15 July 2013 09:00 [Source: ICB]
Correction: The ICIS story headlined: "Market outlook: M&A game continues" contained duplicated text and misspelled the author's name. A corrected story follows.
As the European chemical distribution industry met at the annual Fecc Congress in Hamburg recently, questions were asked about what the future will be for the sector.
In Europe and elsewhere it will most likely be determined by the current, rather dull state of the economy, at least in the short term. Of course, differences between industry sectors (applications) and geographic regions do exist. But demand for chemicals in general is weak currently, so distributors have to deal with lower turnover figures, and sometimes also lower volumes, than in the strong years of 2011 and 2012. This results in margin pressure and a challenge to maintain acceptable profit levels.
M&A may be the sensible exit opportunity
M&A CONTINUES IN 2013
M&A activities in the chemical distribution industry continued to run at a healthy pace during the first months of 2013 (see bar chart). Such transactions are a major growth driver for many companies. In Europe over the past few months, a significant number of the transactions has been executed by small or medium-sized, privately held distributors. The rationale often appears to be expansion of geographic coverage. Pertinent examples are Alsiano's (Birkerod, Denmark) recent acquisition of Swedish distributor Interplast, or Krahn Chemie's (Hamburg, Germany) purchase of ICH Benelux in the Netherlands. Biesterfeld's (Hamburg, Germany) acquisition of compatriot Küttner (Speyer, Germany) was first of all a move to enhance industry coverage, in particular the presence in the rubber and elastomer industries. But an entry into Russia came with it as well. Some deals seem to be influenced by the "encouragement" that suppliers/principals provide at times.
Outside Europe, Brenntag (Mülheim an der Ruhr, Germany) has been active in the US with the purchase of Altivia (Houston, Texas), a distributor of water treatment chemicals, and Lubrication Services (Oklahoma City). Private equity owned IMCD (Rotterdam, Netherlands) made add-on acquisitions in South Africa and in India, buying Chemimpo (Johannesburg) in the former and Indchem International (Mumbai) in the latter. The large players seem to have turned their focus to these other continents, where they are either not yet represented or where attractive growth opportunities are expected to be found. They are going to build or acquire business in emerging countries, driven by the fact that the respective national economies are growing at higher rates than those in the developed world.
The main rationale behind M&A transactions is to expand into new geographies and to add to the application portfolio of the buyer. These two reasons can be found in two-thirds of the recorded transactions. Outright consolidation, defined as the acquisition of a competitor in the same country, accounts for less than 20% of the transactions over the past 18 months (see pie chart).
When it comes to the size of the buying company, then it is clear that the larger companies have an edge. They are certainly more experienced in M&A and have a higher financial capacity. However, it can also be that small, private deals with a local scope are not always picked up by DistriConsult's research and reporting. So there could be a few more transactions in the <€100m ($127m) bracket, which do not necessarily appear on people's radar screens (see pie chart).
FINANCING AND PORTFOLIOS
Although it is not a pure M&A deal, but still a corporate finance transaction, it is worth noting that Azelis secured an "amend and extend refinancing package" to support the company's business plan and growth initiatives. Under the new plan, the company's financing has been extended for a further three years at market interest rates. In parallel, 3i made an equity injection. Azelis is also the only distributor, working according to a private equity sponsored "buy & build" model, that after a strategy review decided to spin off business units that no longer fitted the company's strategic plans for the future. The Plastic Polymers business unit was sold to polymer distributor Gazechim (Beziers, France) and the Composites unit business found a new owner in Velox (Hamburg, Germany). Both these transactions took place in 2012.
The distributors that are controlled by private equity sponsors have to live with the fact that there will be at least "one more" significant transaction for them in the future, when the respective sponsor is looking for an exit. This might be another IPO of a distribution group, just as Brenntag did so successfully more than three years ago, a trade sale or another "pass-the-parcel" deal with the next financial sponsor in line. In any case, such an exit requires that the underlying equity story is a good and sustainable one. Hence the strong focus on revenue, cash-flow and value growth, a task not so easy to handle in times of flat or declining markets.
The hunt for growth opportunities encourages the large distributors - such as Brenntag, Univar, Nexeo Solutions, IMCD or Azelis - to look more and more towards the high-growth areas of the world, mainly in the emerging economies of Asia, and to some extent, Latin America. But the US also provides some good opportunities, as the shale gas boom requires more blended and formulated chemical products; Univar and Brenntag have found this business quite attractive recently.
In Europe, the larger distributors will possibly only be able to selectively make small, add-on acquisitions, as they already have a quite strong position in many countries, either from a supply base or a competition law perspective. That limits their options somewhat. But a range of medium-sized, often privately held and managed companies is out there, ready to do deals, as long as they make strategic and financial sense to them. The problem here is more that of a lack of "willing sellers". Owners of smaller companies will acknowledge in private discussions that strategically a sale might make sense, but then they face the challenge of what to do with the money in times of low returns in money markets or from bonds.
During 2012, the last shares in Brenntag still held by the private equity sponsors, through the acquisition vehicle and long-time majority shareholder Brachem Acquisition SCA, were sold off to institutional investors, so that the free float is now 100%.
DON'T GET STUCK IN THE MIDDLE
This author has argued for quite a while that size matters in chemical distribution. Mainly with respect to the need to maintain critical mass, in order to be able to cope with an ever increasing fixed cost burden. This appears to be going even further, in the sense that companies must make sure they really grow their presence to make sure they do not "get stuck in the middle". Distributors must either be big enough to develop and maintain a broad and comprehensive geographic coverage of large parts of Europe's core industrial areas or they must concentrate on an application specialisation, serving only certain industries. That allows them an expert approach with a high technology focus. Only then can smaller companies stay competitive and remain on the leading edge of the industry.
Being big is not without challenges. Even the large groups must be nimble and flexible enough to cater to a variety of local customer needs, while at the same time maintaining uniform, solid and efficient logistics, IT and supplier management processes, to keep complexity and hence cost-to-serve under control.
M&A activities cannot stop with the purchase of companies. Integration of the newly acquired businesses is critical to the success of a transaction. There, big mistakes can be (and have been) made, that can endanger the whole project, even when a good strategic fit was there at the outset and valuations were moderate.
ARE THE RULES CHANGING AFTER ALL?
In our view the rules are not changing much. But the game has again become dynamic, if not to say hectic, as market volatility remains high and visibility low - upstream as well as downstream - all along the chemical value chain. Both suppliers and customers are looking to their cost position, and to try to make sure they are getting good value for their money from the co-operation with distributors.
Distributors have to make sure they are not getting squeezed on their margins and hence may ultimately find themselves in an unsustainable position. Strong and responsive companies with professional staff will be able to manage the situation and even benefit from it, by taking market share from weaker or less fortunate competitors. But marginal players may find it increasingly difficult to maintain a defendable position in an ever more competitive, demanding and volatile market environment. So M&A transactions may be another option to grow for strong and determined players. On the flip-side of the coin, M&A may be the sensible exit opportunity for the ones that find themselves in an awkward situation where they can no longer compete in the top league.
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