Commentary: Private equity wary on certain chemical deals late in the cycle

Source: ECN

2017/12/07

Private equity firms are still very interested in the chemical sector but are becoming increasingly cautious on certain late cycle commodity chemical plays. While having lost market share in the chemical mergers and acquisitions (M&A) market to more aggressive strategic buyers in recent years, private equity sees opportunities in special situations.

“We also pursue cycle plays at a favourable time but are not finding many now. Most cycles are at a high point. A year ago, multiples were high and debt was cheap. One year later, multiples are higher and debt is cheaper,” said the managing director of a major private equity firm, who spoke at the Young & Partners Senior Chemical Executive Conference in New York.

One pointed out that multiples of publicly traded companies are also at historically high levels. “This makes us a bit cautious about [chemical] cycle plays right now. But not all chemicals move with the economic cycle – you can still find niche areas that have cycled down where most have gone up,” he added.

“The credit cycle is approaching its historical duration, so there is a big focus on downside scenarios and capitalising a business properly. It’s hard to feel good about exiting 5 years from now,” said the managing director of another major private equity firm.

Private equity firms will often seek situations that are in flux in some way, where they can take specific actions. This includes corporations seeking to divest non-core businesses to meet certain objectives.

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Firms see chemical, economic cycles in the late stages

“We try to find things others don’t see to drive improvement, taking calculated risks,” one managing director said.

The other likewise seeks to “embrace complexity”, as if were easy to spot how value could be created, others would have done it already. Instead of targeting particular areas in chemicals, he evaluates “wherever the market presents opportunity”. This includes opportunistic buyouts, corporate carveouts and acquiring distressed debt in a bid for control of the company.

A focus on cycles and a realistic view of where a business is in the cycle is one critical factor for success, he said. Others include prudent capitalisation to withstand cash flow volatility, and also to “expect the unexpected”, preparing for unlikely scenarios.

“We are constantly paranoid about what we don’t know,” said the managing director. “You have to appreciate where you are in the cycle and run scenarios with a variety of return outcomes.” Changes in technology can also be a disruptive factor which can offer opportunities for private equity, another managing director said. This can include a new production process that eliminates a particular byproduct, thereby changing the supply/demand dynamics.

Many private equity firms have certainly exercised patience and discipline in the current chemical upcycle, not overpaying for assets, even as coffers are full of equity capital to put to work after massive capital raises.

A RETURN TO MEGA DEALS?

Private equity has been absent from the flurry of mega deals – say those valued at $5bn or more – for many years. However, this could change in the coming year.

“There’s a short list of private equity firms that could compete [for these mega deals]. We haven’t seen many but we may see them soon. But markets may have to return to more normal situations for this,” said one managing director.

AkzoNobel’s specialty chemicals business is on a dual track process – a sale or an initial public offering (IPO) – and private equity firms are rumoured to be among the likely bidders. The specialty chemicals business, which in 2016 generated sales of €4.8bn and €953m in EBITDA, includes surfactants, polymer additives, salt and ­chlorine products, and pulp and performance chemicals. AkzoNobel estimates the value of the business at €8bn-€12bn.

As mentioned earlier, such a large asset with a diverse slate of product categories is less digestible for a ­strategic buyer, and so would most likely to go to a consortium of private equity firms, who could then sell the businesses piecemeal at a certain point, according to a number of ­sources in the financial community.