Fecc: Don’t get caught in the middle

Merger and acquisition activity in the chemical distribution sector has been particularly active of late, as companies seek to expand into new offerings and markets

Deals are being struck regularly in chemical distribution as companies seek to expand Copyright: Rex Features

In the end, 2014 turned out to be a good year for chemical distributors. Not that many companies have reported detailed figures yet, but anecdotal evidence suggests that despite a more difficult second half, distributors are quite content with their performance.

While turnover growth was moderate, in many cases measures to increase efficiency paid off and listed companies like Brenntag, DKSH and IMCD were able to show improved performance. They could even cope with adverse currency effects, which made life more difficult for companies with global or trans-continental activities.

With prices for chemicals under pressure, driven by the collapse of oil prices since the peak last summer, chemical distributors need to work hard to maintain – let alone even expand – headline growth.

Adding new suppliers or approaching new customers and taking market share from competitors may not always be sufficient. To keep the momentum, companies will continue to look for acquisitions and thereby drive further consolidation of the chemical distribution industry. The need to either focus on core business activities or to gain scale is more apparent than ever.

When it comes to acquisitions and other corporate transactions in the chemical distribution space, 2014 was quite a busy year. With 49 transactions recorded by DistriConsult, acquisition levels were 50% higher than during the previous year, when only 32 transactions were recorded. When broken down by geographic area, Europe and North America were the most active regions. These are also the most mature markets.

Almost two-thirds of the acquisitions were made by companies with a turnover greater than €500m. However, to be fair, some of the smaller transactions with only local scope may not have been picked up by our research.

The main driver continues to be the move into new geographies, with 40%, and addition of new applications and industry sectors, 21%. Outright consolidation accounts for less than a quarter of the transactions.

The allocation of the different transactions to these categories may in some cases be a little arbitrary and subjective, as the rationale behind a deal is not always disclosed and also sometimes there is more than one factor driving a particular buying decision.

Since last summer the slate of listed chemical distributors has another member with IMCD. The initial public offering (IPO) at the end of June last year was oversubscribed and at a price of €31.50 at the end of March the shares are currently trading 50% above the offering price at the time. The company has used the proceeds of the IPO to significantly reduce its debt, resulting is a greatly improved net income, as the financial results for 2014, which were recently published, have shown.

To keep the momentum, the company will most likely continue to make acquisitions. With its de-leveraged balance sheet it certainly has the financial strength to do so.

The growing list of quoted distributors brings more attention to the industry, as these companies are now getting regular coverage from analysts at banks and other financial institutions or even rating agencies such as Moody’s or Standard & Poor’s for the bonds they have issued. This brings more transparency, but also more pressure to perform and stricter requirements regarding governance and compliance.

WHAT WILL 2015 BRING?
Although there are only a few transactions so far in 2015, the announced sale of Azelis by 3i to global private equity house Apax Partners (Apax), rather than the IPO some industry watchers expected, is one of the larger deals in recent history. 3i had been invested in Azelis since late 2006 and was running out of steam a bit, after a substantial management shake-up in autumn 2012 and the need to inject additional capital, due to liquidity constraints at the time.

Apax is, on the other hand, new to chemical distribution and the team there may have been encouraged by the successful IPO of IMCD to make a dash for Azelis. The announcement of the transaction clearly spells out the global ambitions and the international growth plans which the new sponsor has. Generally speaking, private equity is keen to put the funds they have been entrusted with by their investors to good use and debt is again plentiful, as the markets are being flooded with liquidity by the ECB.

Some other private equity sponsors have also been invested for quite a while, for example CD&R (August 2010) and CVC (August 2007) in Univar, TPG Capital in Nexeo Solutions (April 2011; note: in Europe only plastics compounding and distribution) or IK Investment Partners in Unipex (September 2012). Since long holding periods are to some extent unfavourable on the performance metrics of a sponsor and with the equity markets in general being very strong, we might see some more exits, either through an IPO or a trade sale in the not so distant future. Univar had made some preliminary filings with the SEC around the time of the IPO of IMCD, but since then no further announcements have been made and things appear to have gone quiet.

MID-SIZED PLAYERS ARE VERY ACTIVE
A substantial number of transactions were concluded by medium-sized distributors in 2014. The main drivers were access to new applications and a broadening of the geographic coverage. Part of this was driven by some principals’ efforts to reduce the number of distributors they use to cover a certain geographic region. To finance the growth, some of these companies can rely on their free cash flow, particularly when the owner families have only a few members and a strong philosophy of reinvesting profits in the business.

When the financial needs are larger or when some family members require a steady dividend stream, alternative forms of financing must be found. Particularly in Germany the use of mezzanine capital seems to be getting a more favourable reception. In February Overlack obtained a tranche of growth financing from HANNOVER Finanz, in the form of a convertible loan.

The same form of financing had been obtained by Biesterfeld in January 2011. That particular loan, also provided by HANNOVER Finanz, was converted into a minority shareholding (28.6% of the capital) in the holding company of the group in October last year. Recently, Dutch specialty ingredients distributor and food & feed additives blender Barentz International has also tapped the financial markets by obtaining “growth capital” from an unnamed family office as a minority equity partner in the company.

INTEGRATION IS CRUCIAL
Besides finding suitable targets and not overpaying on the transaction, successful integration of the newly-acquired entities continues to be a key success factor. Important tasks in this context are the motivation of the management to follow the new group targets, a speedy transfer of the business on to the acquirer’s enterprise resource planning (ERP) system, the capture of synergies in product procurement and the streamlining of overheads. Conflicts regarding principals must also be addressed and resolved quickly. Some companies are more astute than others at all this. Practice can certainly make the difference, although hiccups can occur even at experienced serial acquirers.

With increased company size comes the need to put adequate management structures in place. Besides line management that is fully tuned to the strategic, tactical and transactional aspects of a distribution business, certain functional expertise needs to be built up. Human resources management plays an increasingly important role. Training and development of management can no longer be, in a sense, outsourced to the chemical industry in the hope that when the need occurs, senior management candidates can be searched for, identified and hired from the outside.

Distribution of chemicals is different from manufacturing of chemicals, after all. In simple terms, distribution is about relationships, manufacturing is about asset utilisation, although the line between the two sometimes gets blurred. The distribution industry must develop its own management pool more systematically than in the past, in order to be able to drive further expansion. In this context, it has been interesting to see that Brenntag has recently appointed the group’s first global human resources director. It might not be so long, until other large distribution groups with global aspirations will follow.

LOOKING FOR GROWTH OUTSIDE EUROPE
Outside Europe, most of the business development activity still seems to be taking place in Asia. That geographic region is still seen as very dynamic, with good growth and consolidation opportunities. The sheer size of its population and the underlying expansion rates make for good growth prospects, as the middle class is asking for more consumer products and thereby driving chemicals consumption. For many producers it is still a white spot on the map, therefore capable local representatives are of the essence.

The US and Canada have also gained attractiveness, although it seems mainly as a source of shale gas- and shale oil-based raw materials. The larger distributors, such as Brenntag or Univar, have heavily invested in infrastructure for the supply of drilling chemicals to the oil and gas industry during the last few years, often in areas remote from other industrial activity. How these investments will work out, in view of the reduced number of drilling rigs in operation after the adjustments made over the last few months, will depend on how fast oil prices recover.

In Latin America, Brazil has fallen a bit from grace, as the corruption scandal around Petrobras and general economic woes appear to bring growth rates for 2015 (and maybe also 2016) close to zero or even into negative territory. Other countries in that region are getting more attention, particularly from Spanish and Portuguese firms that have advantages in terms of the common language and historical trade links.

Africa, which has received a lot of attention generally for its assumed potential for economic growth, has so far been an area where the bigger players such as Brenntag, IMCD or Univar were trying to expand their networks. But some mid-sized companies have made first moves, either in South Africa or in countries where links and a common language exist. Overall, however, many countries’ economies are still in the early stages of the development cycle, where the local business is mainly focused on subsistence farming on one hand and the export of commodities such as minerals, oil or coal on the other.

“MIND THE GAP”
The chemical distribution industry continues to be an exciting space, but also a challenging one. Large multi-country or even global distributors are co-existing with numerous local players, only active in a specific country or geographic region. Both groups can be successful, depending on how good they are at meeting the needs of their principals – that is, the producers of chemicals and the local customers they serve.

The large players – being listed, private equity or family owned – will continue to grow as they roll out their business models to an ever larger number of countries and applications or industry sectors. That growth trajectory is not without potential pitfalls, as the local customer contact still counts a lot and must not be diminished through campaigns and project aiming at the streamlining of operations and the capture of efficiency gains. But financial strength and prudent management enables them to maintain and even expand the position in the industry.

LEVEL OF SERVICE
For the smaller companies, who typically enjoy close customer contacts and deep 
insights into the workings of their target industries, the problems are more related to their attractiveness to leading producers of chemicals. These principals are expecting a level of service that requires investments in infrastructure and people.

Small companies must therefore make up their mind, where they want to compete and then focus on defendable niches. Only then can they afford to fund the growth projects and the infrastructure required, be it in a laboratory or a modern customer relationship management (CRM) system to generate timely project reports.

And then there are the companies that are “caught in the middle”. Distributors that are either no longer operating only in attractive and defendable niches or that are financially and management-wise not strong enough to grow – be it by attracting new suppliers or a moving into adjacent geographic markets. Such companies will need to make some really hard choices in order to get out of the danger zone. This may require the decision to exit certain industries or countries or even sell out altogether, to different owners with a stronger business position.

Guenther Eberhard is managing director of DistriConsult, a European consulting practice focusing on channel management for distributors, producers and investors, based in Switzerland. He can be contacted on +41 44 680 1431 or at geberhard@districonsult.com.Web site: www.districonsult.com