ASC: Steady outlook for M&A deals

The adhesives and sealants sector remains fragmented, offering opportunity for continued consolidation through merger and acquisition. But most of the activity will involve smaller deals

The adhesives and sealants sector should see steady merger and acquisition (M&A) activity going forward, as the industry remains fragmented. Aside from one major deal in the works, much of the activity is likely to consist of acquisitions of smaller players.

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“The adhesives and sealants industry remains fragmented. While there has been some consolidation, there remains a large number of small private companies that could be interesting targets,” says Leland Harrs, managing director and head of chemicals at investment bank Houlihan Lokey.

There have been around a dozen deals in the past year, ranging from small deals in the single-digit million dollar range, to France-based Arkema’s €1.74bn ($1.85bn) acquisition of Bostik – the No. 3 player worldwide in adhesives – from France’s Total in February 2015.

The Bostik deal, while large, does not fall into the realm of consolidation but rather product diversification for Arkema, which created a new business unit within its high performance materials segment for the asset.

“There continues to be a flow of adhesives and sealants deals, but the pace is not heavy – just regular and consistent. The industry continues to be very fragmented below the large players such as Henkel, Sika, H.B. Fuller, etc,” says Peter Young, president and managing director of investment bank Young & Partners.

“As a result, there continues to be mergers and consolidation acquisitions. A few private equity firms have been doing roll-ups such as Arsenal Capital Partners with their Royal Adhesives-based roll-ups. However, they started a sale process for Royal Adhesives a few months ago,” he adds.

The global adhesives and sealants market consists of a small number of large players with the top 10 representing around 40% of market share and with leader Henkel at 20-25%, notes Telly Zachariades, partner at investment bank The Valence Group. Then there is a handful of companies between $100m (€94m) and $1bn in sales representing 5% of the market, with many being divisions of larger companies. At the tail end there are “literally thousands of companies” with less than $100m in sales, with the vast majority under $50m, he notes.

“The big players will continue to bolt on smaller businesses – for technology, niche end-market or geographic reasons. But it’s difficult to do deals in the $100m+ range or above. The big assets have traded or are not readily going to trade, and there’s not much left to choose from in that mid-range,” explains Zachariades.

That would make it difficult for private equity players to find a substantive platform business from which to roll up other deals, he adds.

More M&A activity is likely to take place at the smaller end. “Formulated chemicals in general and adhesives, in particular, will see strong M&A activity,” says Andy Hinz, director at investment bank Grace Matthews.

STRONG BALANCE SHEETS
“Net debt levels for strategic buyers are at historically low levels, which will drive M&A in 2015. In addition, companies selling into markets growing at GDP-type rates need to put cash to work to achieve the level of growth that shareholders are demanding,” he adds.

The global leader in adhesives and sealants, Germany-based Henkel, saw 3.7% organic growth in its Adhesive Technologies segment in 2014, with sales of €8.13bn. Sales growth was strongest in the emerging markets of Africa/Middle East, Asia ex-Japan and Latin America. Adjusted operating profit rose 2.3% to €1.40bn.

Sales in 2015 should get a boost from its €467m acquisition of US-based electronics adhesives firm The Bergquist Company completed at the end of October 2014. Excluding deals, Henkel expects organic sales growth of 3-5% in 2015 for its Adhesive Technologies segment.

HIGH VALUATIONS
“The adhesives market remains fragmented, despite a high level of consolidation over the last 10 years. There are still quite a few private companies with less than $100m in revenues,” said Hinz. “[On the sell side,] high market valuations coupled with the need for an eventual ownership transition are causing many private owners to dip their toes in the [M&A] water.”

Transaction multiples of 8-10 times EBITDA (earnings before interest, tax, depreciation and amortisation) and above are not uncommon, making it a good time for potential sellers to “test the market”, especially as the window for selling at high valuations will not last forever after years of solid economic growth, Hinz says.

“For strategic buyers, the key to unlocking value is understanding an acquisition target’s products and markets at a granular level, and whether they fit cleanly or simply add scale,” argues Hinz. “Buyers are incredibly diligent when it comes to understanding the strategic fit. And in cases where the fit is clear and defendable, we are seeing very strong deal multiples.”

On the private equity side, Arsenal Capital Partners has built up US-based Royal Adhesives & Sealants through a series of acquisitions, the latest being US-based microsphere adhesives firm Advanced Polymers International in January 2015, which followed the buyout of Canada-based polyurethane (PU) foams and adhesives player Chemque in September 2014. Royal has around $600m in annual sales, according to sources in the financial community.

Royal is for sale and “blank-cheque” company Quinpario Acquisition Corp 2 (QPAC 2) – a publicly traded vehicle led by Jeffry Quinn, former CEO of Solutia – is said to be interested, according to media reports and sources in the financial sector. QPAC 2 raised $350m in an initial public offering (IPO) in January 2015. “Royal has been one of the most active consolidators, and I suspect whoever buys Royal will continue to effect that strategy,” says Telly Zachariades.

The sector could appeal to private equity as the level of fragmentation provides the ability to establish a platform and then roll up similar or adjacent businesses to build scale.

“If private equity firms can find a private company to partner with or buy out, they can use it as a platform to build,” says Harrs. “If you take a broad view of the sector, there is an expansive view of what fits. You can build a very diverse portfolio that still has logic to it.” Also, adhesives and sealants companies have “good cash flow characteristics”, including a low level of capital expenditures, allowing them to service debt rather easily.

And the financing market continues to be very supportive of deals, allowing private equity buyers to take on higher levels of debt to fund transactions.

“The debt markets are approaching pre-recession levels, which is allowing private equity buyers to compete with strategic buyers in a competitive process,” says Grace Matthews’ Hinz.

While consolidation will continue, the sector is likely to remain less consolidated than coatings. “There is more logic of scale for coatings companies as they tend to serve larger customers in automotive, aerospace and the architectural space,” says Harrs. “There will always be a need for smaller adhesives companies – you don’t have to be big to be profitable.”