While megadeals will continue to occur with unpredictable timing, the volume of deals can be expected to stay within the mid-600s in the coming years. We can conclude that there is no downward trend in the statistic that matters most: deal activity. However, since 2010 there is no real upward trend either.
Chemical industry M&A has also seen a dynamic shift over the years in terms of rising valuations.
The chemical sector as a whole was awarded an average transaction multiple of about 14.1x for 2017 versus 10.5x in 2016 and 10.4x in 2015. In 2018 through May, the transaction multiple has increased to an all-time high of 15.1x.
Agro-chemicals are driving much of the uplift, increasing 105% from 6.8x in 2013 to 14.0x in 2018. Specialties are not far behind, with a 70% increase, while diversified and commodities declined.
Driving the upswing in transaction multiples
Some may point to improving oil prices as the reason for the surge. While gases are clearly affected, that trend doesn’t account for the general rise that occurred in other sub-sectors even while barrels held below the US$50 mark.
Both specialties and commodities have benefited from an increasingly positive cash flow outlook. Yet neither the improving oil prices nor the positive cash flow outlook factors warrant such high multiples.
The data suggests that high deal valuations are being awarded to companies that increase their position in focused industries through both acquisitions and divestitures, concentrating their strategies around pure-play portfolios. Diversified companies are splitting up, and the deal valuations and market premiums on their stocks are reaping the benefits.
In the short run, it appears that both buyers and sellers are winning. In the long run, the resiliency, or lack of it in pure-play portfolios, will be tested by inevitable cyclical downturns.
Those in the chemical industry are likely familiar with the rationale offered by activist shareholders who lobby for these pure-play moves: shareholders, managers, and operations can all better focus on the unique traits that make commodity companies with much greater cyclicality so different from specialty chemicals companies with higher margins and higher R&D expenses.
In a diversified portfolio, both commodities and specialties may tend to be underinvested and undermanaged. Shareholders do not benefit as the returns are held back and discounted for both specialties and commodities.
Prior to the recession, diversified portfolios had shareholder returns that rivalled specialty chemicals. During the early 2000s, diversified chemical companies were actually trading higher than specialty chemical companies, with EBITDA multiples of about 2.3x compared to about 1.5x for specialty chemicals.
What should we expect in the future for chemicals M&A?
This wave of M&A driving pure-play portfolios in chemicals has a long way to go to achieve the levels of concentration that are likely needed to defend competitive pricing.
Pay attention in the rest of 2018 and 2019 to petrochemicals, paints and coatings, plastics and synthetic resins, polymers and other specialty chemicals as consolidation pushes companies even further into pure-play portfolios, divesting non-core assets.
Many of the underlying factors that are driving the chemical M&A market should continue to create incentives for M&A, including:
- Cheap and available financing
- The need to acquire assets to drive earnings gains in a low-growth economic environment
- Pure-play portfolio restructuring
- The domino effect of divestments from mega-deals going through regulatory scrutiny
What opportunities could these trends offer?
Chemical company executives can use this deal environment to realize their company’s full potential for a better future by:
- Regularly reviewing their portfolios to make sure their current assets fit their core business and to uncover any gaps they might need to fill in order to be able to quickly act when opportunities become available
- Constantly surveying the landscape to be aware of potential acquisition opportunities
- Preparing businesses deemed to be noncore in order to maximize value from a sale