Market outlook: M&A surge set to persist – Valence

The emerging middle class and availability of cheap capital will drive chemicals M&A

The strong performance for chemicals mergers and acquisitions (M&A) seen so far in 2014 is expected to continue, driven by rising demand and ample availability of capital at low interest rates, according to M&A advisors The Valence Group, sponsors of the ICIS Kavaler Awards (see page 26-28).

An emerging middle class in developing countries and stable conditions in mature economies are driving demand and CEO confidence in pursuing M&A to position for growth, according to founding partner, Peter Hall.

According to Hall, the outlook for M&A is the best it has been in 30 years Copyright: The Valence Group

He said: “Very often you hear that valuations are high but we should dig a bit deeper behind that. Mathematically it is true – M&A multiples and are high versus history. But history is not that relevant, as the world economy is a very different environment versus three to five years ago, or before the financial crisis.”

Hall believes the outlook for growth in chemicals is incredibly strong in the medium-to-long term. Emerging economy middle classes are driving demand for products such as cars, housing, furniture, clothing and electronics which are huge markets for chemicals. There is massive pent-up demand for chemicals, which will be released as incomes continue to rise.

He says there is good growth in North America and stability in Europe: “A lot of people talk about Europe being a problem. There is not much growth there but it is a large and stable market.”

According to Hall, the outlook has never been better since the 1970s and 1980s with most CEOs giving a message of quiet confidence about the long-term outlook.

GOOD CAPITAL AVAILABILITY
Very low interest rates and good availability of capital at low costs are also driving growth. He says multiples are not high relative to the environment of low-risk growth helped by the fact that the industry serves so many value chains.

Asked about the impact of demographic trends such as an aging population in many mature and emerging economies, Hall points out that older people need more access to healthcare products. The population may be aging, but it is still growing and chemicals is one of the best-positioned industries to service a growing world population.

“We’ve been more bullish than most people over the past few years. Even putting shale gas aside, just looking at the demand side chemicals benefits entirely from population and economic growth,” he said.

According to Valence Group figures, by the end of the first half of 2014, the market had achieved two thirds of the entire amount of chemicals M&A for 2013. Valence expects 2014 to be at least 50% higher than 2013.

ACTIVIST EYE EUROPE
Activist shareholders will soon target chemicals companies in Europe following the attention they have given to US groups, according to Hall. European companies are already being scrutinised by activist investors seeking to increase value by forcing management to decrease excessive diversity or boost capital returns for investors, he says.

Many European chemical companies are protected from takeover by special share structures or golden shares held by governments in strategic assets. But, says Hall, this will not deter groups such as Dow activist Third Point, which has taken a stake in Dutch group DSM.

“Activists are not trying to acquire a company. They take a small stake of 1-1.5% and put the spotlight on something needing a change. Activists are more attracted to large companies where they can invest €500m-1bn and get a liquid stake.”

He says companies that are large, diversified and undervalued will become targets. They look for opportunities to drive up the stock by identifying underperformance, excessive diversity in the portfolio, or if they are under-leveraged and not returning enough capital to shareholders.

“Every CEO should be sure there is an activist analysing their company. For the last 12 months we’ve been saying it will happen in Europe. People say that companies are protected but that is irrelevant,” he added.

RETAINING A STAKE
Hall believes that CEOs are now more likely to retain a stake in businesses they sell, so that they can benefit from any upside in the divested business. They are also likely to be more cautious about selling to private equity buyers as this can highlight underperformance.

He gives the example of DuPont, which sold its coatings business in 2012 to private equity group Carlyle, with earnings before interest, tax, depreciation and amortisation (EBITDA) of $339m, according to activists Trian Fund Management. For the 12 months to June 2014, it generated EBITDA of $799m as Axalta, according to its Initial Public Offering prospectus. Trian, which is a DuPont shareholder, published a letter claiming DuPont’s conglomerate structure has led to subpar financial performance.

Hall says: “Companies will realise that people will look back at their track record under private equity. It will push sellers to think about restructuring before selling to [private equity]. This creates pressure to prepare them better and more bias towards selling to private buyers or strategic buyers rather than [private equity].”