02 January 2012 00:00 [Source: ICB]
Deal activity is likely to fall off in 2012, weighed down by economic uncertainty and a difficult financing market. Plus, sellers have yet to come out of the woodwork
After a record year for global chemical mergers and acquisitions (M&A) in 2011, the deal market is likely to fall in 2012 in terms of dollar volumes as players struggle with an uncertain economic outlook and financing challenges.
Momentum already has slowed in the second half of the year, and prospects for 2012 hinge on greater confidence in a resolution to the eurozone debt crisis. Yet, underlying buying interest is high while the availability of assets for sale remains limited.
"The chemical M&A market clearly is clearly past the peak - both in terms of dollar volumes and valuations - as greater uncertainty about the economic outlook and a more difficult high-yield financing market has restrained transactions," says Peter Young, president of US-based investment bank Young & Partners.
Through the first three quarters of 2011, a record $64bn (€49bn) in chemical deals were completed on an equity basis compared with $39bn for all of 2010, according to Young & Partners. There were 61 completed deals over $25m in size through the first three quarters of 2011 versus 65 for all of 2011.
"Although total M&A deal volume was strong through the first three quarters of 2011, deal activity has been slowing down due to concerns about the eurozone debt crisis and the possibility of another recession. In fact, the number of completed deals has gone down each quarter since the first quarter," says Young.
"Executives are concerned about the unknown trajectory of the European crisis. This is causing some, but not all buyers to hesitate about pursuing deals until there is more clarity about the future," he adds.
Financial buyers have had the most difficulty buying businesses in 2011, according to Young. Private equity firms' share of the chemical M&A market fell to 5% in the first three quarters of 2011 from 21% in 2010, he notes.
"In the beginning of the year, they were outbid by strategic buyers. But the weak high-yield debt market took over as the handicap in late July," Young points out.
Buyer interest strong
Many bankers say the demand to buy chemical assets is still strong, despite an overall slowdown in M&A activity. The problem has been the lack of assets on the selling block.
"The motivation to do deals remains strong, with corporate cash levels high and leverage levels low. We are seeing fewer auctions, but more one-on-one negotiated discussions," said Chris Cerimele, director and head of chemicals at US-based investment bank Houlihan Lokey, at the Chemical Marketing & Economics Group (CM&E) meeting in New York in early December.
"There is a great appetite to buy in this market, but a lack of opportunities. Companies with strong balance sheets also have no impetus to sell," says Chris Carlisle, head of chemicals for Europe, Middle East and Africa for global investment bank Nomura.
The imbalance of high buy-side interest coupled with a dearth of assets available for sale, has led to relatively high M&A valuations in certain situations.
"Transaction values have held up on strong buyer interest and scarcity premiums," says Cerimele.
Certain chemical assets generating between $30m50m in earnings before interest, tax, depreciation and amortization (EBITDA) are fetching eight to 10 times EBITDA today, he points out.
"Assets have been bid up on the scarcity factor, even as there has not been a huge amount of activity. This is a good dynamic for a seller," says Tim Wilding, managing director and head of chemicals at US-based investment bank Oppenheimer.
Through the first half of 2011, as companies had greater confidence in business prospects, there was a great deal of takeover activity involving publicly-traded chemical targets.
These included US-based Ecolab's acquisition of fellow US company Nalco, Belgium's Solvay buying France's Rhodia, US-based DuPont acquiring Denmark-based Danisco, and Switzerland-based Lonza buying US-based Arch Chemicals. Similar deals could emerge in 2012, notes Carlisle. "
If there is a re-emergence of confidence without valuations running ahead of themselves, then there could be more public-to-public takeovers in 2012," he says.
"But we're not going to see any real pick-up in M&A activity until the global outlook is more stable."
Shale gas impact
The shale gas phenomenon in North America also could drive buying interest as it raises confidence in a chemical manufacturing revival in the region.
"We are increasingly getting comfortable that the North American chemical industry will see a revival in the coming years versus the steady decline that has taken place in the past 10 years with the movement of manufacturing overseas," said John Televantos, partner at US-based private equity company Arsenal Capital Partners, at the CM&E meeting.
"This is being driven by the availability of low-cost natural gas. Europe and Asia cannot match the low-cost energy and feedstock position of the US, which can overcome the high cost of labor," he adds.
Televantos sees increasing investment in the North American chemical industry and a gradual improvement in exports, buttressed by the feedstock cost advantage.
"This gives us greater comfort that this is a great place to invest in. We expect North American producers to export more products worldwide," he says.
Pent-up supply of assets
These strong valuations could lead to sellers coming ou t of the woodwork in early 2012.
"Strong balance sheets for strategic buyers and abundant capital among private equity firms means that a lot of people that have been waiting to sell businesses will finally crack and put them on to the market," says Televantos.
"We're cautiously optimistic on chemical M&A activity in 2012. There is pent-up supply and many private equity assets are ripe and mature," says Leland Harrs, who is managing director and co-head of corporate finance at US-based investment bank The PrinceRidge Group.
"Corporates are well capitalized and acquisitive, and financial sponsors are also active and interested.
"We expect good deal flow in 2012, but no major changes on the upside or downside," he adds.
Private equity companies could be more active on the sell-side in 2012 as many acquired assets are approaching or exceeding their typical three to five year holding periods.
"There are a bunch of sponsor-owned chemical assets working towards the market. For many private equity firms, 2012 is a target year for divestitures, given fund vintage and age of ownership," says Wilding.
"Sponsors that have assets in their portfolios that are past the 'sell-by' date may want to sell to 'put runs on the board,' returning capital to their investors," says John McNicholas, head of investment banking at PrinceRidge.
Despite this, Wilding expects some chemical assets owned by private equity firms to go public through initial public offerings (IPOs).
"The public market is an alternative route for sellers, especially if they believe the M&A process is not giving credit to the asset's future earnings potential and there could be other reasons for raising equity capital such as strategic growth capital or deleveraging," he says. "The equity market may value it more properly in the fullness of time and an IPO does not preclude an M&A sale process in the future," Wilding adds.
He characterizes the IPO market in 2011 as "not great, but not closed. If equity market conditions stabilize in 2012, this could provide the basis for new issuance."
Chemical companies that have filed for IPOs include US-based firms Momentive Performance Materials, MacDermid as well as US bio-based chemical companies BioAmber, Genomatica and Myriant.
On the flip side, "a challenging IPO market could drive sellers to an M&A solution," notes Telly Zachariades, partner at global investment bank The Valence Group.
What's hindering M&A activity?
One phenomenon hindering M&A activity in the short term is the change in buyer and seller expectations since the second half of 2011 when a global growth slowdown started becoming more evident along with greater uncertainty on the impact of the eurozone debt crisis.
"Going into 2012, sellers want to sell at high multiples off of relatively strong 2011 earnings, where buyers are not sure about the external environment in 2012. Buyers are discounting 2012 earnings expectations, leading to wider bid-ask gaps," said Damon Warmack, vice president of corporate development and strategy at US-based Eastman Chemical, at the CM&E meeting.
Even the recent memory of high public market valuations, which peaked in May 2011, and the subsequent collapse in the second half of 2011, may be proving to be a psychological barrier to selling at this time.
As chemical stock prices have declined significantly from their highs, there has been a negative impact on private market valuations as well. Companies may be reluctant to sell assets so soon after such a steep fall.
"The mid-2011 decline in public trading multiples certainly had a negative impact on M&A activity as buyer and seller expectations did not match," says McNicholas. In addition, the US debt ceiling crisis earlier in the year and the growing eurozone debt crisis in the fourth quarter dampened the high-yield debt market, making it tougher to finance deals, says Michael McGovern, head of debt capital markets at PrinceRidge.
Fundamentals versus fear
Zachariades sees a disconnect between the solid fundamentals of the chemical business versus the fear permeating the market from the European sovereign debt crisis and other similar perceived macroeconomic negatives.
"The fundamentals don't jive with all the fear mongering," says the banker. "There is some temporary inventory destocking taking place, but many executives are not seeing weakness in their business beyond the seasonal downturn."
As the focus shifts back to fundamentals, M&A activity will witness continued growth in 2012, he maintains.
"2012 is going to be a pretty good year for chemical M&A based on the fundamentals, which are still strong," says Zachariades.
"Corporates and private equity firms are still flush with cash, and M&A is still a high priority for them to generate growth."
Slower growth could spur M&A
Looking ahead, the slower economic growth environment also could be conducive to deal-making as companies seek other pathways to growing sales and profits.
"As organic growth prospects decline, there is increasing pressure to get growth from external measures such as M&A," Houlihan Lokey's Cerimele says.
"I would argue that in a market where you see slower earnings growth than initially expected, acquisitions can be a very attractive way for corporate buyers to plug an earnings hole - making up for any potential earnings shortfalls," says Oppenheimer's Wilding.
Vantage speciality chemicals nears sale
US-based oleochemicals producer Vantage Specialty Chemicals is close to being sold, with a private equity firm the likely buyer, several sources in the financial community said early in December.
"The sale of Vantage is in the final stage with a buyer already selected and an announcement likely to come within the next month," said one source.
The company, owned by US-based private equity firm H.I.G. Capital, generates about $50m-60m (€39m-46m) in annual earnings before interest, tax, depreciation and amortization (EBITDA), according to multiple sources.
The sale multiple is said to be relatively high at over eight times EBITDA, making for a final price of between $400m-480m or higher, based on a transaction multiple of eight.
Vantage is being sold through a formal auction process that started several months ago, according to sources.
"It was a food fight among private equity firms - many were actively pursuing this asset," said another source.
"Several private equity firms were after this asset - it was hotly contested," a third source said.
"This is indicative of the current M&A market where buyers are willing to pay good multiples for good businesses with scale."
The buyer is likely to be US-based private equity firm The Jordan Company (TJC), said one source.
TJC is no stranger to the chemical space. It already owns US-based Haas Group International, which is a provider of chemical management services.
The Vantage assets comprise three US-based oleochemicals acquisitions made by H.I.G. Capital - Chicago Oleochemicals (which is owned by UK-based Croda), Illinois-headquartered Lambent Technologies and Lipo Chemicals, based in New Jersey.
TJC would not comment on the story, while H.I.G. Capital and Vantage did not respond to inquiries.
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