ICIS Top Chemical M&A: Buyers step up to chemical M&A
The global chemical mergers and acquisitions (M&A) market is set for another robust year, with strong interest from both strategic and private equity buyers and a healthy level of assets coming to market. Interest rates in the US and Europe are climbing, but have not deterred activity yet. Trade tensions and geopolitical concerns have taken a back seat to corporates generating strong cash flows amid a synchronous economic upswing looking to put those funds to work. And private equity is also stepping up to the plate, even beating strategics in winning deals.
With demand for certain high-quality chemical assets high and not enough available on the selling block to meet demand, buyers are taking a more aggressive approach to get deals done.
“We see a lot of aggressive behaviour from buyers with an increase in preemptive approaches where strategics and sponsors are trying to pull an asset from a process or even before, testing the market,” said Leland Harrs, managing director at Houlihan Lokey. “They are offering superior value, certainty of closing and no contingencies.”
US-based adhesives producer H.B. Fuller made a direct approach to acquire Royal Adhesives & Sealants from private equity firm American Securities, noted the banker. The $1.58bn deal was completed in October 2017.
“If it’s a perfect fit, there’s no reason to not act preemptively. You want to determine what the seller deems important, and at least put yourself on the radar screen to separate yourself from the pack,” said Harrs.
“There are a number of situations where strategics or private equity firms will go start a discussion on the buy side because there is demand and you want to differentiate yourself by offering an attractive price and the certainty of a deal,” said Federico Mennella, managing director and global head of chemicals at investment bank Lincoln International.
“You want to offer a credible bid that’s financed with a quick path to signing and completion. It’s proactively shaking the apple from the tree,” he added.
Prospective buyers are even approaching private equity firms that have owned a business for only a couple years – less than the typical holding period of three to five years – to see if they are interested in selling, the banker noted.
For private equity and family office buyers in particular, being flexible on factors such as allowing owners to retain an equity stake is important, he said.
Sellers are also naturally being more selective in a seller’s market, approaching a select group of potential buyers first where there is likely to be a synergistic fit rather than going through a broad and drawn-out auction process.
“Now sellers are much more thoughtful on who buys the business. If certain buyers are familiar with the business, they are more likely to move quickly and maybe pay up for it,” said Mennella.
“As long as there are synergies, a lot of private equity buyers will not necessarily be competitive. So why not go to a select number of strategics first?” he added.
Certain strategic buyers have proven track records of buying and integrating multiple acquisitions, making them a preferred choice in doing a quick deal, said the banker. Examples include RPM International and PolyOne in various specialty chemicals spaces.
M&A BY THE NUMBERS
Global chemical M&A activity has been at relatively strong levels for years. In dollar terms, completed chemical deals rose steadily from $22bn in 2012 to a peak of $65m in 2015 before falling to $42bn in 2016. However, this surged to $155bn in 2017, driven by three mega deals – Dow/DuPont, ChemChina/Syngenta and Sherwin-Williams/Valspar. Without those mega deals, the total would have been $41bn. The first quarter of 2018 saw $19.7bn in deals closed with the Potash/Agrium fertilizer deal accounting for $13.1bn, according to investment bank Young & Partners.
And in terms of numbers of deals, “volume has been healthy, but going down steadily every year since the peak in 2014 when 109 deals were completed”, pointed out Peter Young, president of Young & Partners. So far in the first quarter of 2018, 20 deals were completed (80 annualised) compared to 88 deals for all of 2017.
“The chemical M&A market is very segmented, with some parts very strong and expensive and others much weaker and less expensive. The strongest market has been the specialty chemical industry given the high demand for businesses in that sector and the desire for growth and stability,” said Young. “Any downward shift or flattening of economic growth in the US, Europe or Asia will have the greatest impact on the commodity chemical M&A market and less so on the specialty chemical M&A market.
A HEALTHY OUTLOOK
Young sees 2018 being a healthy year for chemical M&A with the number of deals flat to slightly down versus 2017, but from a relatively healthy base. “Dollar volume will be heavily driven by how many of the mega deals close, the biggest being the Bayer/Monsanto deal. It will be hard to see the dollar total coming in under $75bn,” said Young.
The chemical M&A market continues to be very active with no end in sight to the high levels of interest.
“The M&A market is as active as ever. Chemical CEOs see nothing right now that is changing their minds on M&A being an effective tool in growing their business. There’s no reason to suspect 2018 is going to be any different than 2017 in levels of activity,” said Telly Zachariades, partner at The Valence Group.
“Some people are privately expressing some concerns regarding interest rates, the US political environment, and North Korea and the Middle East. Things of course can change very suddenly when it comes to CEO confidence,” he added.
The US Trump administration’s tough stance on trade, especially with China, has also been a concern. However, executives are taking the pronouncements in stride, he said.
“People are starting to get used to the Trump presidency and are not overreacting to every tweet and comment,” said Zachariades. “Regarding the trade war with China and the impact on exports, they are realising that some of what Trump says is for effect and posturing and is part of his style of negotiating. So even some of these rumblings have been dampened in the eyes of CEOs.”
In the meantime, all the drivers for an attractive chemical M&A market are intact, said the banker.
“The sponsor (private equity) world is still buying and selling. And corporates are using M&A to drive growth, as well as to get out of non-core businesses or those that are worth more to someone else,” said Zachariades.
“The good times will continue to roll”, said Harrs from Houlihan Lokey. “All the fundamentals that have been driving the market are intact. Interest rates are trending up but the cost of borrowing is still low. And public valuations [of chemical companies] remain high, which certainly helps companies be acquisitive at higher multiples.”
For publicly traded chemical companies, the continued resurgence of organic growth in the past few quarters is driving more confidence among senior management to make acquisitions.
“While the economic cycle is getting long, the actual fundamentals remain very attractive and there’s a lot of upside. The oil and gas market rebound is driving a lot of confidence, and the agchem market is showing improvements after years of pressure,” said Alain Harfouche, senior investment banker at KeyBanc Capital Markets.
“It’s true that the cycle has been long, but when you segment the market, some sectors have already cycled down and are just coming back. The US oil and gas market has been though a bear market, which has had a spillover effect on other sectors like water treatment chemicals. Both markets have recovered nicely,” he added.
M&A VALUATIONS AND PRIVATE EQUITY
Even with the recent rise in interest rates, borrowing costs remain low on a historical basis, underpinning high transaction valuations.
“Debt is still abundant and cheap, even with modestly higher rates. And importantly, the amount of leverage you can apply to deals is as high as ever, with some in the range of 7x EBITDA,” said Zachariades.
“Multiples are high and are likely to remain high. The 15x EBITDA buyers are paying for certain high-quality specialty assets is not as uncommon as it once was,” said Zachariades.
“And we even had an instance of over 20x in the recently announced IFF/Frutarom transaction,” he added.
Chemical assets in high demand include those in adhesives, lubricants and additives, noted Lincoln International’s Mennella. “Buyers want special, unique assets. There’s a lot of interest in finding a niche and going after it, including for companies seeking to add another leg to their platforms,” he said.
Sellers still have to be realistic when it comes to valuation, as multiples vary broadly depending on the type of asset.
“Some assets are fairly valued in the high single digits and others into the teens – you need to distinguish based on a number of factors or there will be a disconnect,” said Houlihan Lokey’s Harrs. “Some assets are less scarce and less valuable. Depending on the subsector, we’re seeing a wide range from 8x EBITDA to the teens. You can drive a truck through that.”
Coatings assets in particular continue to be in high demand as the sector continues to consolidate at a rapid pace with about five “clear consolidators”, he noted.
Corporates have clean balance sheets and remain acquisitive while private equity firms are also very eager to invest capital in the chemical sector, the banker said.
“Private equity is actually able to prevail in competitive situations with strategics. They are very motivated and well capitalised, which is supportive of high multiples,” Harrs noted.
Houlihan Lokey advised European private equity firm Astorg in its acquisition of IGM Resins from Arsenal Capital Partners, going against strategic as well as other private equity bidders. IGM Resins produces UV curable materials such as photoinitiators, acrylates and additives for the UV coatings and inks market.
“For a high-quality asset with a leadership position and attractive growth prospects, sponsors will pay up. If you have a high conviction on growth, that will justify a premium multiple,” said Harrs.
Another banker noted that Astorg paid a “solid double-digit multiple” for IGM Resins, which has EBITDA of around €50m.
This year should see the largest chemical deal for private equity in many years, as The Carlyle Group and GIC in March 2018 announced the acquisition of AkzoNobel’s specialty chemical business for an enterprise value of €10.1bn, or about 10.0x 2017 EBITDA. The deal is expected to close before the end of the year.
In 2017, global chemical deals had a median EV (enterprise value)/EBITDA multiple of 10.5x. This has been steadily rising since 2012, where the median EV/EBITDA was 7.5x, noted Chris Cerimele, founder and managing director of Balmoral Advisors.
Through 2018, certain sectors such as CASE (coatings, adhesives, sealants and elastomers), intermediates and polymers are expected to see deal multiples of around 12.5x, he said.
While private equity (PE) firms have raised huge amounts of funds for investment, they have not played as large a role in chemicals deals, aside from the pending Carlyle, GIC/AkzoNobel transaction. PE firms typically favour specialty chemical assets but lately have been creeping into commodities as competition in specialties heats up, said the banker.
“Even with record levels of available capital, PE-backed chemical M&A activity in 2017 was the lowest since 2010 owning to high valuations,” said Cerimele.
PE firms have been forced to pay higher multiples to win deals, with the median EV/EBITDA multiple for North American deals rising to 6.9x in 2017 from 6.2x in 2016. However, this is still far lower than the overall median of 10.5x for global chemical deals in 2017, he pointed out.
“For 2018, as valuations of specialty chemical companies are expected to stay high and PEs reluctant to acquire Asian and commodity chemical companies, PE activity in chemicals is expected to remain lukewarm,” said Cerimele.
“As long as private equity continues to focus on specialty chemical deals and less on China and commodity chemical deals, they will find it tough to win against motivated strategic buyers. This is particularly true of the larger deals,” said Young of Young & Partners. “On the other hand, private equity firms are lowering their return requirements given their need to deploy capital. We are also seeing a lot of private equity-owned businesses being sold to other private equity firms.”
PRIVATE SELLERS COMING OUT
With valuations where they are, “some companies are deciding to sell or considering it, where they never would have several years ago”, said Harrs.
In particular, there are more private chemical assets coming to the selling block as owners seek to take advantage of high valuations and also partner with private equity or family offices to get more competitive.
“Valuations continue to be strong and there are a lot of private owners either in the market to sell, or entertaining discussions with private equity firms to grow their business,” said KeyBanc’s Harfouche.
“A decade ago, many of these companies would never have thought about it. But markets and peers are consolidating and it’s tougher to compete when you lack scale. From a competitive standpoint, you can try to slowly scale the business organically or get capital to supercharge growth,” he added.
And the demand is there for these smaller, private chemical businesses across multiple product areas, said Harfouche.
While assets with scale, strong margins and a good growth trajectory have always commanded attractive valuations, today even smaller ones with EBITDA in the $5m-10m range are being sold at healthy valuations, the banker noted.
This is a function of private equity firms having abundant capital, as well as there being a “serious gap” of private chemical companies with EBITDA in the $30m-50m range that tend to be most attractive to both middle market strategic buyers and sponsors.
“So there’s a ‘buy and build’ strategy to fill that gap where private equity is trying to buy smaller assets and roll them up to that level,” said Harfouche.
Privately owned chemical businesses have also become more receptive to private equity today as the latter’s model and even perception of the group has shifted through the years away from the “Gordon Gekko” (the movie “Wall Street,” 1987) archetype, to more of a growth emphasis.
“The view around private equity has evolved over the last decade. They’re not going to max out leverage, strip out assets and get rid of the team,” said Harfouche. “Today it’s all about adding value, whether bringing in thought leadership and capital, introducing new opportunities not available to smaller businesses, and cross-pollination of best practices accumulated through owning other chemical businesses over the years.”
BACKLASH TO HIGH VALUATIONS
With M&A valuations elevated in many cases, not everyone is comfortable taking part in the action.
“Some buyers just want to sit it out, as valuations are at historical highs. Some are instinctively not comfortable paying double-digit multiples, as there’s the risk that if business turns down, they could be stuck with the asset or generate subpar or negative returns,” said Houlihan Lokey’s Harrs.
Some buyers are starting to avoid hot sectors and instead turning to more traditional businesses. “Certain players are shying away from sectors with inflated valuations – which can be observed in certain sub-segments such as cosmetic ingredients, personal care chemicals, specialty food ingredients or pharma fine chemicals where in many cases 15x is the new 10x in terms of EBITDA multiples,” said Bernd Schneider, managing director and global head of chemicals at Germany-based investment bank Alantra.
Many investors are competing for these assets – assuming they are not cyclical and benefiting from global megatrends – and thereby driving up valuation, he noted.
“Everyone has been jumping on the same assets [in food, cosmetics and pharmaceutical ingredients] because no one wants to buy a cyclical asset at the top. So they turn to the less cyclical megatrend ones, but that leads to inflated multiples,” said Schneider.
Less valuation inflation has been seen in “good old industries” such as resins and polymer additives, where multiples may have risen – if at all – by a turn (1x EBITDA), but not 5 or 6 turns, he added. “This makes these ‘good old industry’ assets more attractive.”
Rising interest rates might be a trigger for a deflation of transaction multiples in the coming years, posing a threat to buyers paying high multiples today, he noted. “Even if EBITDA moves in a positive direction, you can still lose money if you have to exit at a lower multiple,” said Schneider.
“Private equity in particular is now turning to ‘good old industry’ assets, as there is less competition for deals, and less deflation in multiples expected.”
ASIA BUYERS more selective
Another trend is that Asia-based buyers are becoming more selective in acquiring Western chemical assets.
“Asian buyers continue to look at chemical assets and are particularly interested in technology and market access, but they have become more picky in the last few months,” said Schneider.
“Some are not familiar with auction processes in the US and Europe, especially when it is a private equity seller,” he added.
The auction process can involve using a “clean room” into which sensitive competitive information from both the seller and prospective buyer is placed and only accessible by a third-party consultant to evaluate synergies as well as potential problems with any deal.
Another tool used for a quick closing is the “locked box” pricing mechanism, where the price is fixed at signing based on a historical balance sheet rather than determining adjustments to the price at closing, which can extend the process.
Paying interest on the purchase price at closing when using locked box mechanisms is another example of what Western investors and private equity in particular usually agree on, while Asian investors first have to get familiar with the process, the banker said.
“Sellers also typically don’t want to provide indemnities – they want a clean exit,” said Schneider.
“Any many Asian trade buyers do not have experience with W&I (warranty and indemnity) insurance concepts. Because of that and many other cultural differences those buyers need to be treated individually and with special attention in an auction process,” he added.
China-based buyers have their own challenges investing funds abroad because of capital controls imposed by the government, he added.
When weighing a private equity bidder versus an Asian strategic buyer, a seller may favour private equity if it wants a quick sale process and deal certainty is key.
“A private equity buyer doesn’t want to see all 25 sites where Asian chemical companies typically want to visit all locations to tick the box,” said Schneider.
Given the regulatory issues, particularly in China with regard to moving capital out of the country, many Asian companies are prepared to pay a break-up fee to give sellers comfort in case the deal is not approved.
“Sellers recognise there is a greater chance for the deal to fall through, so many buyers are proactively providing break-up fees. This is a relatively recent trend,” said Schneider.
DOWNTURN IN 2019?
And while the good times are rolling in today’s chemical M&A market, activity could be poised to slow down in 2019, especially if interest rates continue to march higher.
“It looks like 2018 will be another strong year for chemical M&A. However, deal activity from 2019 onwards is expected to relatively cool down, dampened by higher interest rates and a cyclical easing in global trade and investment,” said Cerimele of Balmoral Advisors.
“After a six-year bull market in chemical M&A, people are questioning how long this will last.”
But for the rest of 2018, higher deal valuations continue to be bolstered by improving economic conditions and inexpensive financing while companies continue to consider M&A necessary to drive higher earnings growth, he said.
FLAVOURS AND FRAGRANCES HEATS UP
MERGERS AND acquisitions (M&A) activity in the flavors and fragrances (F&F) sector is heating up, as companies race to build their capabilities in natural flavours.
“The F&F space has been particularly active. The IFF/Frutarom and Givaudan/Naturex deals are evidence of further consolidation with a focus on natural flavour ingredients which is a bigger part of the F&F market than fragrances,” said Allan Benton, vice chairman and head of chemicals at Scott-Macon.
“This consolidation is analogous to the coatings market, where there are three major players and the agricultural chemicals market, where there will be four major companies after the Bayer acquisition of Monsanto,” he added.
US-based IFF announced its $7.1bn acquisition of Israel-based Frutarom on 7 May, creating an “industry leader in naturals”, the company said.
“Frutarom has been one of the more acquisitive F&F companies, completing more than 30 transactions in the past three years,” said Benton.
Earlier in March, Switzerland-based Givaudan announced the acquisition of France-based natural flavors company Naturex. It would acquire 40.6% of the shares of Naturex for €522m, and launch a tender offer for the rest, for a total cost for the equity of around €1.29bn.
The total enterprise value (TEV) for the transaction including net debt is €1.45bn, noted the banker. “With these two acquisitions, four F&F companies – Givaudan, IFF, Firmenich and Symrise – will have slightly more than 60% of the global market and will plan to maintain or grow their positions,” said Benton.
“The emphasis on natural ingredients is a big driver. Frutarom is primarily a flavours and natural ingredients company which will add significantly to IFF’s presence in the flavours space. In 2017, flavours accounted for 48% of IFF’s sales with the balance in fragrances,” he added.