M&A: The market’s missing pieces
11:55 AM MDT | March 12, 2013 | —Vincent Valk
Chemical sector M&A activity slipped in 2012 as economic uncertainty and a scarcity of available quality assets dragged down volumes despite favorable market conditions. Strong conditions remain, however, and activity should rise in 2013.
The year 2012 was an unusual one for the chemicals M&A market since low CEO confidence and a lack of quality assets for sale undermined a market awash in cash and easy financing. However, bankers expect activity to rebound in 2013, especially in the second half, as CEO confidence improves and divestiture activity picks up.
Last year was surprisingly slow, says Lee Harrs, managing director/chemicals and co-head corporate finance at The PrinceRidge Group (New York). Despite this, “the conditions were good,” he adds. Financing markets are attractive with buyers able to finance at very low rates even for large deals. Both chemical companies and private equity firms have capital waiting to be put to work. Executives continue to view acquisitions as a way to grow by gaining market share and to improve cost or market position in a low-growth environment, although they are cautious about getting far from core businesses, bankers say.
Young & Partners (Y&P; New York) says that chemicals sector M&A deal value fell 73% year-on-year (YOY), to $22 billion (CW, Feb. 18, p. 13). Volume was down, too, by 23%, to 64 deals. Uncertainty and “concern about the global economic and financial outlook” were the main reasons for the decline, says Peter Young, president of Y&P.
Specialty chemical deal activity was “down from a very high year” in 2011, says Allan Benton, vice chairman at Scott-Macon (New York). “Acitivity came down some but did not stop.” Scott-Macon says that specialty chemicals deal value for closed transactions fell 62% YOY in 2012, to $23.6 billion, while deal volume fell 32%, to 34 transactions. The figures for 2012, while down significantly from 2011, were closer to the 10-year medians for specialty chemicals. The ten-year median for specialty chemicals deal value stands at $31.1 billion, while the median number of transactions is 34, according to Scott-Macon.
“The numbers speak for themselves,  was less robust than 2011,” says Mario Toukan, head of chemicals at KeyBanc Capital Markets (Cleveland). “In 2011, you had a number of large transactions; in 2012 there were fewer megadeals.”
In 2011, the chemical industry did, indeed, see an unusual number of big M&A transactions—Ashland-ISP, Berkshire-Lubrizol, Clariant-Süd Chemie, DuPont-Danisco, and Solvay-Rhodia, to name just a handful. By contrast, in 2012, 7 deals over $1 billion were completed compared with 17 in 2011, according to Y&P. One of those, Eastman’s $4.7-billion acquisition of Solutia, was announced very early in the year.
There is, however, one important metric that bucked the downward trend in 2011: valuation multiples. According to Scott-Macon, the median Ebitda multiple for specialty chemical deals in 2011 was 10.4 times (x), a slight decrease from a record 10.7x median multiple in 2011. The median multiple for 2012 was 8% above the 5-year median from 2007 to 2011, Scott-Macon says.
The resilience in multiples reflects, essentially, the easy availability of cheap deal financing and a scarcity of assets, which drove valuations up for the attractive assets that did sell. “The cash was chasing fewer and fewer assets,” Toukan says. “For a buyer … financing is wide open, but what are you going to use it to buy? Nothing.”
Reluctance on the part of strategic buyers to diversify and add businesses not in line with core capabilities contributed to low volumes with high multiples, Toukan says. Strategic buyers “are disciplined and will go after only deals that have a lot of synergy and if they find that they will pay to get it,” he says. Otherwise, they will stand back, he adds.
Money, for nothing
The strong financing market stood in the background of a shaky M&A market in 2012. “Right now, the financing market is phenomenal,” Toukan says. There is tremendous investor appetite for both high-yield and investment-grade debt, he adds. Companies that wish to refinance are having no trouble doing so with historically low interest rates, bankers say. Conditions are highly favorable for buyers. “Financing markets are still very strong,” says John McNicholas, head of investment banking at PrinceRidge.
The lack of assets, however, is constraining deals, despite the ready availability of financing. “There’s excess liquidity in the market—more dollars than assets,” Harrs says. “You are in the catbird seat when you have an attractive asset for sale.” Those assets are, of course, fetching high Ebitda multiples. “You have a lot of dollars chasing not enough deals,” Harrs adds.
There are several reasons the supply of available assets is tight. On the lower end of the market, private owners of small businesses are reluctant to sell because of recent economic performance. The performance of small, privately owned chemical companies in 2012 was “mixed, but mostly good,” while 2011 and 2010 were middling, Toukan notes. This means that while Ebitda multiples may have been high—at least for quality businesses—the basis for that multiple is still a three-year performance that is mediocre in many cases. Meanwhile, the tax changes that came into effect at the start of this year did not motivate many private sellers, Toukan says. Most private deals are below $100 million, and the level of small deals fell significantly from 2011 to 2012, Toukan says.
Divestiture activity has also been slow. “Historically, divestitures are a much larger chunk of deal activity,” Toukan says. However, the megadeals, described above, that were closed between late 2010 and early 2012 are still sorting themselves out, he adds. “These folks take a year or two to digest [the acquired business]” and figure out what to hold on to and what to divest, Toukan says. “They need time to figure it out and a lot of those deals closed in the past 12–18 months.”
Financial performance and cash balances also play a role in the lack of divestiture activity. Some companies may want more time with good performance before divesting pieces of their businesses. Also, most companies have little need for cash at the moment. “When you are sitting on a bunch of cash generating zero, you don’t need more cash generating zero so you don’t liquidate,” Toukan says.
Private equity in the mix
Private equity firms, meanwhile, are involved in a number of processes as both buyers and sellers. Bankers say that the level of private equity activity held steady from 2011 to 2012. Easy access to capital for leveraged deals has been a boon to private equity buyers, although they can still struggle to compete with companies for strategically attractive targets, bankers add.
Since the end of the economic downturn in 2009, private equity firms have been working to sell off assets that they held through the lean years—a process that is not yet complete. “The asset shedding has not played itself out completely,” Harrs says. “The assets that are performing really well have been sold or will be sold soon, but there are some that are still slogging along and will be held longer than the traditional period of five years.”
Strong financing markets have helped private equity firms that are holding onto assets, however. Companies themselves have been able to tap the market to push out debt maturities. Private equity owners, meanwhile, have used dividend recapitalizations to get some financial return when selling is not an option, bankers say.
Private equity is, of course, still on the hunt for deals. Bankers agree that firms have large supplies of cash from investors, and the strong financing markets are also a benefit. “Financing markets are very strong right now, and they are able to get pretty good leverage to support competitive bids,” says Christopher Cerimele, director/chemicals at Houlihan Lokey (Chicago).
Private equity buyers are also actively approaching potential targets, Toukan says. These approaches are suported by increased industry knowledge, large amounts of cash from investors, and easy access to deal financing. However, private equity buyers are wary of motivated strategic buyers, Toukan says.
Because of this, private equuity buyers are closely monitoring the strategic interest of cash-rich corporate buyers when both are involved in a sale process or auction. If a corporate buyer believes an asset is a strong strategic fit, it will often have the means, and the reason, to outbid private equity firms, according to Toukan. However, if a corporate buyer is uncertain of an asset’s fit, private equity firms will be aggressive, he adds. Private equity firms are “very carefully monitoring the behavior and activity and rumor mill around strategic buyers” in sale processes, Toukan says.
Most firms active in chemicals retain advisors to help them understand the industry, including the health of potential targets and the thinking of strategic buyers. Additionally, many firms, such as SK Capital and Arsenal Capital, focus on the industry specifically and have partners who are industry veterans. This helps them both buy and run companies, and compete with—or choose not to compete with—strategic buyers in sale processes, Toukan says.
Confidence lagged, but improving
CEO and CFO confidence, meanwhile, took a hit last year because of a variety of economic uncertainties. These made executives reluctant to pull the trigger on M&A deals, bankers say. “There was a lot of uncertainty last year[.] … [P]eople were pessimistic about Europe,” Cerimele says. “I think there was some disappointment that emerging markets were softening.”
Last year, uncertainty abounded in a number of regions. “You had the [US] election; you had the eurozone,” McNicholas says. Slowing growth in China and the US fiscal cliff also created some trepidation among executives about buying companies, bankers say.
Confidence does appear to be improving, although bankers disagree about the extent of the improvement. “Overall, CEO and CFO confidence got significantly better during the first two months of this year,” Toukan says. Companies are reconsidering acquisitions and becoming more aggressive as other growth routes, such as emerging markets, stall out, he adds.
Confidence is up “maybe a little bit,” McNicholas says. “For the most part if you talk to people, maybe on the margins they feel better, but I wouldn’t call it significant.”
Some regions also have a more certain outlook than others. Europe, while it has thus far avoided worst-case scenarios, is still a concern, bankers say. Emerging markets pose opportunities, but also risks as big economies like China, Brazil, and India have slowed down. The United States, while low-growth, is regarded as the most-certain region, partly because of shale gas and partly because of evidence of recovery in key chemical end-markets, such as housing. “The US is more certain because of shale gas,” Cerimele says.
A rosier outlook
Rebounding confidence and continued strong financing markets mean bankers are optimistic that M&A activity will pick up through 2013. Most say that they expect the year to improve as it goes on. The improvement will come “because of cash levels; because of the financing markets[.] … [T]he fundamentals are good for a healthy market,” Cerimele says. “So our sense is that it will be back-end loaded but still a good year.”
“Confidence will continue to improve,” Toukan says. Other factors should drive the market to rebound, as well. Private company owners may be more inclined to sell as performance improves. “My personal view is most of them will be thinking about a deal this year or next year,” Toukan says. “By the end of this year, they will have a couple of years of good growth under their belts. Acquirers look at a trend line, and entrepreneurs are saying they need more good years for a sale.” Private-seller activity was at a “very low level” in 2012, and a return to even below-average levels would represent a big increase, Toukan adds.
Divestiture activity should pick up as well as acquirers from the megadeals of 2011 figure out what businesses may not fit. “I think [divestitures] will hit more in late 2013,” once companies that made big acquisitions figure out which assets are noncore, Toukan says. “There will be more corporate divestitures once those large deals have been digested and the acquirer figures out what to keep and what to sell,” he adds.
Some economic trends are also favorable, bankers say. The US housing market appears to be in recovery, and while growth is starting from a very low level, it is still growth. This is helping drive interest in suppliers of construction chemicals, which were hard-hit during the recession. The shale gas revolution is helping drive interest in the US industry in general, and in oil field chemicals in particular.
Companies are also getting more proactive about deals—an example being A. Schulman’s unsolicited bid for Ferro (p. 6). Bankers say that direct approaches are becoming more common as confidence improves and companies look for creative ways to find growth. Buyers are also very focused on finding targets that meet their strategy and goals, and are increasingly willing to approach those targets before they come up for sale, bankers add.
“I do hear that corporates are making direct approaches to other corporates more often, which is a sign of confidence,” Harrs says. “It’s also a sign that [companies] know what they want, and are willing to... put that out there and see what happens.”
Financing markets are expected to remain robust, at least for the balance of the year. Investors remain in a search for yield, although financing is historically wide open and cheap and thus may tighten somewhat. “Things will scale back, but probably not anytime soon unless it is event driven,” Toukan says.
Activity did pick up during the second half of 2012, and during the final quarter of the year activity was in line with 2011 levels, according to Toukan. Houlihan Lokey’s deal flow was slow in January, but has picked up in recent weeks, according to Cerimele.
Uncertainty does remain, particularly with regard to Europe. However, Harrs says, “I don’t think companies are foregoing attractive opportunities over fear of basically anything.”
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