LONDON (ICIS)--Interest in chemical company acquisitions continued to be strong throughout 2017, but the steady growth of multiples paid for targets and the failure of several of the year’s most high-profile deals raises questions over whether buyer appetite has peaked for the time being.
The number of merger and acquisition transactions agreed in the sector continued at the rates seen over the last few years, averaging 26 deals per quarter, but the scale of acquisitions fell compared to the fever pitch of the last few years, when many of the industry’s biggest players merged to create progressively larger superfirms.
2017 vs 2016
Chemicals industry M&A value fell 70% during the first three quarters of 2017 compared to the same period a year earlier, but this is comparing against an extremely high bar. The $231.1bn of chemicals M&A throughout 2016 was $85bn higher than in 2015, and quadruple the $55.6bn in 2010, according to Deloitte.
The flurry of growth has been overwhelmingly concentrated in the upper tier of acquisitions, which make up the lion’s share of the growth. Although the number of acquisitions done at over $1bn has barely moved in 2016 compared to 2010, the value has skyrocketed, with $231.1bn compared to $39.2bn at the start of the decade.
In terms of pure deal value, none of the first three quarters in 2017 broke the $20bn mark, a watermark beaten each quarter last year when M&A dealflow was $50bn or higher for three quarters of the year and averaged $42.25bn per quarter.
The year also saw Europe diminishing in prominence as an arena for M&A compared to China and the US, after several years where European companies were either the acquirer or the target in some of the largest deals, such as ChemChina’s $42bn planned acquisition of Linde, or Bayer’s $57bn takeover of Monsanto.
As of the end of the third quarter, only two deals involving European players stood in the top 10 of the year for M&A, compared to nearly half in 2016.
One of those was the now-scrapped merger between Clariant and Huntsman which, at an estimated deal value of $6.73bn, would have been the most significant transaction so far this year. A takeover attempt of AkzoNobel by PPG also fell apart on the back of opposition by the Dutch company.
Deals and megadeals
Another significant European deal that does look set to cross the finish line was BASF’s acquisition of Solvay’s polyamides business for $2.2bn, representing an extremely reasonable seven times earnings before interest, taxes, depreciation and amortisation (EBITDA) compared to the fever pitch some valuations have reached.
The company has also agreed to merge oil and gas arm Wintershall with LetterOne’s exploration and production business DEA, to create a significant German player with combined revenues of €4.3bn in 2016.
At the time when peers like Dow and DuPont and Bayer and Monsanto were pursuing megadeals, Kurt Bock had faced pressure to secure a transformational deal for BASF, a push that still rankles for the CEO.
“Sometimes it feels like with today’s standards, everything is small unless you spend double-digit billions of dollars, but it’s really about the competitiveness of the individual businesses,” he said earlier this year.
While many of these flagship deals were brokered in 2015 or 2016, the complexity and regulatory scrutiny of company mergers at this scale means that many are still inching toward the finish line.
The merger of Dow and DuPont was completed in the second quarter of the year and the business published its first financial results as a combined company in November, while Bayer and Monsanto are negotiating a European Commission review about the impact of their merger on Europe’s agricultural sector. Hundreds of millions of dollars-worth of divestments are still expected if the deal is to close.
The merger process continues for Linde and Praxair, but Linde reached the crucial 90% shareholder assent threshold in November, allowing it to squeeze out remaining investors, while the Agrium and PotashCorp merger is now expected to conclude in early 2018.
Cheap debt, expensive
The fundamentals driving the churn of acquisitions and divestments by chemicals players continue to hold, with cheap debt fuelling purchases and the need to divest non-core assets and move further up the value chain still resonating for European firms.
Market consolidation has been driven by the need to generate growth in a tepid economy. Global growth has strengthened in 2017 and with it company sales, but a decade of economic weakness has left chemicals producers seeking scale as a means of boosting earnings.
Acquisitions can also offer more predictable returns with lower risk than new greenfield investment, with more immediate cashflows and benefits that are simpler for investors to digest, according to Lloyds Bank director for chemicals James Buckle.
“What we’re hearing from commentators and companies is that they’re more likely to look at M&A [mergers and acquisitions] as a way of growth rather than brown/greenfield investment, because you can measure the impact on your bottom line much more through M&A, removing a degree of uncertainty,” he said.
This has fuelled speculation for years that prospects are becoming unaffordable, a potential threat to the M&A boom, but this has yet to become apparent, according to advisory firm Valence.
If so, why are acquisitions still being undertaken at a brisk pace?,” the company said.
The sum that high-margin specialty chemicals and additives companies can hope to fetch on the sales block has risen from 10 x enterprise value to earnings before interest, taxes, depreciation and amortisation (EBITDA) to 14 times over the last seven years, according to the firm.
The prices that companies are fetching does mean that multiples may have moved in some cases above margin growth, but announced profits tend to lag share price rises, meaning that it will not be clear until early next year whether costs and multiples have decoupled, the firm added.
However, 2017 was a year when valuations and, arguably, a lack of strong targets, did come into play, with AkzoNobel citing the expense of acquisitions at present as the primary motivator for pursuing a merger with Axalta rather than a takeover.
This caution led to a more deep-pocketed potential acquirer, Nippon Paints, move into talks with the US firm, although those negotiations also fell apart due to the Japan-based firm being unwilling to meet Axalta's price.
Prices were also cited by outgoing Covestro CEO Patrick Thomas as a factor in his decision to use the company’s growing war chest on a €1.5bn shareholder buy-back instead of an acquisition.
“We said mid-year that if there were any M&A opportunities [we would consider them] because we obviously have plenty of cash, but only if they were value-creating. By the end of the third quarter, our conclusion was that no M&A target we looked at would generate value for us – they were too highly priced,” Thomas said, speaking to ICIS in October.
Rise of the activists
Another trend that has belatedly surfaced in the European M&A sector this year is the rise of the activist investor. Coming several years after analysts projected a growing activist presence in Europe as the list of available targets fell in the states, at least two deals this year were characterised by their presence.
US hedge fund Elliott Advisors was a strong ally to paints maker PPG during the firm’s attempt to buy AkzoNobel, advocating on the company’s behalf and even taking the Dutch firm to court in a bid to unseat board chairman Antony Burgmans.
Clariant also found itself in the firing line, after White Tail intervened during its planned merger with US rival Huntsman, a rare instance of an activist pushing to avoid a deal rather than broker one.
These instances speak to the growing prominence of activists in Europe, but also their limits. In the US, activists were a driving force in some of the biggest deals in the sector, pushing Dow and DuPont together despite longstanding opposition by Dow CEO Andrew Liveris, and replacing DuPont chief Ellen Kullman with the more receptive Ed Breen.
Conversely, Elliott failed to impose its will on AkzoNobel despite the support of some other prominent shareholders, due in part to worker representation on its board and shareholder base.
And White Tale was successful with Clariant, but the Huntsman deal was widely seen by industry sources as the weakest of the spate over M&A deals over the last few years, with few compelling synergies between the companies.
With headline M&A deals continuing to surface at a relatively brisk pace and private equity interest in the sector continuing strong, no immediate downturn in activity is expected in early 2018.
AkzoNobel’s specialty chemicals business divestment is expected around the end of the first quarter, with a sale seen as the likely outcome, and AkzoNobel itself may still face another offer from PPG or another player.
With Axalta's hopes of a Nippon Paints buy dashed, there is the potential for a rapprochement between Akzo and the US-based company. Whatever the outcome, the trend of consolidation in the paints and coatings sector does not seem to have run its course yet.
The megadeals may also continue to produce acquisition targets through regulator-dictated divestments or the shifting priorities of the businesses as they integrate and scrutinise their newly-combined operations.
But, after a year when deals were scrapped or failed to materialise because of price concerns, and some players seemed almost to be chasing deals for the sake of avoiding being left behind in the M&A wave than because of a compelling value proposition, some moderation may set in.
With the global economy booming at present and only a moderate drop-off from that expected next year, and central bank monetary policy remaining doveish despite some mild adjustments, companies are likely to have the cash and debt finance available to continue to snap up opportunities.
A crash is unlikely, but with pricing potentially breaching profits for the first time in several years, and fewer available targets than there have been for some time, the market may dial back its spending spree until valuations cool down.
By Tom Brown