Catalyst

The ongoing credit crunch has put the brakes on large chemical M&A deals. Activity has slowed after a frenzied spring and early summer that saw $1-billion-plus deals frequently surface. Investment banks still need to place $200 billion-$300 billion in leveraged buyout (LBO) financing that was committed before credit markets froze in July. Banks are reluctant to fund further big deals until those loans clear, analysts say. Among big industry deals in the pipeline are Basell’s pending acquisition of Lyondell Chemical, which has $21 billion in debt financing attached, and Apollo Management’s planned acquisition of Huntsman, through its Hexion unit, valued at $10 billion including debt.

“In practical terms this means that for the next few quarters we may not see another Hexion-Hunstman transaction sponsored by a large private equity fund,” says Chris Cerimele, senior v.p. at Lincoln International. “At least, probably not in the U.S.”

Attention and activity is shifting toward deals in the middle market, or those with lower price tags. “Funding is still available for smaller deals, it’s just that the loan cost is 150 basis points (1.5 percentage points) more expensive than it was earlier in the year,” says one executive at a private equity firm that targets transactions as large as $500 million.

Deal structures are changing and terms have become more “lender friendly,” Cerimele says. “Previously a single lender would fully underwrite a deal and then syndicate post-closing,” he says. However, “we are now seeing the return of club deals, with pre-close syndication required,” he adds. Buyers are putting up more equity, and loan pricing is higher, Cerimele says. “Covenants, which had begun to disappear during the height of the market in the first half of 2007, are now reappearing,” he says.

Chemical makers, particularly those with strong balance sheets, appear better positioned now that private equity faces financing constraints. Producers say they are evaluating acquisitions, particularly bolt-on deals, but are, so far, still cautious. M&A activity is likely to be tempered by the credit crunch and concerns over the economic outlook, says Wesley Chinn, chemicals analyst with Standard and Poor’s (New York). “However, the shakeup in M&A appears to create some opportunities for chemical companies looking for strategic assets,” because firms previously faced stiff competition from private equity firms.

Dow Chemical shares surged today after it postponed an institutional investors meeting scheduled for November 6 and 7, fueling speculation that a major transaction could be imminent. Dow shares gained 3.8%, to close at $46.50/share on October 12. The shares had traded flat most of this morning, and posted the gain after the announcement was made early this afternoon.
“As we move ahead with our transformational strategy, making solid progress on several fronts, we continue to explore a number of exciting opportunities to deliver long-term value to Dow shareholders,” Dow says in an e-mail to investors regarding the postponement. “Within a few months, we will re-schedule a meeting that offers valuable insight to the company’s strategic direction, affords a rich opportunity for meaningful dialogue, and ensures we make the best possible use of everyone’s time.”

Companies involved in three pending $10-billion-plus industry acquisitions in the U.S. each indicated last week that financing for the deals remains in place, despite the much tougher credit conditions that have emerged since the deals were announced.
Sabic, which is paying $11 billion to acquire GE Plastics, scaled back the size of a planned bond offering by nearly 50% last week, in one sign of the change in credit conditions. Sabic had planned two separate eight-year bond offerings of $1.95 billion and €590 million ($800 million), but now will pursue a single $1.5-billion bond offering, according to Moody’s (London). The yields on the bond could exceed 10%, according to published reports, a sign that borrowing costs have moved sharply higher in recent weeks. Sabic will increase borrowings under senior secured credit facilities, typically loans from banks or other institutions, to $7.7 billion, from $6.4 billion, to close the financing gap. Sabic is expected to close the purchase of GE Plastics by late September.
Basell, meanwhile, said last week that it will borrow up to $21 billion to finance its acquisition of Lyondell. Basell obtained debt financing commitments as of July 16 from Citigroup, Goldman Sachs, and Merrill Lynch, and as of August 8 from ABN Amro, according to regulatory filings. The lenders have agreed to provide $14 billion in senior secured credit facilities. Basell will seek to raise the remaining $7 billion from the sale of high-yield bonds or secondary senior secured credit facilities. Lyondell is also apparently monitoring credit markets. “Basell has substantial assets, and, if the financing were not obtained and the merger did not occur, Lyondell would have recourse against Basell,” Lyondell said in regulatory filings last week.
Hexion, which is set to acquire Huntsman for $10.6 billion including debt, restated in quarterly regulatory filings last week that the deal is fully financed and set to close in first-quarter 2008, pending regulatory review. Hexion is number one globally in epoxies, and Huntsman is number three. Hexion, which is owned by private equity firm Apollo Management, may actually benefit from a prolonged antitrust review and it may be happy to extend the close until early next year. “It will be very, very difficult for private equity to issue high-yield bonds before year-end,” says one investment banker.

The global credit squeeze that has shaken debt and equity markets during the past few weeks may cool the feverish pace of industry M&A. Banks are left holding debt of about $400 billion in uncompleted management and leveraged buyouts worldwide, according to estimates compiled by Baring Asset Management (London). Several big chemical deals are in that pipeline, including Sabic-GE Plastics, Basell-Lyondell, Hexion-Huntsman, and Carlyle-PQ Corp. Industry deals with committed financing are likely to proceed, say M&A advisers that CW contacted earlier this month. However, the relationship between buyers and their lenders could become tense if banks are stuck with debt they cannot sell on the bond market. That will curtail further lending until banks are able to clear the backlog. Most bankers expect a recovery by early 2008, citing an overall strong economy. “This is a different situation than what has happened in the past,” says Richard Whitney, managing director/chemicals at Credit Suisse (New York). Lenders have clamped down despite low default rates and relatively strong earnings and valuations, Whitney says. “Credit supply and demand is out of balance right now. It is not just in chemicals. It is on a global scale. There are so many large transactions that need financing.” Borrowing costs will rise as lenders demand higher risk premiums, analysts say.
“We think this is more of a correction or pause,” says Ron Kahn, head of the debt private placements group at Lincoln International (Chicago). “If you go back to the last serious credit crunch, back in 2001, it was driven by defaults and bad credits.” But the drivers are different now as defaults are low and earnings strong. “This has nothing to do with the fundamentals. It’s purely a liquidity issue,” Kahn says. Deals already in process are progressing, says Chris Cerimele, senior v.p. at Lincoln International. However, sale processes that were planned or just starting are likely to be delayed until after Labor Day, as buyers and sellers wait for the situation to stabilize. Banks are likely to tighten lending terms going forward, analysts say.
“M&A could be a tale of two cities for each half of the year in 2007,” says Peter Young, president of Young & Partners (New York), an M&A advisory firm. “There are enough announced and completed first-half deals so that 2007 will still be a pretty active year. The second half is going to be tough, however.

Rohm and Haas (R&H) says it is considering “strategic options” for its salt business, which could include a divestment or spin-off. The company says it expects to make a decision by year-end. R&H’s salt business posted sales of $505 million in first-half 2007, an increase of 19% from the prior-year period. Earnings for the six-month period were $37 million, an increase of 85%, in line with improved sales performance, and offsetting higher operating costs, R&H says. Revenue increased on stronger pricing in the industrial and consumer markets, as well as increased demand for ice-control salt and other bulk products, R&H says. R&H’s salt business accounts for roughly 10% of its revenues and includes the Morton Salt name and trademark, including the image of the Morton Salt umbrella girl, a well-recognized consumer product symbol in North America. Also, R&H will no longer seek to maintain credit ratios consistent with an “A” rating, according to quarterly regulatory filings made late last month. “Rather, we intend to manage our debt levels in a manner consistent with maintaining investment-grade quality ratios,” R&H says in the filings. The company expects to maintain a debt ratio of 50% over the next several years, up from 35% at the end of the second quarter. R&H says it will use cash to: reinvest in core businesses; build new platforms to address growing needs in health, water, energy, and other areas; make selective acquisitions that add new technology or broaden geographic presence; continue to increase dividends; and to repurchase shares. R&H announced plans last month to repurchase up to $2 billion of its common stock, including $1 billion in shares through an accelerated buyback program this quarter that will be funded by the issuance of new debt.