INSIGHT: Operational risks a feature as M&A activity increases

14 January 2011 16:14  [Source: ICIS news]

By Nigel Davis

A focus on operational riskLONDON (ICIS)--Chemical companies won’t be eschewing financial discipline any time soon so one might expect the lid to be kept on capital spending and on merger & acquisition (M&A) activity.

But pushing strongly against that restraint in 2011 is a backlog of maintenance and of deals.

On the M&A front, companies are beginning to turn their attention away from simply how far they can push debt out to what prime assets they can sell, and where they can acquire.

Companies of all sorts in chemicals have been particularly successful at refinancing. Some got the timing just right before the downturn hit. The cash that flowed into sector companies last year is being used to pay down debt but also to fund more strategic business ambitions.

The balance of negotiating leverage between buyers and sellers is beginning to approach parity, commentators are saying, a fact which indicates that more M&A activity is on the cards.

“We are entering a time when chemical and energy deals will likely rise to a very exciting level - satisfying more than two years of pent-up demand,” due diligence and environment, health and safety (EHS) advisers, Pilko & Associates says in a just-published ‘grey paper’.

The M&A outlook may be changeable, the company’s founder and chairman, George Pilko adds, but the M&A market is, at the start of 2011, much better balanced.

Pilko’s company does a lot of due diligence work in the chemicals and energy sectors and is focused on EHS. It has organised numerous transaction round tables over the past 10 years and in recent months has been questioning industry executives about their plans.

The chemicals recovery means that sellers have more negotiating leverage and private equity is bidding aggressively, Pilko says.

Forced sales are largely a thing of the past while sellers are beginning to offer up better assets.

The rise in quantity and quality is likely to be seen this year, or for as long as the chemicals upturn persists.

DuPont’s $6.3bn (€4.7bn) bid for Danisco and the agreements signed by INEOS, PetroChina and China National Petroleum Corporation (CNPC) on 11 January give an inkling of the way M&A activity is heading.

Pilko still suggests that Asian and Middle East buyers are likely to dominate in chemicals and refining because they have access to the funding and are more willing to take longer-term strategic moves: they seek technologies and human resources. There may be more stock-driven mergers.

But Pilko also suggests that operational risks (OR) assessment will be important in this round of M&A - as important as possible EHS aspects of the deal.

Many companies scrimped on maintenance capital expenditure during the recession, he claims, and buyers have become more sensitised to those risks.

“This is because buyers and sellers are realising that operational risk issues can greatly impact future capital expenditure demand - thereby impacting valuation and ROI [return on investment]; not to mention the potentially devastating effects of a black swan event on operating performance, market capitalisation and corporate reputation.”

Sellers were surprised during the 1990s when faced with sometimes significant EHS claims after closing because they had provided broadly defined indemnities for buyers, Pilko says.

The key for sellers now, he adds, is to carefully craft indemnity provisions - or to reduce the selling price to effectively cash-out the OR and EHS “deficiencies”.

($1 - €0.75)

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By: Nigel Davis
+44 20 8652 3214



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