NEW YORK (ICIS)--It’s been a roaring mergers and acquisitions (M&A) cycle in global chemicals, but the tide may be turning as players turn cautious as the economic cycle heads into the late stages and many commodity chemicals may be near peak profitability.
2017 has featured strong levels of activity, a number of mega deals and heady valuations in certain specialty chemicals sectors. Interest continues to be high among corporate as well as private equity players, but the latter have been largely squeezed out in the competition.
Looking towards 2018, many of the factors driving the chemical M&A market should continue to be in play – cheap and available financing, the need to acquire assets to drive earnings gains in a still low-growth economic environment, as well as portfolio restructuring including after major acquisitions.
“The underlying bread and butter M&A activity is well into its fourth year of high levels of activity as well as multiples, particularly if you exclude the monster deals of over $5bn,” said Telly Zachariades, partner at investment bank The Valence Group.
The average chemical transaction multiple in chemicals year to date is about 10.2x, compared to 10.3x in 2016 and 9.9x in 2015 – very consistent over time, he noted. However, following a long period of strong chemical M&A activity and high multiples being paid for specialty chemical assets in particular, some buyers are turning cautious.
NERVOUS ON CHASING DEALS
“It’s still a very active market, and appetite is good. But some people are getting nervous that others are chasing deals and paying big prices and that nothing has calmed down,” said Mario Toukan, managing director at KeyBanc Capital Markets.
“There is a sense that people are starting to say: When is this going to stop? Most corporates and private equity players are not expecting a crash but thinking what could be the catalyst that could soften up the market going into 2018,” he added.
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 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 five years from now,” said the managing director of another major private equity firm.
Recent high profile deals have garnered solid valuations, such as HB Fuller’s October 2017 acquisition of Royal Adhesives & Sealants from private equity firm American Securities for $1.575bn, or 11.4x expected earnings before interest tax, depreciation and amortisation (EBITDA) for Fuller’s 2017 fiscal year ending early December. KMG closed its $495m acquisition of pipeline performance chemicals company Flowchem from private equity firm Arsenal Capital Partners in June 2017 at a trailing 12-month EBITDA multiple of 11.5x.
Arsenal then sold polyurethane products producer Accella Performance Materials to Carlisle Companies in a deal that closed in November 2017 for $670m, with a multiple of at least 10.4x EBITDA.
For highly sought after assets in the coatings, adhesives, sealants and elastomers (CASE), intermediates and polymers markets, the average deal multiple has been about 12.5x trailing 12-month EBITDA, said KeyBanc’s Toukan.
The success of Royal Adhesives, which was built from a roll-up strategy of multiple acquired assets, could drive similar strategies in the adhesives sector, which is still a highly fragmented market, he noted.
Chris Cerimele, managing director at investment bank Balmoral Advisors, also sees high interest in the adhesives and sealants sector, where companies are seeking to expand their geographic footprint in the US and add environmentally friendly technologies or other performance characteristics to solve customer problems.
“Adhesives and sealants is still a fragmented market – and still a very bright spot for a roll-up,” said Cerimele. “These assets also tend to be friendlier for private equity because a lot of them are in formulated, branded products, where private equity doesn’t necessarily need that chemical expertise.”
However, overall, potential buyers are getting concerned that the US economy is in the late stages of the economic cycle – one of the longest expansions in history from the low in early 2009.
“This transcends the chemical sector. Once the economy reverses, banks slow down lending and boards aren’t as eager to do deals,” said KeyBanc’s Toukan.
And at today’s historically high multiples, a number of private equity firms and corporates are aiming to sell ahead of any turn in the market, he added.
While highly coveted specialty chemicals assets can sustain double-digit EBITDA multiples, for cyclical commodity and intermediate chemical businesses, “getting significantly beyond 7x EBITDA needs good reasoning”, noted Bernd Schneider, managing director and global head of chemicals at Germany-based investment bank Alantra.
BASF’s planned €1.6bn acquisition of Solvay’s polyamide 6,6 business represents a multiple of about 7x trailing 12-month EBITDA through June 2017.
“One of the biggest issues is the overall macro environment – geopolitical instability with North Korea and Iran, the US Federal Reserve and central bank policy, Brexit and Catalonia, and US tax reform,” said Federico Mennella, managing director and head of global chemicals at investment bank Lincoln International.
“Some people are saying this could be as good as it gets – you’re not going to get lower interest rates or peace in the Middle East, so it may be a good time to take advantage of it,” he added.
At The Valence Group’s M&A conference in October, “no one could come up with any defensible reason why the market would turn down, other than some sort of unforeseen geopolitical event”, Zachariades said.
“The fundamental profitability of the chemical industry continues to improve, and that is the basis for the new level of multiples. On top of that you continue to have low cost of debt, an abundance of capital and investor pressure to generate growth, which is hard to achieve organically. Plus, companies have a better ability to extract synergies today than five years ago as many sectors have seen significant consolidation and management teams have gained experience and confidence in participating in this,” said Zachariades.
“Absent an exogenous shock to the system, there is no reason why multiples wouldn’t stay where they are. This is the new norm,” he added.
DEMAND EXCEEDS SUPPLY
In the meantime, demand for chemical deals is higher than the supply of quality assets on the market, according to at least one investment banker.
“There’s not an abundance of quality assets. Demand is exceeding supply, and so assets are being bid up,” said Leland Harrs, managing director at Houlihan Lokey.
“The tone of the M&A market is still strong – there is no sign of let-up, in interest, valuations or availability of capital,” he added.
“There’s a ton of cash still out there – strategic buyers are seeing a good economy with cheap lending, and private equity firms have plenty of available cash, along with a strong mid-market lending market,” said Lincoln International’s Mennella. He estimates that US private equity funds overall have around $550bn in dry powder for deals that they can also leverage with debt.
Houlihan Lokey’s Harrs sees a “decent flow” of assets hitting the market in the coming years – from private equity firms exiting as well as corporates that seek to divest non-core assets.
“Many transactions reflect the underlying desire to become more focused – companies divesting businesses that should be worth more to someone else,” said The Valence Group’s Zachariades.
However, “public companies typically don’t shed quality assets at a rate that meets demand”, said Houlihan Lokey’s Harrs. And high transaction valuations are not the main driver for owners to sell, he noted.
“Valuations are not enough – the sole reason. People don’t want to miss a window, but they don’t always react to a tick up in the market. Most sales are not about timing the M&A market but simply because corporates are refocusing or hold periods are up for sponsors,” said Harrs.
“On the margin, valuations may stimulate sales, but they are not the main driver,” he added.
Other valuations, in particular the high trading multiples of publicly traded chemical companies, are hindering deals. There are very few acquisitions of publicly traded companies, Harrs pointed out.
Japan-based Kuraray’s planned acquisition of US-based activated carbon producer Calgon Carbon for $1.3bn, including the assumption of about $200 in debt, announced in September 2017 was an exception, he noted.
Kuraray is paying a 63% premium to the prior trading price, for an EV/EBITDA (enterprise value/earnings before interest, tax, depreciation and amortisation) multiple of about 20.2x trailing 12-month EBITDA.
However, Calgon Carbon’s business improved markedly in the first half of 2017 versus the second half of 2016. Annualising its $40.7m in EBITDA in H1 2017, Kuraray is paying about 16x annualised EBITDA.
Deal success for publicly traded chemical companies is highest when they stay near their core by building scale or expanding to a new geography. Conversely, where companies have added new fundamental activities, products and geographies, they have destroyed value, according to Jason McLinn, partner at global management consultancy Bain & Company and head of its chemicals practice in North America.
“You need to stick to your knitting to a degree. The best acquirers use M&A as an extension of their corporate growth strategy rather than just undertaking it on an opportunistic basis,” said McLinn at a meeting of the Chemical Marketing & Economic Group in New York.
PRIVATE EQUITY CHALLENGED
In this high transaction valuation environment, it is hard for private equity firms to win deals. As many have avoided commodity chemical deals, they are competing in the specialties arena where competition from strategics tends to be stronger.
“As a result, private equity’s low market share of acquisitions has continued. In the first three quarters, they only represented 6.0% of the number of acquisitions and 2.9% of the dollar volume,” said Peter Young, president of investment bank Young & Partners.
Yet the chemical sector continues to be attractive to private equity, partly because of the breadth and diversity of businesses.
“You can be a market leader in a niche, even as a small to medium size company. But if you’re dealing with an asset dependent on the economic cycle, or housing cycle, that is capital intensive, and you put debt on top of equity, that can be a challenge. You have to consider the downside scenarios,” said Bain & Company’s McLinn.
In deals they are able to win, private equity firms have to work harder to make their investments profitable, he said.
“Buying an asset at 6-7x EBITDA, waiting a few years and selling at 10x is a thing of history,” said McLinn at a meeting of the Chemical Marketing & Economics Group in New York in early November.
“Now you have to work harder – either bringing in capabilities to make it perform better, or bringing that technology in-house [to create more value]. You have to sweat acquisitions more to find value – the low hanging fruit of just cutting costs is gone,” he added.
Private equity firms can beat strategic bidders in winning a deal if they have a greater ability to break constraints inherent in the target than the owner or other strategics, noted Tom Shannon, partner at Bain & Company and leader of its global industrial goods and services practice.
“Corporates have many constraints. It’s the ability of private equity to act without these constraints [that can build value]. They can break the contraints of running the business for quarterly earnings, having multiple business units competing for capital, or being able to find the right talent,” said Shannon.
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.
“We try to find things others don’t see to drive improvement, taking calculated risks,” one private equity firm managing director said at the Young & Partners conference.
Another private equity firm executive 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 carve-outs 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,” he added.
Changes in technology can also be a disruptive factor which can offer opportunities for private equity, the other 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.
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.
MEGADEALS DISTORT PICTURE
This year has seen the closing of the largest deal in chemical industry history – the merger of equals on 1 September creating DowDuPont, which now sports a market capitalisation of over $160bn. Earlier in June, Sherwin-Williams closed its acquisition of Valspar for over $11bn. Also in June, ChemChina closed its $43bn buyout of Syngenta.
These three mega deals have driven the total equity dollar value of global chemical deals over $25m in size to a record $149bn in just the first three quarters of 2017, according to Young & Partners. That compares to $42bn in completed deals in 2016 and $65bn in 2015.
Young points out that without the mega deals, the dollar volume has been “solid, but not spectacular”. In addition, the number of deals over $25m in size at 67 through the first three quarters of 2017 is down slightly on an annualised basis from the 95 deals completed in 2016.
Paul Hodges, chairman of consultancy International eChem, sees the proliferation of mega deals in the chemical industry as driven by the “sugar high” of cheap financing.
“Dow/DuPont, Praxair/Linde, Huntsman/Clariant are all deals that would have seemed highly improbable in more normal times,” he said.
Huntsman and Clariant have since called off their planned merger in the face of activist shareholder opposition.
Mega deals can also trigger further M&A – not only as divestments may be required by antitrust authorities to close the deal, but also as the combined portfolio gets a fresh new look by management.
In the case of DowDuPont, already there are plans to split into three companies – focused on commodity chemicals, specialty chemicals, and agricultural seeds and chemicals, with potentially more on the table on the specialties side.
“I’m convinced that with all these mega mergers, we’ll see more mid-sized deals going forward,” said Alantra’s Schneider.
ELECTRIC VEHICLE IMPACT
One megatrend that will increasingly make waves in the M&A market is the electrification of vehicles. While widespread adoption could take a decade or two, it may come sooner than many think. And the trend is front and centre in the minds of buyers and sellers.
“We hear this in many conversations with clients: What is the exposure of the business to the megatrends of electric vehicles and autonomous driving? This can apply to businesses such as lubricants and lube additives,” said Alantra’s Schneider.
CHINA M&A POWER GROWING
One interesting aspect of today’s M&A market is the emergence of China-oriented special private equity firms that are becoming more active in acquiring Western assets.
“There are quite a lot of these chemical companies that are listed on the Chinese stock exchange with a strong drive to expand or diversify, and buy European and US assets to achieve a global market leading position, and thereby sustain the further development of the stock price,” said Alantra’s Schneider.
“If a deal makes sense from a strategic perspective, the Chinese government will approve an outbound deal, despite the official constraints on capital outflows,” he added.
Thus, the acquisition targets will typically have a significant technology and formulation component that can be leveraged in the China market, he noted.
“Many of the buyers are new chemical companies, including smaller conglomerates, that even many industry practitioners have never heard of – they may have $100m-$300m in annual revenues and are listed on an exchange. They often have significant firepower, sometimes with the ability to buy companies with revenues larger than their own,” said Schneider.
“The typical logic of whether company A can buy company B based on size and operational synergies doesn’t work with many Chinese buyers – you have to look behind the Chinese curtain,” he added.
These companies can secure the funds to close a deal either by raising more equity capital, deploying capital from government-owned investment vehicles, or by partnering with private equity firms that bring deal experience to the table and are specialised in acquiring Western assets to leverage their potential in China markets.
AGIC TARGETS POLYMERS
One example of such a private equity firm is AGIC (Asia-Germany Industrial Promotion) Capital, which describes itself as “the leading Asian-European private equity firm focused on industrial technology investments in Europe”.
AGIC is led by Henry Cai, formerly executive chairman of Investment Banking Asia Pacific at Deutsche Bank, before starting up AGIC in 2015. During his investment banking career of over 20 years, including at UBS and BNP Paribas, he helped bring around 200 Chinese state-owned and private companies to the public marketplace, according to AGIC.
Among the major investors in AGIC is China’s sovereign wealth fund China Investment Corp. AGIC initially raised $1bn for its first fund and is now seeking another $2bn-$3bn for its second, to be completed later in 2017.
AGIC seeks mid-sized technology oriented acquisitions in Europe, including in advanced materials and technologies. Among the subsectors in this category are high performance plastics, polymers and alloys, along with biodegradable materials, nanotechnology and carbon fibre components.
While it has yet to buy a chemical or plastics producer, in January 2016 AGIC partnered with ChemChina and GuoXin to buy Germany-based plastics and rubber processing machinery company KraussMaffei Group for €925m as its first investment.
Another such specialised private equity firm is Mandarin Capital Partners, which focuses on buying mid-size European businesses with “significant market potential in China”.
Mandarin acquired and sold a majority stake in Italy-based performance additives and specialty chemicals producer ItalMatch (acquired in 2010, sold in 2014) and in 2014 bought a majority stake in Italy’s Industrie Chimiche Forestali, a producer of adhesives and fabrics for a wide range of consumer applications.
Often these specialised private equity firms act as intermediaries for Chinese buyers, said the banker.
A NATURAL NEXT STEP
“Often you don’t see the chairman of a Chinese company engaging directly in the acquisition process. Instead it is a private equity vehicle or in some cases an advisor with knowledge on how to do these deals,” said Schneider.
“The private equity fund takes a majority stake and then sells it back to the trade buyer, either immediately or in a few years. But it usually has the ultimate buyer in mind on day one,” he added.
For a number of mid-size Chinese chemical companies, acquiring Western businesses, in particular with technological and formulation expertise, is a natural next step in their development, the banker noted.