Interview article by Tom Brown
LONDON (ICIS)--Chemicals companies are looking to mergers and acquisitions over investment in new greenfield or brownfield production capacity as a more predictable, lower-risk way of driving growth, according to a chemicals specialist with UK banking group Lloyds.
Increasing certainty of stable oil pricing and a more bullish economic outlook relative to the same time a year ago have led players in the industry to look to bolt-on and larger transformational acquisitions, which offer more predictable cashflows than new capacity, according to James Buckle, director and regional head of chemicals and manufacturing products, global corporates, commercial banking for Lloyds Bank.
“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," Buckle said.
Mergers and bolt-on acquisitions can provide more immediate and predictable cashflows than building a new petrochemicals plant, making it a more compelling avenue for growth while the global economy remains sluggish, according to Buckle.
The wave of M&A spending is driven in part by a more optimistic market compared to last year, with the oil production deals agreed between OPEC and some non-OPEC states establishing a price floor for oil over the last months and giving a clearer view on company balance sheets in the mid-term, Buckle said.
Pre-buying and healthy industrial growth is likely to result in a banner set of first-quarter results from European chemicals players, according to Barclays Bank.
The perception of prevailing political uncertainty in Europe as a result of the spate of major elections slated for the year belies the continuing momentum of economic growth in the continent, meaning that company performance is a lot stronger than headlines may currently suggest.
“Despite political upheaval from Brexit, the US election, and increasing protectionist sentiment, it is a very different world now, and on balance much more positive. The OPEC and non-OPEC agreements have given the chemicals industry some form of price stability,” Buckle said.
“It's a very significant contrast to where we were this time last year,” he added.
The M&A landscape for the last year has been dotted with merger agreements between some of the largest companies in the chemicals industry such as Dow and DuPont, but opportunities for bolt-on deals are continuing to emerge as producers move to slough off non-core businesses.
While the former draw the bulk of the headlines, smaller, less transformational deals are a less costly, time-consuming, competition authority-fraught way of driving growth, according to Buckle.
“[Transformational deals] are very costly from a time perspective, with a very high degree of regulatory scrutiny, so companies are looking at bolt-ons as a potential way forward,” he said.
The M&A drive is being driven by a torrent of cheap money sloshing around the financial system, due in part to central bank moves to discourage bank saving and encourage lending.
The European Central Bank has held interest on deposits for private banks at negative rates for over two years. This, coupled with low rates for savers, has created a substantial pool of investors looking for returns.
“From a bank lending perspective [the market] remains very competitive,” said Buckle. “For investors looking at broader capital markets, yields remain very low and they have been depressed through corporate bond-buying programmes, which means there’s been a race for yield from investors looking to place that money.
“Cash on balance sheet continues to be a drag, so placing that money in anything that has a positive yield is a more positive use than anything else,” he added.
The danger with an acquisition-focused market fuelled by readily-available cheap debt is of acquisition multiples creeping up, a factor underlined by strategic buyers increasingly bidding as aggressively as the private equity buyers that have traditionally been a mainstay of the chemicals mid-market.
“If we stray slightly away from purely chemicals, manufacturing in its broader sense has seen valuations creep up and become very competitive. Strategic buyers have become a lot more active,” Buckle said.
Valuation creep is also a danger that has been noticed by company shareholders, Buckle added, and price discipline is holding so far despite some froth in the market.
“Market participants are telling us [the market is] competitive [but] there are limits,” he said. “Discipline prevails and when we talk to our clients [we hear of] clear expectations from equity investors that discipline must be adhered to from a valuation perspective," he said.
Although executive outlooks are rosier now than in early 2016, the current firm pricing for European chemicals is unlikely to continue, with several key markets facing the onset of lower pricing due to oversupply.
The spectre of eroding feedstock price competitiveness in the wake of the US shale gas boom, passed over for Europe for several years due to the extent of the fall in the oil price from late-2014, is also likely to become more deeply felt in coming years.
The mathematics of the move by European players to import lower-cost shale feedstocks from US to crackers in the UK, Norway and Sweden seem to be holding for now, but whether shale gas will be a solution for European firms in the longer-term remains unclear, Buckle said.
Staying ahead of international competition in terms of research and innovation remains the key route for European players to continue to prosper in the face of uncompetitive energy and feedstock costs, Buckle said, particularly for companies that are not in a position to take a dominant role in a particular market.
“Some companies have demonstrated some very clear strategies that are focused on cost and targeting market share, and they have been very effective. Time will tell whether their assumptions hold true,” he said.
“I think… we’ll see the large-scale names focused on costs and volumes, [and there] is room for mid-sized firms to operate where their value add is their intellectual property and innovation. Time has shown us that more often than not these companies do get acquired if they are successful, or they become JV partners with the larger names that can take products to market through their larger platform,” he added.
Chems industry targets M&A over new capacity for growth - Lloyds
Interview article by Tom Brown