22 February 2013 10:28 [Source: ICB]
The Indian specialty chemicals industry, dominated by family-owned small- and medium-size companies, has achieved high growth in recent years. However, lack of managerial capability and resources limits the scalability of such companies, thereby offering attractive acquisition opportunities. On the other hand, large chemical companies are targeting such acquisitions to overcome delays in approval for green-field projects and also to gain faster access to the subcontinent's market.
Players shopping for niche chemicals companies in India will find plenty of opportunities
Consumers' preference for value-added products that use specialty chemicals has also increased significantly. In the past five years, several specialty chemicals multinational companies have used the acquisition route to establish their presence in India. During FY12, there were 24 deals in specialty chemicals, with an estimated value of $801m.
India's specialty chemicals industry is well positioned to become an attractive market for merger and acquisition (M&A) activities. The companies in the sector have customized product portfolios with the right value proposition driven by strong local presence and in-depth understanding of customer needs. But they lack the financial resources to compete on a national or global scale.
Global chemical companies, on the other hand, have access to low-cost financing. Their cash positions put them in a better position to enter into negotiations with Indian chemical companies. Sectors such as dyes, inks, pigments, pharmaceuticals and agro-chemicals provide significant M&A opportunities.
The specialty chemicals industry has high margins and has demonstrated revenue growth of about 13% per annum during the past five years. It caters to various end-use markets such as consumer durables and personal care that are non-cyclical in nature.
Attractive acquisition opportunities are available because India's small specialty chemical companies lack the know-how to scale up their operations. Access to right technology and other resources is a major bottleneck for them.
In certain sectors, companies face competition from global-scale Chinese companies. To increase their competitiveness, Indian companies are seeking investments that will finance product improvements through research and development (R&D).
Significant numbers of the country's specialty chemical companies are family-owned businesses and some first-generation entrepreneurs are facing a succession void because of the next generation's unwillingness to join the family business. Such owners are looking for exit options through sell-outs.
India's chemical industry is traditionally highly fragmented, with very few integrated large companies, although this trend is changing. Yet, there are ample small companies with strong regional presence and local market understanding. Such companies are ideal acquisition targets for global companies.
There are several major drivers for mergers and acquisitions in the industry. Product portfolio rationalization is one; acquisition of an existing company with a supplementary or complementary product portfolio is a preferred way to expand presence.
Huntsman's acquisition of Laffans Petrochemicals' ethylene oxide derivatives business in 2010 helped establish the buyer's presence in a business complementary to its amine-based international product portfolio.
Speed to market is also important and local companies dominate regional markets in the Indian chemical industry. Large domestic and global manufacturers have opted for the M&A route to acquire these small players, thereby gaining faster access to new markets. In 2009, for example, German major Lanxess acquired the chemical and wind power assets of Mumbai-based specialty chemical manufacturer Gwalior Chemical Industries.
Backward integration for feedstock sources and forward integration for downstream opportunities are preferred ways of deriving value from an integrated value chain. Crystal Group, an agro-chemicals company, acquired Rohini Seeds in late 2011, gaining access to commercial and hybrid seeds of various crops, state-of-the-art seed-processing plants, a seed lab and extensive R&D programmes.
There are many challenges in the acquisition process of Indian specialty chemical companies. Smaller companies lack strong managerial capabilities, leading to information asymmetries. In the past, there has been a perceived lack of trust from acquirers as far as financial-performance data is concerned.
In the family-owned businesses, vendors are often unwilling to part with control and prefer to retain a majority stake.
Because of the specialty chemicals industry's high profitability and strong growth prospects, vendors are looking for higher valuations. This has been demonstrated by an increasing price/earnings (P/E) multiple for acquisition deals in the sector - its average P/E multiple increased to 9.3x in FY12 from 8.9x in FY11 and 8.0x in FY10.
CRITICAL SUCCESS FACTORS
There are several critical success factors for alliances and acquisitions in Indian specialty chemicals. A clear strategic intent is vital. Evaluation of the attractiveness of a target should be driven by the prospective acquirer's strategic intent. The acquirer needs to carefully analyse future growth prospects, volatility and sustainability of growth, technological changes, trends in end-consumer industries and regulations in the sector.
Binay Agrawal is a Consultant for Chemicals at TATA Strategic Management Group. Contact Binay
Manish Panchal is the Practice Head for Chemicals, Energy and Logistics at TATA Strategic Management Group. Contact Manish
Planning successful post-merger integration is another factor to consider. As most of the targeted specialty chemical companies are unstructured, the post-acquisition organisational structure needs to be decided and conveyed to target management beforehand.
Any uncertainties during the integration phase may lead to unwarranted fears about lay-offs, restructuring and reporting relationships and could alienate top performers.
Because India's specialty chemical sector has demonstrated phenomenal growth in the past and is expected to grow in future, it has already seen significant M&A activity. This trend is expected to continue as small Indian companies seek partnerships for scaling up or look for exit routes through sell-outs.
However, not all companies are willing to transfer control so target identification is highly critical. Success stories in the sector show that such acquisitions have given international players quick access to the Indian markets. Global companies looking to establish a presence in India and planning to ride the high growth wave in its specialty chemical industry should be on the look-out for hidden jewels in the sector.
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