21 May 2014 16:23 [Source: ICB]
Despite increasing headwinds from the Ukraine crisis and continuing “macro-risks” from developments such as an unexpected shock in China, the markets for chemicals and polymers around the globe have been developing smoothly in recent months.
This bodes well for distributors of chemicals and polymers, who have seen stable business and a steady flow of merger and acquisition (M&A) deals announced and completed over the last 12-15 months.
This article will explore some of the underlying drivers of industry dynamics and analyse their impact on M&A in the distribution industry.
The acquisition of other distributors certainly remains a key element of the growth strategy for mid-sized and large distributors. They account for around 75% of the trans-actions recorded by DistriConsult since the beginning of 2013. While transaction numbers have come down slightly in 2013 when compared with 2012, 2014 to date has been a rather active period.
The main reasons for transactions, seen from the perspective of the acquiring company, continue to be geographic expansion and access to new industries and application areas. Mid-sized companies in Europe are tending to enhance their footprint in other parts of the continent, while larger companies seek to add business in the fast-growing regions of Latin America and Asia-Pacific.
Only about 20% of recent deals can be classified as outright “consolidation”; that is, the takeover of a competitor with similar activities in the home territory of the buying company.
The shale gas boom in the US and the resulting revival of the chemical industry in that country will have a profound impact on the chemical industry and product supply patterns globally. Europe may become a net importer of products which have so far been produced there for export.
We may experience a reversal of product streams and supply chains, which may very well benefit distributors in their function as importers into the region. While this is expected to apply mostly to large-volume petrochemicals and intermediates, specialty chemicals will experience some impact as well.
However, the exploration for and the production of shale gas and oil also require chemicals in “remote” areas of the US. This is an area where larger distributors such as Brenntag and Univar appear to see opportunities. Both have made acquisitions of oil and gas chemicals supply specialists, such as Treat-em-Rite Corp and Magnablend, respectively. Brenntag has also expanded the depot in Dickinson, North Dakota, significantly in order to better serve oil and gas customers.
FINANCING THE GROWTH
A key aspect of any long-term company strategy, and particularly the M&A part, has always been financing. Basel III and other regulatory initiatives that followed the 2008-2009 financial crisis put increasing pressure on banks when it comes to their equity and underlying capital. That, in turn, has made the banks look at their credit books more carefully. Many small and medium-sized companies have found it more difficult than before the crisis to obtain debt financing for growth initiatives, investments and M&A projects.
“The main reasons for transactions... continue to be geographic expansion and access to new industries and application areas”
With distribution being a business which is usually highly cash-generative, many companies are to a large extent still “self-financing”, even when they make sizeable acquisitions (in relation to their company size) or grow otherwise in larger increments. When that is not the case, or a shortfall exists for other reasons, alternative sources of financing have been tapped by some companies to bridge the gap.
There is liquidity in the market and many investors are looking for a good yield at an acceptable risk level. So we may see more of that in the future.
FINAL REACH ROUND APPROACHES
When the most recent round of registrations under the EU Registration, Evaluation, Authorisation and Restriction of Chemicals (Reach) regulation was completed in June last year, one could almost hear a big sigh of relief throughout the market. However, the pressure is still on, as companies have started looking at their lower-volume products. The next deadline in June 2018 may in theory appear to be still quite some time in the future, but in practice it may show some impact already before that timeline.
A number of producers abroad, who have only limited exports to Europe, could start to prune their product ranges before the above deadline. Or, if they decide to continue production, may seek to market their product at home or in other geographies, free of the restrictions imposed by Reach. A registration is out of the question to them, as the cost for that may be prohibitively high for products with less than 100 tonnes/year and only low-to-moderate margins.
As this “low-volume business” quite often goes through importers, or “distributors”, in Europe, these companies will quite likely see their business shrinking. If the producer cannot afford the registration, it is in the author’s view unlikely that the distributor can. Customers will also feel negative effects, as they will be limited in their technical and commercial options, when products are no longer made available on the market.
This effect will be more felt by the smaller distribution companies, who tend to be associated with smaller producers relying on products imported from abroad. In the end, however, nobody is able to escape this development.
On the other hand, some producers and their respective distributors, who opt for a registration, may benefit and prosper. But in the end, the regulatory constraint will lead to more consolidation in the distribution industry.
One of the drivers of M&A is that size – in the sense of critical mass – matters quite a bit. However, it is not only the size of a chemical distributor that must be big enough to help carry the increased fixed-cost burden, which results from growing regulatory complexity and the need to amortise investments in infrastructure such as application laboratories and technical expertise.
There are a number of medium-sized distributors that have the profitability and the financial strength to support the investments required. The question for some of them is more whether they have the right structure to support the growth.
As business continues to be volatile and customer needs become ever more diverse, distributors tend to face increasing complexity on both the supplier and the customer side of their business activity.
When acquired companies are added, this can quite easily pose very challenging management issues. Care must be taken that an acquired company is integrated in a swift but circumspect manner, so that the full benefits of the acquisition can be captured and a uniform management philosophy throughout a group of companies can be maintained.
Acquisitions are very often about going into new geographies or adding new application areas to the company’s portfolio. Therefore, it is important to learn from the existing staff in the new subsidiary and not just to impose the head office doctrine on them. Only then the synergies expected from the transaction will materialise.
To achieve cohesion within a group, a set of clearly communicated and understandable set of values that form a sort of guard rail for the work done by the sales force in the field and subsidiaries further away from the HQ needs to be maintained. Strategy development processes must allow for iterations in a combined “bottom-up/top-down” approach when plans are made and budgets are set.
Details of the implementation should be delegated to local staff, based on their understanding of specific customer needs, but guided by well communicated corporate policies.
This requires managers and employees who can translate customer needs on one hand and parent company guidelines and objectives on the other into coherent business strategies and workable action plans.
Education and training concepts for new hires as well as attractive career paths for more experienced employees, typically in their 30s and 40s, will become the key to attracting the right staff.
M&A projects, and particularly assignments within integration teams, can be the key building block of structured management development programmes. That way, com-pany philosophy can be spread and suitable talent can be identified at the same time.
GETTING FIT FOR THE FUTURE
Chemical distributors continue to face challenges in the future. One aspect of addressing these is certainly an optimisation of the structures and processes within the individual company, which has to go hand in hand with a systematic and coherent approach to strategy development and implementation. Growth will necessitate the diligent management of product portfolios and supplier relationships, which are a key driver of success.
On the M&A front, access to new markets, defined in terms of both geography and application coverage, continues to be high on the agenda of the financially strong and cash-rich companies. So we will continue to see transactions.
However, this part of the game is not only about identifying suitable targets and willing sellers, but also about proper execution of the acquisition process and a seamless integration after a deal is consummated. Distribution companies who employ the right people, keep doing their homework and continuously hone their skills will come out on top.
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