Chemical distribution M&A - what's next on the horizon?

16 July 2012 00:00  [Source: ICB]

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There is greater activity in the emerging markets of Asia and Latin America, to-date mainly driven by the larger firms

The macro environment may not be attractive, but there are still a lot of good reasons why companies in the chemical distribution sector may want to restructure

The year 2011 brought record results for many distributors, often better than in 2010, and allowed them to generate cash. Lately there have been some reservations about how this might continue into 2012, but so far, most people seem to remain cautiously optimistic.

Chemical producers continue to outsource activities, with more and more companies understanding the work that distributors do and appreciating the benefits that a good channel set-up can bring. Also, customers rely more on their distributors for timely deliveries of chemicals in exactly the quantities they need.

That chemical distribution has gained more attention lately is also somewhat related to the fact that Brenntag's initial public offering (IPO) some two years ago was an outstanding success. The IPO and the subsequent private placements of shares with institutional investors have not only allowed a complete exit of the private equity investors, but have also helped to raise the profile of the whole industry.

And with Switzerland's DKSH, which listed on SIX Swiss Exchange in Zurich in March of this year, another company with a strong chemical distribution element (not necessarily in terms of turnover, but in share of profit of the whole group) is now out there in the market, vying for investor attention. These companies, and many others in the industry, are constantly developing the "equity story" they are telling their institutional and private investors. In this context, mergers and acquisitions (M&A) projects are an important theme.

M&A MOVES WITH EQUITY MARKETS

M&A activity typically comes in waves. It is correlated with the overall market for equities. That would not bode so well for the immediate future, owing to uncertainties of the global economy. But in the long run, we will always see a certain level of activity.

Recent history shows all this quite clearly. After a raft of management buyouts (MBOs) and subsequent strong emphasis on "buy-and- build" activities in the early years of the last decade, all debt-fueled deals came to a virtual standstill during the crisis years of 2008−2009.

Since transactions take some time to prepare, there will always be some activity, even if the general market appetite is quite depressed. The year 2009, with only six transactions recorded globally, can serve as evidence for that. During 2010−2011, there was a significant rise in activity in all continents. And 2012 looks reasonably active, with 11 transactions recorded for the first six months. Europe is still the continent that shows the majority of transactions, at least in 2010 and 2011. This could owe to the maturity of the industry there and the fact that business in the US was quite slow until recently.

There is, however, greater activity in the emerging markets of Asia and Latin America, to-date mainly driven by the larger firms, such as Brenntag, Univar orNexeo Solutions.

BUYERS HAVE DIFFERENT MOTIVATIONS

Today, three groups of distribution companies are active in M&A as buyers and to some extent, also as industry consolidators:

The listed companies, mainly Brenntag, which are building in Asia (and conceivably also in Latin America) and selectively adding in niches elsewhere, not covered adequately to-date. Newly listed DKSH has also declared its intension to add to the existing network of subsidiaries, particularly in Europe, where they do not yet have the geographic footprint and reach they enjoy in Asia.

Private equity-owned distributors such as Azelis, IMCD and Nexeo (in Europe more known for its activities in plastics distribution and compounding), try to continue their "buy-and-build" approach in the run up to a possible IPO, which requires a certain company size. Asia appears to be on their radar and probably Latin America. Univar also belongs to this category. It seems to be working on filling gaps in geographic reach, also in Europe.

Privately owned, including family-run, distributors who make selective acquisitions to gain momentum, increase attractiveness to suppliers and maintain critical mass. They tend to stay in their "home" geographies or at least adjacent to them. Companies in this category have accumulated significant cash positions during the strong years of 2010 and 2011 and now want to put these funds to good use.

THE SELLERS' PERSPECTIVE

Sellers of distribution companies are motivated by another set of considerations about their business. Some may want to tackle a succession issue; some may have realized life is getting more difficult for small, less focused companies (see below) and an exit now might make sense.

In any case, they will think long and hard about the value of their business and what will happen to it in the context of new ownership. Many questions will arise and answers are not always easy to find. Particularly, issues around the "correct" valuation of a business can lead to long and protracted discussions about real and perceived values and may even break a deal.

In times of uncertainty, valuation models can result in greatly varying results, depending on the assumptions made for the future and the numbers plugged into the models.

A level-headed approach, supported by independent advisors, should help to bridge gaps that may suddenly open up. Earn-out mechanisms for the purchase price may give the old owner an extra incentive, should the economy change strongly to the positive. In an earn out, the seller retains a stake in the company for around 2−3 years, which will vary in value depending on the performance of the group.

These concepts also allow for risk sharing and can give some protection to the buyer in case of a deteriorating business environment. And then of course, the question remains about what the seller is going to do with the proceeds. No easy answers here in times of high-financial volatility, when an investment in your own, well understood and smoothly running company may be the best investment of which somebody can think.

BOUNDARY CONDITIONS

Competition authorities, particularly in Europe, have lately taken a more robust stance vis-à-vis consolidation. When Univar, for example, tried to acquire Quaron in 2010, it was only allowed to do so in the Benelux. In France, where this would have led to the merger of the number two with the number three in the marketplace, the authorities signalled strong objections and Univar withdrew its notification.

That part of Quaron was bought at the beginning of 2012 in a second round by Kem, a JV formed by German family-owned and managed distributors Overlack and Stockmeier. The large players with a strong footprint in Europe may therefore only add on small businesses to complement the set-up.

M&A is also much more prevalent in the distribution of specialty chemicals. This might be driven by the fact that less physical assets are typically bought and integrated compared with an industrial chemicals deal. In specialties a lot of warehousing is carried out by third parties, whereas industrial deals can be a "rough" consolidation play with layoffs and other side-effects that are not so easy to manage and communicate to stakeholders.

ON CONSOLIDATION

From the customer perspective, chemical distribution is inherently a local business. So the statement "big is beautiful" may not always be correct. But in many ways "size matters," very much so with respect to the critical mass a business needs to thrive. Ever more stringent regulations that are devised by governments and supranational bodies, and increasing expectations about quality and service lead to a need for higher levels of professionalism.

Having good compliance with Responsible Care / Responsible Distribution charters maintained across the industry make good business sense. After all, society grants the industry a "license to operate" and the companies that comprise it need to make sure people around them are satisfied with what they do as individual companies and as an industry.

Comprehensive Product Stewardship in this respect makes a lot of sense. This increases the fixed cost burden and may trigger the need for more investments. These costs need to be offset against a sufficiently high turnover. Also, larger companies are often more attractive to well-educated and ambitious employees. All this favors further consolidation.

The only way out for smaller companies is to focus on distinct and defendable niches, which some companies successfully do. But some business opportunities may be left untapped and one has to learn the art of "saying no" in a polite fashion. Globalization is there, particularly for the producers of chemicals. On that interface, a "global presence" is needed. But as mentioned before, when looking from the perspective of the mostly small customers, distribution is a local business. And these customers are demanding more services delivered locally. Some more enlightened ones are even willing to pay an adequate price for it, to secure long-term supply of goods and services.

Reaching and maintaining "critical mass" continues to be an issue. That will drive further consolidation, with strong privately owned companies also being active in the field, not just the top five or 10 distributors globally. Staying independent as a company, means sharpening the profile and grabbing available opportunities to differentiate from competitors in the marketplace with both hands.

Guenther Eberhard is managing ­director of Swiss-based chemical ­distribution consultancy DistriConsult. For more details, email geberhard@districonsult.com

Visit Paul Hodges' Chemicals and the Economy blog to read more analysis of the latest moves in global chemical markets


Author: Guenther Eberhard



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