02 May 2014 10:06 [Source: ICB]
The outlook is for healthy activity in 2014 as the stars align for deal-making. However, mega deals are scarce, and the field of private equity buyers is getting crowded
All the factors are lining up for a robust global mergers and acquisitions (M&A) market in chemicals – from a good supply of assets for sale, bountiful private equity capital, cheap and available financing, and rising valuations. Transactions are mostly in the mid-market, as there is little appetite for mega deals on the part of chemical companies. In the meantime, competition is growing fierce among private equity firms.
Competition is growing fierce among private equity firms
Copyright: Rex Features
“The challenge for private equity buyers has been the level of competition from other private equity investors who are targeting chemicals, and also concerns about how they will exit down the road if the business is of limited interest to strategic buyers, and if IPOs [initial public offerings] continue to be few and far between in chemicals,” he added.
Where 10 years ago, there may have been one or just be a handful of private equity firms bidding on a chemical asset, the field has become increasingly crowded. In some auctions, a dozen of these buyers have advanced to the second round, sources in the financial community noted.
While high valuations are good for sellers, some private equity buyers are feeling the pinch as multiples march higher.
“Private equity firms are interested but are feeling the higher multiples. It is tough to find deals at attractive prices in these frothy auction situations,” said Leland Harrs, managing director and head of chemicals at investment bank Houlihan Lokey.
“Private equity continues to be exceptionally aggressive, beating strategic buyers,” said Mario Toukan, managing director and head of chemicals investment banking at KeyBanc Capital Markets.
In cases where there are many private equity players bidding in an auction, the ones with a focus on chemicals can gain an edge.
“Some PE firms try to dabble in chemicals, but the ones that are successful know the space. As a seller looks at the playing field where everyone has a big checkbook and cheap financing, industry expertise raises the certainty level of a close,” said Toukan.
“Most sellers get a lot of comfort from buyers that know the space and that can get their arms around complex industry-specific issues. They are more likely to win the deal versus an industry agnostic buyer,” he added.
Private equity firms with a strong focus on the chemical sector include Arsenal Capital Partners, SK Capital Partners, CCMP Capital Advisors and American Securities.
“Private equity is increasingly crowded and competitive, and has been evolving from a generalist model to a specialist model,” said Chris Cerimele, managing director at investment bank Grace Matthews.
Recent announced deals involving private equity include Rhone Group/ASK Chemicals, Goldman Sachs, Koch/Flint Group, OpenGate Capital/Solvay’s Europe PVC compounding unit, HIG Capital/American Pacific, Clayton, Dubilier & Rice/Ashland Water Technologies, Arsenal/Danlin Industries and Arsenal/Kel-Tech.
LEVERAGE LEVELS HIGH
Availability of debt financing on good terms and at high leverage levels has been the strongest since before the financial crisis of 2008-2009, according to most investment bankers.
“Larger businesses being sold at say 10 times EBITDA [earnings before interest, tax, depreciation and amortisation] or more can currently get leverage of 6-7 times. Leverage can range from 4-7 times, depending on the business,” said Telly Zachariades, partner at investment bank The Valence Group.
“We are back to the leverage levels we last saw in 2006 and 2007 with low equity contribution requirements of 20-25%, historically low interest rates, and equity return targets which in some case can be below 20%. That is a pretty potent concoction bringing the stars in alignment for private equity,” he added.
Private equity firms have a substantial amount of equity capital and the availability of debt at attractive rates has allowed them to be very competitive in the M&A marketplace as buyers, noted Young of Young & Partners.
“Lenders are allowing very high debt/EBITDA ratios for deals, and interest rates, although a bit higher than a year ago, are still very attractive. Debt covenants are also very generous in favour of the private equity buyers,” Young said.
That in no small part, is contributing to surging M&A valuations in the chemical group, as well as seller expectations of achieving those high valuations.
“Seller expectations are high, driven by cycle peak valuations in the public market. This is also linked to the financing market,’ said Houlihan Lokey’s Harrs.
“Seller expectations are through the roof – we’ve not seen them higher in 10 years. Public valuations are strong and we’re seeing private equity owned businesses thinking about IPOs,” said KeyBanc’s Toukan.
US public valuations for chemical companies are pretty lofty at 10.7 times EBITDA, noted the banker.
So far, PQ Corp, owned by The Carlyle Group, and Trinseo (Styron), owned by Bain Capital, have filed for IPOs, aiming to raise up to $450m and $200m, respectively. Orion Engineered Carbons, owned by Rhone Group and Triton Capital, is also exploring an IPO, according to one banker.
“You’re seeing these IPOs now because we’re at the point where the chemical industry is on the upside of the cycle,” said The Valence Group’s Zachariades.
The public market is also in many cases valuing chemical companies at or above transaction levels, he noted.
“Public company valuations are coming in above M&A valuations and DCF [discounted cash flow – another way to value assets]. Either the public markets are predicting a much stronger outlook for the industry, or companies are currently overpriced. Either way, it’s a great time to take advantage if you can,” Zachariades said.
The median specialty chemical company M&A multiple in 2013 was a healthy 9.5 times EBITDA, although less than 10.4X EBITDA in 2012, noted Allan Benton, vice chairman and the head of the chemical practice at investment bank Scott-Macon.
“Good quality specialty chemical companies with high margins, can command double-digit multiples,” said Benton.
One example is the announced sale of food and beverage ingredient systems firm Performance Chemicals & Ingredients Company (dba SensoryEffects) to Balchem for $567m, or 10.7 times estimated 2014 EBITDA, he noted.
SPINOFFS, DUAL TRACKS
Other companies are planning tax-free spinoffs of chemical units to existing shareholders. This includes FMC splitting into two units – ag and health & nutrition, and FMC Minerals (soda ash, lithium); DuPont spinning off its performance chemicals segment (TiO2, fluoroproducts) and US forest products company Rayonier spinning off performance fibers (cellulosic specialties for applications in coatings, plastics, cosmetics and pharmaceuticals).
In some cases, companies filing for IPOs or planning spinoffs are pursuing dual-track exits, signaling that the asset would be available for sale.
“Some of these assets will probably be sold. Companies are separating to optimise value, so it is definitely possible. However, some are too big to be sold – there are just not a lot of groups looking to make big deals,” said Toukan.
LACK OF MEGA DEALS
The lack of mega deals – say $3bn in size or larger – has been noticeably absent lately, where they had once been prominent in the mid-2000s up to the financial crisis of 2008-2009.
On the demand side, “the story is complicated”, said Young of Young & Partners. “Although strategic buyers have been active, they have been somewhat selective. They are also cautious about doing very large deals.”
“Ten years ago, companies were building for segmentation, diversification and scale. Now the trend is just the opposite – many are looking to downsize,” KeyBanc’s Toukan said.
Indeed chemical companies over the past several years have narrowed their focus, evident from major divestitures by Dow Chemical, DuPont, PPG Industries, Ashland, Rockwood, Clariant, Solvay and Chemtura.
“Many companies have been making a proactive effort to streamline their portfolios. A cleaner story can put you in a more favourable position with investors, and there is a growing sense that having multiple different businesses is not really an advantage,” said Cerimele from Grace Matthews.
Look for further divestiture activity, especially from Europe-based companies. Belgium’s Solvay is looking to sell its Eco Services (sulphuric acid regeneration) unit. Germany’s LANXESS has a new CEO – a development which can often result in asset sales.
RISE OF THE ACTIVIST
But the rise of activist investor participation in the market has accelerated that trend.
“Now in many cases activists have come in, taken positions in companies, and are pushing them to shed non-performing or non-core assets,” Cerimele added.
“Activists are more active in the chemical industry because a lot of businesses are not trading at the proper valuation,” said Toukan.
On the supply side, there has been an increase in of assets for sale from chemical companies, “in a few cases under pressure from shareholder activists”, said Young of Young & Partners.
Dow is in the process of carving out its chlorine and epoxy resins businesses for potential sale or partnership, and is targeting overall divestitures expected to result in pre-tax proceeds of $4.5bn-$6bn – revised in March from its previous target of $3bn-$4bn, which represents the chlorine/epoxy carve-out.
Dow has attracted the attention of activist investor Dan Loeb and his hedge fund Third Point. Loeb has publicly pushed for Dow to split its petrochemicals and specialty chemicals businesses. Speculation has been gaining in the investment community that Dow could separate its agricultural chemicals and seed business as well.
However, not everyone is focused on selling just yet. “There hasn’t been a huge rush to the exits. Some companies want to increase EBITDA before a sale,” said Houlihan Lokey’s Harrs.
“They don’t expect the market to deteriorate drastically and have good earnings visibility for the next 6-9 months. They are looking for a quantifiable improvement they are confident of achieving. However, some that are holding onto assets appear to be trying to time their exit to perfection,” he added.
Overall, the chemical M&A market is poised to see strong activity in 2014, though perhaps not as strong as in the last peak in 2011.
“Baring a significant economic or financial disruption, we will have a strong M&A market this year, but do not expect a barnburner. There is a noticeable lack of very large deals,” said Young of Young & Partners.
“Even the announced Dow divestitures are only moderately large and many will not start until the third quarter. Dow is working though the carving out of the operations to be divested, which may push the deal completion dates to 2015. Further, a number of corporate restructurings are being done as spinoffs rather than M&A deals, with DuPont and FMC as examples,” he added.
Young characterises the chemical M&A market as one of “a particular personality. It’s like a baseball team that hits singles and doubles instead of home runs,” he said, referring to the lack of mega deals. “That doesn’t mean they’re not winning the game.”
KeyBanc’s Toukan also sees a higher level of activity in 2014 with a strong start in the first quarter, but not to pre-crisis levels in terms of number of deals.
“The stars are aligning – you have corporate and private equity divestitures, cheap financing and high leverage multiples, and strong M&A valuations. All the drivers for M&A are there,” he said.
“The M&A market is a factor of many levers – CEO confidence, debt availability, the cost of debt, leverage multiples, and plentiful supply of businesses to acquire. As you check off the boxes, it’s hard to imagine a better environment,” said The Valence Group’s Zachariades.
SHALE GAS IMPACT
One of the new drivers for M&A activity in the US is shale gas. While direct investment to build or expand chemical capacity to take advantage of cheap feedstock has boomed to the tune of over $100bn, shale gas has also opened the minds and wallets of buyers.
“Shale gas has opened people’s minds to the chemical sector. Many are looking to chemicals as a way to play shale gas,” said Cerimele from Grace Matthews.
Some obvious plays are oilfield chemicals and water treatment – sectors that support the production of hydrocarbons.
“Oilfield chemicals are on fire right now and the growth rates are phenomenal. M&A valuations are in the low double-digits [on EBITDA],” said KeyBanc’s Toukan.
“Both financial and strategic buyers are looking to extend their presence or gain a foothold in oilfield chemicals. This is a burgeoning subsector and companies are trying to differentiate themselves with new formulations,” said Houlihan Lokey’s Harrs.
Arsenal Capital has been amassing assets in oilfield chemicals with acquisitions of Kel-Tech, Danlin Industries in 2014 and Flowchem (pipeline chemicals) in 2013. Calumet Specialty Products is buying Anchor Drilling Fluids for $235m. Solvay acquired Chemlogics for in 2013 for $1.35bn, or 10.7 times EBITDA.
Other hot areas of chemical M&A activity include water treatment, coatings, adhesives, food ingredients, plastics compounding and construction chemicals, bankers noted.
Shale gas may also be improving sentiment towards the US chemical industry in general.
“6-7 years ago people were writing off the US chemical industry. Overall manufacturing was moving offshore and there was not nearly as much investment domestically in the sector, which was viewed as having limited growth prospects,” said Grace Matthews’ Cerimele.
“Shale gas has changed that. Chemicals was once the road less travelled. Now more people are waking up to the possibilities,” he added.
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