August 2010 Archives

With interest rates scraping the depths and businesses hoarding record amounts of cash on their balance sheets, the time is ripe to make acquisitions as well as refinance debt to push out maturities.

While refinancing debt at low rates is a no-brainer, there are plenty of pitfalls in the mergers and acquisitions (M&A) game.

Already we are seeing M&A activity heating up, evidenced not only by more completed transactions and a higher deal backlog, but also by the emergence of hostile takeover bids.

Australia-based mining giant BHP Billiton's unsolicited offer to acquire Canadian fertilizer major PotashCorp for $130/share, or around $39.6bn (€31.3bn), was rejected by the target on August 23. US-based Airgas has already rejected a revised offer by US-based Air Products to take it over at $63.50/share, or about $5.4bn.

In the chemical arena, there are an increasing number of assets on the selling block, but typically, the ones of the highest quality are not readily available. It may well take a hostile bid to walk away with a prized asset.

The attempted takeover examples above in the fertilizer and industrial gases sectors are linked by one important quality - the assets are unique and rare.

PotashCorp is the global leader in the production of potash - an essential mineral in enhancing crop production. The company, in its rejection letter to BHP, characterizes the potash industry as having substantial barriers to entry, few producers and no product substitutes.

And how many industrial gases companies are out there of any size? In the US, you're down to Air Products, Praxair and Airgas. Outside the US, there are France's Air Liquide, Germany's Linde and Japan's Taiyo Nippon Sanso.

In Airgas' latest salvo against its pursuer on August 23, it complained that Air Products has so far failed to offer an appropriate price - "one that compensates our stockholders for Airgas' scarcity and synergy value."

PotashCorp and Airgas are no doubt rare and quality assets. And scarcity always commands a premium.

But while companies with strong balance sheets should look for synergistic deals, it's important not to get carried away on price.

Alembic Global Advisors partner Hassan Ahmed concludes that the chemical industry has a track record of value-destroying M&A activity. Chemical company buyers have on average seen their stock prices drop 3.8% over one year and 19.4% over three years.

The key mistake buyers have made was to overestimate synergies and thus overpay for acquisitions.

"Overestimating synergies leads to unattainable expectations - and stock underperformance typically results when promised synergies fail to materialize," said Hassan in a research note.
On the financing front, companies should be lining up to refinance debt - that's a no brainer.

One big lesson of the financial crisis of 2008-2009 was that you should not wait until the last minute to refinance your debt.

US specialty chemicals firm Chemtura and Canada's NOVA Chemicals caught with debt coming due in a collapsing financial market basically had two choices as the clock ticked away - declare bankruptcy or sell out. Chemtura chose the former and NOVA the latter.

Today there is no excuse for a company not to push out its debt maturities. Interest rates are at record lows, and financing is available - even to those companies without the most stellar credit ratings.

US specialty chemicals firm Ferro in August sold $250m in senior notes due 2018 with a coupon of 7.875% - not the cheapest debt, but not bad for a company with a speculative "B" credit rating from ratings agency Standard & Poor's.

That's security you can take to the bank.

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QE2 has arrived in the US! - not the famed cruise ship, but the second round of quantiative easing by the US Federal Reserve.

The pace of economic recovery in the US has been painfully slow, and momentum is waning with persistent high unemployment, weak housing and construction markets and tight credit availability.

And abroad, there are still the minefields of the European debt crisis, which is already resulting in austerity measures by governments, and a potential economic slowdown in China.

So what is quantitative easing and more importantly, how could it help the economy and the chemical markets? In this action, the Fed will essentially buy up US Treasuries with cash, resulting in a two-pronged impact.

First it injects cash into the economy, boosting overall money supply and liquidity. Secondly, buying up Treasuries puts upward pressure on Treasury prices, driving down the yield and ultimately interest rates.

So money becomes more plentiful and borrowing costs go down. This will give a boost to the overall economy, and hopefully juice-up important end markets for chemicals such as automotive, housing and construction, and consumer durables (white goods).

Plus, an added benefit will come in the form of even lower rates at which companies can refinance their debt. Right now, chemical companies are already lining up to raise funds on attractive terms.

On August 5, US specialty chemical company Ferro sold $250m in 7.875% senior notes due 2018. US specialties firm Chemtura is looking to sell $450m in senior unsecured notes due 2018 to finance its exit from bankruptcy. And Brazilian chemical giant Braskem is issuing an additional $350m in 6.875% senior unsecured notes due 2020 after selling $400m in notes in April at 7%.

Normal monetary measures by the Fed would involve simply taking down the discount and Fed Funds rates, but these are already at record lows after unprecedented "easing" steps through the global financial and economic crisis of 2008-2009. With a targeted Fed Funds rate of 0-0.25%, there is basically no more room to maneuver.

But the QE2 measures the Fed is taking will be somewhat limited in scope - at least for now. Right now, the plan is to use funds from maturing mortgages in its $2 trillion securities portfolio to buy up Treasuries. This will amount to around $10-$20bn every month. Observers are hopeful that this could be the first step towards more robust easing actions ahead.

Upon the initial news of QE2 on August 10, which was widely expected, the US stock market reversed much of its losses by the end of the day. But on August 11, the Dow Jones Industrial Average plunged 265 points, or 2.5%, to 10,378, on weaker-than-expected manufacturing data from China and renewed concerns about a global economic slowdown.

China's industrial production in July grew 13.4% year on year - hardly a weak showing, but it was the smallest gain since August 2009.

Economically-sensitive chemical stocks fell harder on the day, including Dow Chemical (-3.1%), DuPont (-3.0%), Hunstman (-5.8%), Eastman Chemical (-3.6%), Celanese (-5.5%) and Georgia Gulf (-10.6%).

It will take more than just baby steps to revive the fading recovery. With inflation currently low, and a greater risk for deflationary conditions ahead, it's time for the Fed to crank up the printing press.

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Dow Chemical's second-quarter earnings miss triggered a 10% decline in its stock price - not because it missed badly (Q2 earnings per share of 54 cents only fell short by 2 cents) but because everyone else thrashed estimates so handily.

On July 27, DuPont posted earnings per share (EPS) of $1.17, beating Wall Street estimates of $0.93 by a wide margin. On July 30, Eastman Chemical followed up with Q2 EPS of $2.05, blowing away Street estimates of $1.65. PolyOne, Westlake and Arch Chemicals followed up with earnings beats as well.

Plus, leading up to Dow's earnings release on August 3, investors bid up the company's stock in anticipation of another earnings beat. And why not? Dow had built a solid history of exceeding Wall Street earnings expectations, having done so in the previous three quarters - and in spectacular fashion.

Unplanned outages led to a 7-cent hit to Dow's EPS, noted Deutsche Bank analyst David Begleiter. Adjusting for this, Dow would have beat estimates, but not by much.

Lastly, Dow's bullish outlook was slightly more muted than some of its peers, with CEO Andrew Liveris expressing a "guardedly optimistic" view of the US economy, and growth continuing in emerging markets, "although at a tempered pace."

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