5 minute read 1 Jul 2018
A refinery

How the chemicals M&A market has changed, and what lies ahead

By

David Gale

EY Global Advanced Manufacturing Transactions Leader

Advanced manufacturing leader with over 25 years of business experience, including the past 18 years focused on transactions. Board member for the Boys & Girls Clubs of the Twin Cities.

5 minute read 1 Jul 2018

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Deal volume has been strong through 2Q18, and more consolidation is coming, spurred by low-cost financing, restructuring and divestments.

Looking at the value of deals announced for the global chemicals industry from 2017 to 2Q18, it might be fair to assume the unprecedented wave of M&A activity that the sector saw in the middle of the decade has slowed significantly.

A closer look at the data, however, shows that the industry appetite for deals continues unabated in 2018, though in more bite-sized pieces. At the same time, the demand is also still strong for divesting assets that may not be part of a company’s core business, but which would be a nice fit elsewhere.

So there are plenty of opportunities for companies that are looking to add to their business through M&A. In fact, 411 transactions were announced through May, a pace that will make 2018 the most active deal year since 2011 if it continues.

ma infographic

The wave of chemical industry deal activity over the past several years has been driven by slow organic growth, weaker demand in China, overcapacity of commodity chemicals in developed markets and pressure from activist investors to maximize shareholder value.

In the middle of the decade, this helped lead to a whole new level of deal size. For the prior decade leading up to 2015, any deal that came near the US$20 billion level was considered a “megadeal.” However, 2015–16 gave a new definition to the term as deals far exceeded that historically high watermark, with four deals valued between US$40 billion and US$70 billion.

Volume high even as deal value declines

In 2017, deal value declined. Though there has been some pickup in value so far in 2018, only eight deals have crossed the US$2 billion mark since the beginning of the year. Still, while 2017 did not come near the record-setting 2016 levels for deal value, several deals were pushed over into 2018 due to deal complexities.

Meanwhile, volume, a truer indication of deal activity, held steady continuing the trend of increasing activity that the industry has seen since 2013. More importantly, while values flare up occasionally, volume holds steady.

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

Summary

Cheap and available financing, pure-play portfolio restructuring, and the hunt for earnings in a time of low growth are among the reasons why M&A may be an attractive strategy in the current environment.

About this article

By

David Gale

EY Global Advanced Manufacturing Transactions Leader

Advanced manufacturing leader with over 25 years of business experience, including the past 18 years focused on transactions. Board member for the Boys & Girls Clubs of the Twin Cities.