In a nutshell, or should I say in a stainless steel tote tank, the future of the chemicals industry in 2015 looks exciting. The conditions for buying companies and merging businesses in the sector are good, and they continue to build on the steady increase in activity over the last two years. Corporate balance sheets are generally strong, and both strategic and private equity buyers are seeking opportunities to acquire new firms, encouraged by low interest rates and growing world demand.
As Peter Young, president of investment bank Young & Partners says,“The strong Mergers and Acquisitions (M&A) market in 2014 … will continue into 2015. Pent-up demand for growth and the build-up of cash have been and will be drivers for demand for strategic buyers. While available low-cost debt financing and unused funds will continue to drive deal demand for financial buyers.”
In 2014 alone, there were almost $40bn worth of deals, including almost 90 deals worth over $25m each. This represented an 8% increase in the number of transactions in the first three quarters of 2014 compared to the same period the year before, a situation that doesn’t look like changing.
As Bernd Schneider, managing director and head of chemicals at investment bank N+1 says, “We expect the healthy chemical M&A momentum to continue in 2015. The overall environment of high liquidity and available financing on the one side and both strategic and financial investors’ appetite to invest … are here to stay,”
Mario Toukan, managing director and head of chemicals investment banking at KeyBanc Capital Markets, is also upbeat, believing that the first quarter of 2015 could be “flush with new deals”.
So things are hotting up and they don’t look like cooling in the coming months, but why?
Why should we expect more deals?
Telly Zachariades, a partner at The Valence Group investment bank, helps explain. “A number of factors are conspiring to make this M&A market unusually buoyant. Companies are continuing to be active in restructuring their portfolios, sometimes of their free will and sometimes under pressure from activist investors. Activist investors usually act as a catalyst to accelerate or encourage restructuring, which often leads to M&A activity.”
This includes an increase in investor activity that is targeting the chemicals sector, particularly in the US. This is evident in recent asset sales, where several big companies have been part of sell offs and trades including DuPont, Ashland, Dow Chemical, American Pacific, Ferro, Air Products, Calgon Carbon, MeadWestvaco (a packaging company with a specialty chemicals operation), Innophos and OMNOVA Solutions.
Dow, for example, is solidifying its chlor-alkali and derivatives businesses, by increasing its divestiture target to $7bn-8.5bn by the middle of 2016. Whilst in December 2014, it agreed to sell Angus Chemicals, an additives and intermediates producer to private equity firm Golden Gate Capital for $1.2bn. It also sold its sodium borohydride business to Vertellus Specialty Materials, whilst its polyolefin films plant in Ohio, was part of a $225m deal with Valgroup Packaging Solutions.
DuPont, meanwhile, is rumoured to be planning to spin-off its performance chemicals segment, including the world’s largest titanium dioxide (TiO2) business before the end of the year.
Ashland completed the sale of its elastomers business to Lion Copolymer in December 2014. While OMNOVA Solutions is said to be in the sights of investor Barington Capital, which is pushing for the sale of the company’s engineered surfaces segment (decorative components, functional surfaces for buildings and automotive).
Deals like this become understandable when you begin to see them through the eyes of an investment specialist. As Zachariades makes clear, “Chemical companies are relatively easy targets when it comes to activists. You can easily look at a company with multiple divisions of which not all will be #1 or #2 in their field, or which are more cyclical or more commodity or have low growth. Then the question becomes: Why remain in these businesses? The answer is usually not so simple. But rest assured – we’ll continue to see more of this dealing activity in 2015.”
But what makes the current business climate for mergers and acquisitions so interesting is that there is a double storm, with corporations, as well as investors, taking an interest in buying up chemical firms.
“For corporates, the main question is: How do we grow? The global chemical market grew at just 2% over the past 12 months,” said KeyBanc’s Toukan. “CEOs are focused on whether they can build out a new business that can grow faster than GDP.”
Bernd Schneider, of investment bank N+1 agrees that corporates are looking to buy, but sees other reasons and some more specialized areas for growth. He believes that, “Higher growth opportunities outside Europe are expected to continue urging owners of maturing businesses to reconsider their portfolio strategy and make use of attractive valuation levels. However, buyers are increasingly picky, so the valuation gap between attractive businesses directly addressing the mega trends – food and feed ingredients, functional food, etc – and more mature ones such as standard textile or leather chemicals, commodity polymers/fibres has the potential to widen.”
What might stop mergers from happening?
Certainly there are some factors that might affect the number of deals that happen in the coming months, not least of which is the uncertainty of global politics in Ukraine, Russia, Southern Sudan and North Africa, Thailand and Turkey.
The European economy still holds areas of weak or stagnant growth, and oil prices continue to cause hesitancy among investors. That said, the decline in oil prices, while compressing margins at certain petrochemical companies, particularly those in the US, may have a net positive impact on M&A, as European and Asian producers become more price competitive.
“The biggest single risk out there is interest rates going up. That would reduce the amount of leverage you can put on an asset, as well as increase the cost,” said The Valence Group’s Zachariades. “The competitiveness of private equity players is very much dependent on the cost of debt. Private equity firms won about 50% of the asset auctions in 2014 versus corporates.”
The debt financing market has been strong for many years, but it too moves in an economic cycle, meaning that at some point in the future it will soften and interest rates will rise. Investors and CEO’s know this, and may well decide to act, and buy now, rather than wait for the cycle to end.
Private equity firms have always been major players in M&A, and they will continue to be in the foreseeable future. As Young from Young & Partners says, “They accounted for 25% of the total number of deals completed and 29% of the dollar value ($9.3bn) in the first three quarters of 2014. This is an increase from the pace earlier in 2014 and 2013 and will continue in 2015. They have a lot of money to invest and the chemical industry has become a popular sector.”
This is a belief supported by Toukan from KeyBanc, he notes how some private equity firms “have really defined themselves in chemicals. Arsenal, SK Capital, CCMP, American Securities and HIG – have been buying all the businesses. They’ve built a lot of expertise over the years in chemicals and are winning against sector agnostic funds.”
Another appeal of the chemicals industry for many investors is how streamlined it is. During the financial crisis, many firms went out of business, so only the profitable remain. A point outlined by John Beagle, managing director and co-founder of Grace Matthews investment bank, “The quality of assets is very high. The pressures on the chemical industry over the last 10 years have made companies better. If they’re not good, they don’t exist anymore. (So) it’s a good time to be a seller. Sponsors are still challenged to find assets at a reasonable price.”
So what sectors are investors looking at?
Opinion is divided on where the next big deal will come from, but Beagle from Grace Matthews has some names to share.
“The benefit of scale in formulated chemistry has never been greater with the ability of large companies such as PPG industries, Sherwin-Williams and AkzoNobel to leverage technologies, supply chains and brands.”
Chemical companies with business in attractive end markets such as construction are gaining interest, as well as niche businesses such as food ingredients, will be a hot sector according to KeyBanc’s Toukan.
Meanwhile, N+1’s Schneider said, “We expect particularly high momentum in food/feed additives, lightweight materials based on glass or carbon fibre composites, and coatings. The consolidation in certain chemical sub-industries such as construction chemicals where consolidation can additionally pick up momentum (with St Gobain’s recently announced intention to acquire Sika, or agro and pharma oriented fine chemicals) should continue throughout 2015.”
This is a good time to be in the chemicals industry. The world economy is going from strength to strength, so there is good business to be made for both employees and employers. But with an increasing amount of money chasing acquisitions in 2015, it is a seller’s market. So if you are a chemicals business owner who is considering selling then, as John Beagle with Grace Matthews said,” this would be the time.”