Market outlook: M&A is here to stay

After a stellar year, conditions for 2015 are perfect for another year of strong performance

The year 2014 was a remarkable year for chemicals mergers and acquisitions (M&A). Record transaction values could be observed, driven by an increasingly large average deal size. Though raw material prices declined significantly in 2014, key conditions required for a prosperous deal year for 2015 are positive: ample availability of liquidity, healthy demand and valuation levels that are convincing sellers to push the button now and explore strategic options for non-core assets.

Ample liquidity will help fuel a strong year for chemicals M&A Copyright: Getty Images

In the Western world and particularly in Europe, portfolio restructuring is still a major theme. Higher growth opportunities outside Europe are expected to continue, urging owners of maturing businesses to reconsider their portfolio strategy and make use of attractive valuation levels. However, buyers are increasingly picky, so that the valuation gap between attractive businesses directly addressing the mega trends such as food and feed ingredients and functional food and more mature ones such as standard textile or leather chemicals, commodity polymers/fibres has the potential to widen. The availability of shale gas in North America will drive target searches of many potential buyers that are afraid of losing competitiveness on the raw material side.

Activist investors such as Third Point (which has acquired a stake in DSM) have discovered Europe and are expected to increase M&A activity and accelerate the portfolio switch of European diversified chemical companies. Though North America’s chemical industry has been revitalised, areas of expected higher growth such as China, southeast Asia, Turkey or Brazil will continue to play an important role for targets.

Due to the political and economic isolation of Russia and increased uncertainty in the region, potential targets in Russia are assumed to be least sought after within the BRIC (Brazil, Russia, India and China) countries.

PRIVATE EQUITY BOOST
Private equity is expected to play an important role in 2015. Since 2011, financial investors have been increasingly competitive in chemicals auctions. This is driven by the beneficial financing conditions and leverage multiples that can be applied on acquisitions. On the other hand the partially mixed outlook of strategic chemical players leads to cautiousness relating to the valuation of potential targets.

The ongoing trend towards secondary buyout transactions between financial investors will probably continue in 2015. The predominant reason for that assumption can be found in the end of a private equity investment cycle of usually between five to eight years, before a portfolio company can be sold and the profits have to be distributed to the investors. Private equity firms that are concentrating on raising funds have to prove their market access and track record of attractive deals. That puts additional pressure upon them with respect to the exit timing for portfolio companies, particularly when overall financing and economic conditions are excellent. The average equity contribution in leveraged buyouts has continuously decreased over the last five years and approximates pre-crisis levels. Also conditions in the leveraged loan market remain extremely conducive to new issuance. Debt capital markets facilitate a higher leverage and dividend recaps for portfolio companies with a high cash-conversion. Middle market borrowers also have more financing options available to them. Institutional funds are open to lending to rated mid-market companies with unitranche lenders having raised significant funds as firepower.

Private equity will continue playing a more important role in the M&A market as long as financing conditions remain very attractive.

STRATEGIC BUYERS BLOSSOM
The war chest that strategics have been piling up is tremendous. Despite apparent cyclicalities, the average cash balance of a selection of the leading chemical corporations is clearly pointing upwards with a compound annual growth rate (2000-2013) of 14.5% (see chart). The increasing cash balance can be interpreted as one indicator for the war chest of corporates and consequently for competitiveness in chemicals auction processes. Solid balance sheets provide some credit protection to strategics. Though total indebtedness of chemical companies has risen to record levels, maturities should be manageable in 2015. The cash balance is supposed to even further improve in 2015 with low raw material prices widening the margin spread and strengthening chemicals CEO’s courage to pursue non-organic growth options.

A particularly high level of M&A activity can be expected for sectors such as food/feed additives and lightweight materials based on glass or carbon fibre composites coatings or adhesives. The run for high margin businesses addressing the global mega trends will lead to sellers’ markets where a selected auction is a preferred process option in order to find the right buyer at an optimised purchase price.

For those businesses, buyers will find few targets and seller-friendly conditions. In seller’s markets, material-adverse change clauses can hardly be observed, while buyers increasingly use share and purchase agreement insurances, and are prepared to bear the costs. The consolidation in certain chemical sub-industries such as construction chemicals has been given momentum by St Gobain’s recently announced intention to acquire Sika. In agro and pharma/life science oriented fine chemicals, ICIC merging Allessa with WeylChem, Permira acquiring CABB or Merck KGaA taking over Sigma Aldrich are three fine chemical landmark transactions spurring consolidation. This is assumed to continue throughout 2015.

Another wave of consolidation might also be ahead in fertilizers. On the other hand, commodities businesses continue to face difficulties in finding the appropriate exit option – especially in economies with lagging GDP growth. Though emerging commodity players have shown up on the M&A table (such as Mexichem acquiring Vestolit or Oman Oil Company taking over Oxea), an outright sale does not – in many cases, apparently – happen at sufficiently attractive conditions for sellers, so joint ventures have become an exit route of choice in order to share risks and hope for selling the residual stake when conditions improve.

Consolidation in subsegments with overcapacities such as rubber chemicals has not yet occurred and still appears to wait for the right stimulus of a successful landmark transaction. Improving financial figures could positively ­impact the probability for such a deal. For the same reason, 2015 will most probably be a year where many previous auction attempts that did not succeed – mostly from 2011 and 2012 – could be revisited using the results of the previous process and continued in strictly limited auctions or even in bilaterial discussions.

IMPACT OF OIL PRICE
While no direct causal connection between the crude oil price and overall M&A dynamics can be established, subsegments of the industry dealing with alternative feedstocks may suffer from structurally lower oil prices. The chemical value chain based on renewable feedstock could be one example, oil and gas drilling chemical companies – which were much sought after – are another one.

Temporarily, North America, which has become increasingly enticing for buyers seeking access to cheap feedstocks might lose attractiveness from an acquisitions perspective. The decisive question, however, will be, does the market expect oil prices to remain low or anticipate the a return to the old heights soon? Either way, the lower raw material prices for crude oil and many industry metals will improve the balance sheets and current trading of further downstream chemical companies whose purchasing is not directly link to the oil price (eg, by means of price formulae). This might further contribute to potential sellers getting convinced to look for strategic options for non-core businesses.

Sizewise, the trend to larger deals is expected to continue or even pick up further momentum in 2015. Many renowned strategic Western players such as Dow, DuPont, DSM, Evonik or LANXESS are in the middle of sizable portfolio adjustments and could contribute to a record chemicals deal flow. Historically, the valuation of chemical assets seems to be on a high level and surely reflects strong demand and limited availability of attractive assets. Various observations do, however, not point towards building a transaction valuation bubble:

• The trading multiples based on the Enterprise Value divided by the EBITDA are – for many chemical subsegments – higher than the respective transaction multiples, though the latter usually contain the synergy premium
• Low number of chemicals IPOs
• A new age began after the financial crisis years 2008-2010, making comparisons of multiples (before/after) difficult.

The key assumption of any positive outlook is certainly the manageability of geopolitical turmoil related to Russia/Ukraine, Israel/Gaza, Thailand, Iraq or North Africa. The probability of the positive outlook’s occurrence appears to be high, since the global economy has apparently learned to cope with the existence of a scattered field of crisis spots. At least as long as these spots are isolated and each is only considered to have a minor impact.

Bernd Schneider heads the chemicals sector activities of global investment bank N+1 Group, which has advised on 143 transactions closed in the last 24 months, corresponding to a total volume advised of €24.6bn, and €1.5bn raised in the capital markets.bernd.schneider@nplusone.com

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