One striking aspect of today’s chemical mergers and acquisitions market is the persistently high valuations – the result of an abundance of money chasing a limited number of deals. (Photo illustration: Blend Images/REX/Shutterstock)
By Joseph Chang
NEW YORK (ICIS)--The desire for deals is strong and conditions ripe for a high level of chemical mergers and acquisitions (M&A) activity in 2017. A number of mega mergers – the highest profile being Dow/DuPont – are pending regulatory approvals, while other major and mid-market deal activity chugs along.
One striking aspect of today’s chemical M&A market, and one of considerable debate, is the persistently high valuations – the result of an abundance of money chasing a limited number of deals.
“From a transactional perspective, strategics are still paying premium multiples for good assets. Strategics are paying top dollar because of lack of organic growth. And the US/North American market is still very attractive for global players, with stable growth and also fragmentation, allowing for roll-ups,” said Mario Toukan, managing director at investment bank KeyBanc Capital Markets.
“There is confidence and liquidity – a lot of firepower. That dynamic has not changed or slowed, and is even picking up pace,” he added.
In early December 2016, Germany’s Evonik Industries acquired the silica business of US-based JM Huber for $630m, or 10.5x expected 2016 earnings before interest, tax, depreciation and amortisation (EBITDA).
Evonik is also in the process of completing its $3.8bn acquisition of US-based Air Products’ performance materials division (PMD) comprising epoxy curing agents, polyurethane additives and specialty additives. The deal, announced in May 2016, represents 15.8x EBITDA for the 12 months ended March 2016.
“Fifteen times [EBITDA] really is the new 10x. Five years ago, if someone paid 10x, you’d think it was very high. Today 15x is of course a high multiple but not off the charts and reasonably well accepted by the Street for sustainable high quality, high growth specialty businesses,” said Telly Zachariades, partner at investment bank The Valence Group.
“Boards are more supportive of CEOs wanting to engage in M&A, and the stock market is reacting more positively to M&A,” he added.
While traditionally, the acquiring company’s stock price would often decline rather significantly upon the announcement of a major deal, reflecting the premium being paid for the business, today the equity market hardly bats an eye and even rewards deal-making in some cases.
When Evonik announced the $3.8bn Air Products PMD deal on 6 May, its stock actually rose 4%.
Germany-based LANXESS’ September announcement of its planned €2.4bn acquisition of US-based Chemtura (lubricant additives, flame retardants) prompted an 8% jump in the acquiring company’s shares.
LANXESS is paying a multiple of around 10x trailing 12-month EBITDA of €245m for Chemtura, and about 7x including expected synergies.
“There is a shortage of deal flow relative to the amount of money chasing deals – both from corporates and private equity. Prices are getting bid up to historic levels,” said Leland Harrs, managing director at investment bank Houlihan Lokey.
Overall valuation levels are several turns of EBITDA more than two years ago, he noted.
“Strategics factor in synergy potential – they can pay 10x, but it’s really 7x with synergies. Sponsors must see prospects that are different than what’s right under your nose – such as from higher growth levels if the business is managed better,” said Harrs.
“In addition, they can underwrite to an acquisition/rollup scenario where they can buy one business, and then several others like it. People will pay more for a $50m EBITDA business than a $25m EBITDA business, all things being equal,” he added.
“Buyers feel they can pay more, and there’s also a big push for some companies to become more focused on specialty chemicals – those businesses with over 20% EBITDA margins,” said Allan Benton, vice chairman and head of the chemicals group at investment bank Scott-Macon.
“Companies will even pay higher multiples than their own trading multiples, believing they can bring their own valuations up,” he added.
While M&A valuations are indeed at high levels, it pays to watch and analyse the trends in specific groups such as specialties and commodities, where valuations move in different cycles, according to Peter Young, president of investment bank Young & Partners.
For example, commodity chemical transaction valuations fell around 25% in 2015, but have been up 35% through Q3 2016. And “contrary to conventional wisdom”, specialty chemical valuations are actually down 25% through Q3 2016 after surging 40% in 2015, Young pointed out.
“Analysis by analogy doesn’t work. This year has been a great time to sell commodity assets, while specialty chemicals have slipped – it is totally different from what you’re hearing,” said Young.
Along with valuations, M&A activity is largely expected to remain robust in 2017, barring any major macro shocks.
“I think we’ve plateaued, but at a high level. We’ve been in the valley at the peak of the mountain for two-three years now and the circumstances that led us to the peak continue to persist. Absent an external shock, it looks like 2017 will be humming along as strongly as 2016,” said The Valence Group’s Zachariades, “although technically volumes will inevitably come down due to some of the ultra large deals of 2016”.
“There are plenty of businesses for sale. Sponsor and corporate interest remains high, and debt remains cheap. The alternatives to M&A are unattractive as there is zero to low organic growth, and there’s little point in having cash sit around with low interest rates. The stars remain in total alignment,” he added.
In 2016, through the first three quarters, M&A activity is actually tracking lower than in 2015 – both in dollar volume and number of deals, for those over $25m in size, according to Young & Partners.
On an equity basis, there have been $31bn of deals greater than $25m in value completed through Q3, well below last year’s pace.
“Just to tie with last year’s $65bn would require closing $34bn of deals in Q4, which is impossible. Completion by year end of either the Dow/DuPont deal or the ChemChina/Syngenta deal would have bridged that gap, but both have been severely delayed by antitrust and other considerations” said Young.
In terms of number of transactions, 61 deals over $25m in size were completed through Q3 2016 versus 91 deals for all of 2015.
“Again, on an annualised basis, we are on a slower pace compared to last year. Even last year showed a slowdown in volume from the 109 deals in 2014,” said Young.
“Looking forward, the value of deals announced but not closed at the end of Q3 was $227bn [59 deals]. However, the list is dominated in dollar terms by just a few mega deals such as Dow/DuPont, Bayer/Monsanto, ChemChina/Syngenta, PotashCorp/Agrium, and Sherwin-Williams/Valspar. None of these will close in 2016. Some may not close at all,” he added.
The election of Donald Trump as the next US president is spurring optimism across the industrial arena in the US and largely globally, as his policies are viewed as economically friendly and expansionary. Concerns about Trump’s anti-free trade policies have so far been put on the back burner.
“There was thought that a Trump presidency could throw the market for a loop because of the uncertainty factor versus a status quo pick, but the market has taken it in stride,” said Zachariades from The Valence Group.
“Corporations and private equity firms are enthused about lower taxes and regulations, a friendly attitude towards the energy industry and the possibility that there will be less antitrust scrutiny than under the Obama administration,” he added.
The election of Trump, and Brexit were major surprises in 2016, but both events were well digested by global equity markets – less so by the debt markets with regard to Trump as interest rates have risen on inflation expectations.
“Trump is very beneficial for the chemical industry – in the US but also in other countries. Pushing back on climate change will reshuffle value chains. Less regulation means less costs,” said Bernd Schneider, managing director and global head of chemicals at investment bank Alantra.
While overall the macro trends are healthy, he sees challenges for the chemical sector from rising nationalism, the prospect of duties on imports, and the abandoning of proposed trade agreements such as the Transatlantic Trade and Investment Partnership (TTIP) between the US and the EU.
“Anything against free trade is a burden for the chemical sector, as it’s a global industry,” said Schneider.
However, there’s an argument that a more protectionist stance in the US could spur international companies to make sure they have a solid footprint in the world’s largest economy.
“If Trump takes a protectionist view or implements protectionist policies, there’s a question of whether it could increase interest in companies putting a footprint in the US. It could be a positive catalyst for M&A,” said Chris Cerimele, managing director at investment bank Balmoral Advisors.
“And if oil continues to recover, it puts the US in a more competitive position [US petrochemical producers use cheaper natural gas-based feedstock], and that could drive M&A as well. Those two factors are causing the market to be more bullish than less,” he added.
If Trump “cuts the teeth out of lending regulations”, that could loosen things in the financing market, even as interest rates rise modestly, Cerimele said.
“The US political situation with Trump is more supportive of M&A in 2017. We’re optimistic,” he added.
Even as interest rates move up, a lower corporate tax rate in the US being assumed under a Trump administration would be helpful to M&A, said Benton of Scott-Macon.
“European and Chinese chemical companies will want to buy assets in the US, including US Gulf Coast ethylene assets as a result of the competitive feedstock costs in the US,” he noted.
And some Middle East firms such as Saudi Aramco are seeking downstream transactions in the US, noted Benton from Scott-Macon.
A recent interesting deal by Aramco is its November 2016 acquisition of the CO2-based polyols technology called Converge from US-based Novomer in a transaction worth up to $100m, he said.
PRIVATE EQUITY OUTLOOK
Private equity firms, or sponsors, have largely taken a back seat amid the strong level of overall chemical M&A activity in the past several years, as strategic or industrial buyers have been more aggressive.
However, with burgeoning war chests and still-cheap financing, their level of buying interest has not waned and they are winning some mid-sized deals.
“Sponsors have been relatively quiet in 2016 as valuations are ‘peaky’ and strategics aggressive. But the financing markets are still very much alive and open. This will spur sponsors to be more aggressive in the M&A market,” said KeyBanc’s Toukan.
Yet now certain big players in private equity are making a renewed push into chemicals.
Private equity firm Carlyle bought Atotech (metal and surface finishing coatings and chemicals for electronics and industrial) from France’s Total in October 2016 for $3.2bn, or 11.9x 2015 EBITDA.
“It’s been tougher for private equity because strategics are being quite aggressive and paying more, accounting for synergies, than in the past. They have had to be aggressive in this market,” said The Valence Group’s Zachariades, noting the healthy multiple paid by Carlyle for Atotech.
“Valuations are ramping up further and further. Normally you see strategics being able to outbid sponsors but now you are seeing sponsors outbid even strategics that have synergies with the target business in certain cases,” said Schneider from Alantra.
Private equity giant Blackstone entered the chemical space again for the first time in years with the December 2016 announced acquisition of Solvay’s acetate filter tow business for around €1bn, or 7x EBITDA.
The relatively low EBITDA multiple disappointed some in the investment community, although it was for a commodity business.
“On the plus side, we believe that Solvay’s sale process interjected quite a bit of instability into the filter tow market and is partly to blame for the rampant pricing issues. On the downside, the reported 7x EBITDA multiple appears on the lighter side of what could have been expected,” said Frank Mitsch, chemicals analyst at Wells Fargo.
Mitsch covers US-based chemical companies Eastman Chemical and Celanese, both of which have acetate filter tow businesses.
“Private equity has a greater chance of winning deals if it is a very big business, more commodity in nature, or when it is in a highly consolidated sub-sector with regulatory approval issues,” said The Valence Group’s Zachariades.
In the US, both Eastman Chemical and Williams have crackers for sale – about as commodity assets you can get, as they produce the basic building block chemical ethylene.
“Companies prefer to be downstream in areas that will benefit from low raw material costs rather than in those raw material chemical producers themselves – like ammonia, propylene and ethylene,” said KeyBanc’s Toukan.
“The universe of buyers – strategics and sponsors – for commodity-based assets is very, very narrow. I would not be surprised to see a sponsor involved for those crackers,” he added.
Many large chemical companies are seeking to unload commodity chemical businesses to focus on specialties. Yet they will likely have to settle for more modest multiples.
“We’re seeing cyclical assets being lured into sales. However, there has not been a proportional increase in valuations in commodities versus specialty areas like food ingredients and composites where they are very innovation focused,” said Schneider from Alantra.
“Cyclicals are being sold at slightly higher than their historical average but the valuations have not risen at the same rate. Commodities might get 7x instead of 6x, but at the higher end such as food ingredients, today you can easily get 13x, 14x or 15x. Really the gap is widening between commodity and specialty, and it has to do with competition – there is less competition for commodity assets,” he added.
And commodity chemical assets are perceived to be at the top of the cycle or leaving the top.
“They are certainly not at the bottom, and nobody wants to buy at the top,” said Schneider.
“Private equity firms receive a lot of publicity, but continue to lose market share in terms of acquisitions. They accounted for only 7% of the total number of deals completed through Q3 2016, a startling loss of share compared to the historical norm of 20-25% and a drop from their 9% share through the first half,” noted Young of Young & Partners.
“Even their share of the dollar volume was low at only 3% of the total through Q3 2016, down from 4% in the first half,” he added.
For large deals, private equity firms have had difficulty outbidding strategic buyers, but for mid-range deals with $10m-50m in EBITDA, they will still play a very healthy role, noted Schneider of Alantra.
“Mid-size strategics tend to be a little more cautious, while private equity players still have huge amounts of funds that they have to spend,” he said.
NEW ASPECTS/SPECIAL SITUATIONS
Motivated buyers on both the strategic and private equity side are in some cases making direct approaches to potential targets, bypassing bankers, noted Harrs of Houlihan Lokey.
For example, Italy-based Italmatch Chemicals bought US-based Compass Chemical (organophosphonates for water treatment, oil and gas) from private equity firm One Rock Capital Partners in June 2016 without a banker, he noted.
“People are turning a lot of leaves and beating the bushes for deals,” said Harrs.
And there is a new class of buyer in the M&A market today.
“One trend is that we’re seeing more wealthy family office funds – those with $100m or more – foregoing traditional private equity investments, and seeking to make direct investments,” said Cerimele of Balmoral Advisors.
“They are hiring professionals and essentially operating like a private equity firm, contacting bankers on deals. This gives them more direct control – they can be a decision maker and more hands-on. And they tend to have longer investment timeframes than private equity. They are becoming an increasingly important part of the market,” he added.
Leveraged buyouts, once an important aspect of the chemical M&A market, have faded in 2016 as public trading valuations have risen.
“One area that’s been quiet but should really be a bigger piece of the M&A market is ‘take privates’. The chemical sector still has many smaller cap public companies that would likely be better served in the private domain. The issue is that valuations are so high, that these are harder to consummate,” said KeyBanc’s Toukan.
“The Trump rally has been significant and many chemical stocks are hitting all-time highs. But once the overall equity markets normalise, we’ll see more of these conversations and transactions emerge, he added.
Examples of public chemical companies being taken private in the past few years are US-based OM Group (coatings and inks additives, magnetic materials) by Apollo Global Management, and Zep (consumer and institutional cleaning chemicals) by New Mountain Capital – both in 2015.
In dual track processes, where a sale process and initial public offering (IPO) are being run simultaneously, the businesses tend to wind up being sold.
“M&A valuations are at historic levels – they are so narrow between public and private that often an IPO doesn’t make sense,” said KeyBanc’s Toukan.
Examples include Arizona Chemical being sold to Kraton Polymers (January 2016), AVINTIV (formerly PGI) to Berry Plastics (October 2015) and PQ to CCMP Capital (partial sale in December 2014), he noted.
Chemical companies have had great difficulty going public, according to Young & Partners. Going all the way back to 1980, the highest dollar amount raised in IPOs in a single year was $5bn in 2006 and the highest number of IPOs was 14 in 1995.
“For most of the years, the dollar volume was under $1bn and the number of IPOs between zero and three – astonishingly low numbers,” said Young.
“This year has been different. The number of IPOs has hit the historical peak of 14 in just three quarters. However, all of the IPOs were extremely small and all were Asian companies. The total dollar volume through Q3 was just $717m,” he added.
INSET IMAGE: (Photo illustration: Alan Adler/REX/Shutterstock)