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M&A: Solid activity expected to continue in second half
10:19 AM MDT | August 28, 2013 | Vincent Valk
With a first-half recovery in activity and a number of large chemical assets put up for sale over the past two months, bankers say the remainder of 2013 should be busy for merger and acquisition (M&A) activity. In July, Dow Chemical, DuPont, and Ashland announced they are evaluating strategic options—including possible sales—for assets that generate more than $15 billion in total revenue. Financing remains favorable, and private equity firms are interested in chemical assets, bankers say.
Deal activity increased in the first half, although hardly to peak levels, according to Peter Young, president of Young & Partners (Y&P; New York). Some $19 billion in M&A deals over $25 million was completed during the first half of 2013, about double the level of 2012, according to Y&P. The number of completed deals was up 20% year-on-year (YOY), to 42, Y&P adds. “Although market volume in the first half has picked up … the number of large deals is still subdued due to residual CEO concerns about global economic and financial issues,” Young says. “Volume going forward should be solid.”
Other bankers and analysts agree that M&A activity should rise through the second half but offer some caveats. “There is a significant improvement in activity,” says Mario Toukan, head/chemicals with KeyBanc Capital Markets (Cleveland). “The second half should be stronger than the first but not at historical norms.” The second half should “pick up, but not at the pace we’ve seen in the past,” says A.J. Scamuffa, US chemicals leader at consultancy PricewaterhouseCoopers (New York). “I think 2014 will be strong, but I don’t see 2013 being that strong. The second quarter was exceptionally slow, and it will get better, but not that strong,” he adds.
One risk is the state of financing markets. Easy financing for M&A transactions has been a boon, but debt markets got a bit choppy this past spring. Interest rates have started to rise from record low levels. “If you’re looking for potential downsides to the current market, one of the things that may happen is some of the easy credit that’s been available starts to dry up and we see rates go up, but overall I think we’re looking pretty good for the next 18–24 months,” says Telly Zachariades, partner with The Valence Group (New York). “Obviously, we’ve already seen some edging up of interest rates, and that has had a little impact on the edges—but, thus far, it’s been pretty marginal.”
When Federal Reserve chairman Ben Bernanke discussed pulling back quantitative easing in the spring, it gave some bankers in the debt market pause. “It was the first indication that … the door isn’t going to close, but rates will start creeping up,” says Patrick O’Keefe, principal with Excellere Partners, a private equity firm. “Whether they creep up enough to materially impact the market is another question.”
Higher interest rates would make financing costs higher generally but could have a particular impact on private equity buyers. Private equity firms have typically been able to support solid multiples for businesses of all sizes largely because of the easy availability of debt. Private equity firms have been heavily involved in most auction processes, bankers say, and have been aggressively pursuing desired acquisition targets. “If you’ve got 10 people in the running [in an auction process], more than half are probably private equity,” Zachariades says.
Strong financing markets have supported strong Ebitda multiples for chemical companies that were sold to private equity buyers. Adhesives maker Adco, for example, sold to Arsenal Capital for nine times Ebitda, with two-thirds of the purchase price covered by debt. Adco will be integrated into Arsenal’s Royal Adhesives business. Last year, DuPont sold its automotive coatings business to Carlyle for about eight times Ebitda, in a deal valued at more than $5 billion. “A number of deals that have been announced recently have been [private equity] because they can get a lot of leverage,” Toukan says.
Higher interest rates could make things more difficult for private equity buyers—however, many bankers say they are more interested in the chemical industry than ever before. “As we talk to private equity about what they like in industrials, chemicals is usually one of the first things they talk about,” says David Bradley, global head/industrials investment banking at Jefferies (New York). At a panel of private equity insiders at Jefferies’ Global Industrials Conference at New York earlier this month, all four participants listed chemicals as a strong area for investment—the most of any industrials sector. “There are usually a lot of assets and good cash flows [in chemicals],” Bradley says.
Hedge funds, including activist investors, have recently taken notice of the sector along with private equity firms. Activist funds, for their part, motivate industry executives to speed up portfolio evaluation, as in the case of companies like DuPont and Ashland, but generally do not them to do things they otherwise would not, bankers say.
Such portfolio evaluation includes interest in acquisitions on the part of chemical companies in addition to divestitures. “Boards are encouraging CEOs to do M&A to build scale, get growth, get synergies, and to build a better market position in the event that we go into a period of really low growth,” Bradley says. Industry executives often see M&A as a path to growth in a sluggish economy.
Most companies are cautious, however. “Large strategic buyers will pay a bit more [than private equity], but they want a clean business,” says John Beagle, managing director with Grace Matthews (Milwaukee). Sellers of high-growth businesses that can fit snugly into large chemical companies are commanding high multiples. Most chemical companies are looking for assets in growing markets with a technology advantage that can be folded neatly into existing businesses. However, such situations are quite uncommon, since such assets are rarely up for sale. FMC’s $345-million acquisition of omega-3 fatty acid maker Epax (Alesund, Norway), to give one example, represented a double-digit multiple, according to a source.
Oilfield chemicals, construction chemicals, and personal-care chemicals are three industry subsectors that currently attract lots of M&A interest, bankers say. Oilfield chemicals are more complex but have generated a lot of interest because of the shale boom, according to Beagle. The specialized nature of the business makes it an attractive investment for many chemical companies. “It is technological expertise, engineering-intensive, one-off customized products for different customers and different wells,” Beagle says.
Personal care “is resilient. It has good organic growth opportunities. It’s got a lot of moving parts and a lot of opportunities to make a play into it,” says Lee Harrs, managing director/chemicals and cohead/corporate finance with The PrinceRidge Group (New York). The US housing rebound, meanwhile, is driving interest in construction chemicals, bankers say. “The market has come back nicely for a lot of products, and companies want to get exposure to it as a result,” Harrs says.
Regardless of sector, most industry bankers say the end of this summer is shaping up to be unusually busy. While most say that the multibillion dollar portfolio announcements are unlikely to have a trickle-down effect into the rest of the M&A market, they are optimistic that the end of 2013 will be better than the beginning—and better than 2012—for chemicals M&A. Companies and private equity firms still have loads of cash, executive confidence— which dragged down the market in 2012—has improved somewhat, and while interest rates might rise, they would be rising from all-time lows. It all adds up to a solid, but not spectacular, year.