place," said O'Brien.

He did not rule out larger deals, but said the company was not interested in adding a fifth leg to its now four core businesses of Aqualon, Water Technologies, Performance Materials and Consumer Markets (Valvoline).

M&A valuations are also on the rise, as financing becomes more available, but are not to the point where they would choke off deal activity.

"We've seen a significant increase in valuations from the 2009 trough. This is good for sellers and a mixed bag for buyers. Sellers are now willing to sell assets, whereas in 2009 many would not." says Young. "But pricing is not skewed heavily to buyers or sellers - it is a market conducive to dealmaking."

Allan Benton, vice chairman and head of the chemical practice at US-based investment bank Scott-Macon, notes that enterprise value (EV)/EBITDA multiples for completed global specialty chemical deals in 2010 in the year to date "are at good levels - back up to where they were prior to the trough in 2009. Strategic buyers are paying up."

The median EV/EBITDA multiple was 10.1 times in the first half of 2010, compared with multiples of 7.3 times in 2009, 9.6 times in 2008 and 9.8 times in 2007, according to Benton.

"We're seeing financing and transaction multiples on the rise," says Justin Vorwerk, co-head of corporate finance at PrinceRidge. "Anecdotally, buyers in smaller deals up to $200m in size can borrow up to 4.75 times EBITDA. That's pretty aggressive. And buyers in larger deals can borrow up to around 5.25 times EBITDA."

In early 2009, at the height of the financial crisis, financing was simply not available. "It would be difficult to borrow even two times EBITDA, as the EBITDA component kept falling," notes Vorwerk.

 "Multiples continue to be at good levels - back up to where they were prior to the trough in 2009. Strategic buyers are paying up"
Allan Benton, vice chairman, Scott-Macon
Valuation multiples vary by business, but some bolt-on deals involving quality businesses have been done at double-digit EBITDA multiples, while other commodity deals have been done at around five times, according to Harrs.

Ashland Distribution is being sold at 10.4 times, trailing 12-month EBITDA, according to Ashland's official EBITDA number of $89m for its distribution unit.

"We conducted an extensive auction process and had many interested parties - both strategic and private equity players. We think we sold at a fair price," said O'Brien.

However, a source familiar with the deal says the business had EBITDA of $122m in the 12 months through September 2010, excluding allocated corporate costs that the buyer would not assume. That would make for a more modest multiple of 7.6 times EBITDA.

There are a decent amount of assets for sale and plenty of deals in the works. Zachariades sees around 30-40 chemical assets for sale, representing a "fairly active environment."

Look for US-baed Dow Chemical to seek deals for its high density polyethylene (HDPE) and polypropylene (PP) assets.

Rather than seeking a "big bang" plastics transaction similar to its failed K-Dow deal with Kuwait's Petrochemical Industries Co. (PIC) in December 2008, the company will now aim to create joint ventures (JVs) or sell off select commodity plastics businesses.

"We will look to [JV] or divest the commodity pieces," said chairman, president and CEO Andrew Liveris, on the sidelines of Dow's Investor Day in Midland, Michigan, US. "Expect some transactions in the next 12-24 months, but there will be no big-bang deals - just selective deals."

According to sources, other businesses for sale include US coatings producer Quest Specialty Chemicals, US white oils supplier Sonneborn and US-based engineered glass producer Potters Industries.

These assets are all owned by private equity firms. Quest is owned by chairman and CEO Fred Quinn and Huron Capital Partners, which made its first acquisition in the coatings business in 2004, forming Quest. It then started rolling up other acquired coatings assets into Quest. Sonneborn is owned by Sun Capital Partners, while Potters is a subsidiary of PQ, owned by Carlyle Group.
"There's a big glut of deals waiting to get done by year end in the US - it's a tax situation driving these deals"
Chris Cerimele, director, Houlihan Lokey

Hot spots in M&A include coatings, as well as chemical distribution, notes Benton. "In chemical distribution, there had been more consolidation in Europe in past years, but it appears that activity is now moving to the US," he says.

Chemical deal activity continues to be strong worldwide. Through the first three quarters of 2010, the "Asia and rest-of-the-world" category took the lead, with 38% of the total number of deals in the regions, compared with 32% in Europe and 30% in the US. In 2009, only 28% of the deals were done in "Asia and rest of the world," with 41% in Europe and 31% in the US, according to Young & Partners.

Cross-border M&A is set to increase in 2011, with Asian buyers seeking Western chemical assets. The Indorama/INVISTA PET deal set to close in Q1 2011 could be the first of many on this front.

"Foreign - especially Asian buyers - will increasingly look at US assets. Not only do they want to expand out of their home territories, but also acquire intellectual property and technology to grow their business globally," says Kassin.

The strong competitive position of US commodity chemical companies, bolstered by cheap natural gas, will attract buyers abroad, notes the banker.

"The US market has turned around. Years ago, nobody thought the US would be competitive, but low and sustainably low natural gas prices have been a boon to US producers," says Kassin. "We could very well see more deals in the commodity space."

State-owned ChemChina has been seeking assets in the US, according to a financial community source, which adds that Netherlands-based DSM's Keltan elastomers business is attracting interest from Asian buyers.

"Private equity firms are hungry for deals in their more recent funds, and also looking to exit assets in vintage funds"
Telly Zachariades, partner, The Valence Group
In Europe, Reach compliance could also drive chemical M&A. "Asia is rearing its head and targeting Europe, with Reach compliance being a key factor," says Constantine Biller, director and senior analyst at US-headquartered professional services group IMAP's UK office, Clearwater Corporate Finance. "Many Asian companies are not compliant, so the only way they can service Europe-based customers is by having production within Europe."

Biller says Reach compliance had been an important factor for Japan's Mitsui AgriScience International when it purchased Ireland-based agricultural chemicals firm AgriGuard in August.

European companies that are niche market leaders in a specific product area or that have a real value-added portfolio will be particularly attractive. "The Asians are hungry for those sorts of activities," says Biller.

Additional reporting by Will Beacham in London

European M&A to accelerate

Will Beacham/London

Merger and acquisition (M&A) activity in Europe's chemical ­sector should continue to ­accelerate in 2011, as the gap between buyers' and sellers' expectations narrows, and private equity ­players look to exit investments, ­according to a UK-based M&A lawyer.

Improving trading conditions in 2010 have created a more buoyant M&A environment for chemicals in Europe, which should continue next year, according to Jeffery Roberts, a partner at Gibson, Dunn & Crutcher.

Roberts says the gap between buyers' and sellers' expectations of value will continue to shrink next year, allowing for more transactions to take place. "The valuation gap will still be there in 2011, though it may continue to narrow. It has been a good year for transactions in the chemical sector, with values rising from 2009 to 2010."

A debt refinancing "wall" ­is approaching in 2013-2014 for private equity players who did deals in the boom years of ­2006-2007, which will further stimulate M&A activity next year, Roberts believes.

"Clearly there is not enough debt available to refinance everything, so they will need to think of ways to deal with it," he says. "A number of private equity clients are considering their options. People need to do this sooner rather than later."

But macroeconomic factors such as rising energy prices and the impact of austerity measures could put the chemical industry under pressure and negatively impact M&A.

Paul Hodges studies key influencers shaping the chemical industry in his Chemicals & the Economy blog


By: Joseph Chang
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