9 minute read 14 Oct 2020
Aerial view of an oil refinery at night

Why it’s an exciting time for M&A in chemicals

Authors
Otto Schulz

Partner, Strategy and Transactions, EY-Parthenon GmbH

Physicist with 25 years’ experience in chemicals strategy consulting. Focused on delivering value potential through innovation, growth and sustainability.

Daniel Riegler

EY EMEIA Sell and Separate Leader

Strategic consultant with great enthusiasm for his work. Enjoys spending time with wife and three children. Loves to go fly fishing in the Alps.

9 minute read 14 Oct 2020

Near record-setting M&A activity in 2019 was followed by strong potential – and disruption – in 2020. Where do the opportunities lie?

In brief
  • Global trade disputes, tightening environmental regulations and structural challenges in key end markets have challenged the chemical industry in recent years.
  • Some subsectors (e.g., paints, coatings) have decreased profitability and continue to increase debts.

The last few years have been challenging for the chemical industry. Global trade disputes and tightening environmental regulations have put the entire industry under pressure.¹ Chemicals businesses have to deal with cost constraints and uncertainty, amplified further by the global slowdown caused by the COVID-19 pandemic. Structural changes in the automotive sector and other key end-markets have created additional challenges. Meanwhile, subsectors such as paints and coatings, and plastics manufacturing have lost profitability and continue to accumulate debts.

Historically, financial distress such as this has been a major driver of mergers and acquisitions (M&A) due to relatively attractive company valuations.² In addition, companies intend to recapture lost market shares and margins whilst others may be forced to merge. This background may present opportunities for chemicals-related M&A, despite complex deal surroundings.

In this article, we summarize 2019’s global M&A activity in the chemicals industry and assess what it might look like in the second half of 2020 and beyond.

Megadeals drove 2019’s highs

In 2019, the value of all global M&A activity in chemicals rose to the second-highest level of all time — US$182b.³ This figure was driven mainly by three megadeals: Saudi Aramco/SABIC, the IFF/N&B business of DuPont, and Showa Denko/Hitachi. 

The average deal size was close to the highest value of the last 20 years.⁴ Private equity (PE) investments played a strong role, with eight of the 30 largest deals (representing close to 30% of deal value) mainly related to carve-outs, such as the Lone Star/BASF construction chemicals business and the IMM/Linde Korea business.

Intense M&A activity also took place in the subsectors of plastics manufacturing, other specialty, and paints and coatings (Figure 1).

Figure 1: Share of individual subsectors on total M&A value in chemicals (excluding the top three transactions)
Share of individual subsectors on total M&A value in chemicals (excluding the top three transactions)

The COVID-19 pandemic has intervened

We expect a significant decline in megadeals and cross-border-related M&A transactions due to the COVID-19 pandemic in 2020. Deals have been postponed, and pricing might be complex due to high volatility. Unlike in previous crises, travel bans have limited many site visits. However, the intensity of carve-outs might be expected to increase due to portfolio adjustments and business model reorientation induced by the crisis in the second half of 2020. Also, more certainty will improve deal financing options.

We expect the average transaction value to be the key driver of any decline, as evidenced by very low transaction values, especially in crises.⁵ The 2009-related transaction value was the lowest ever. We can see a similar story in 2020 deals to date. This perspective is based on several key drivers: 

  • Higher risk for large strategic moves in times of high uncertainty
  • Big players unwilling to sell at low valuations during a downturn 
  • Reduced sales-price expectations of distressed targets dealing with liquidity pressure due to the COVID-19 pandemic
  • Temporary lack of debt financing possibilities for PE
  • Short-term to midterm-related impact of travel bans and restrictions. In the long run, cross-border M&A activity might be affected by increased protectionism as an additional result of the pandemic crisis.

Earlier downturn times illustrate the effect of uncertainty on chemicals-related M&A activity (Figure 2). The impact of a major crisis can be significant; we saw a decreased number and value of transactions after the global financial crisis in 2009 and after the dot-com crash. We expect a similar structure after the COVID-19 pandemic.

Figure 2: Global M&A activity in chemicals between 1999–2019
Figure 2: Global M&A activity in chemicals between 1999–2019

Some higher M&A activity expected

From a sector perspective, we expect high levels of global M&A activity in fertilizers, plastics processing, and paints and coatings. This forecast is based on a calculated takeover probability combined with the degree of consolidation per sector (Figure 3).⁶ According to our research, the following factors determine takeover probability:⁷

  • High price volatility (highest correlation)
  • Being headquartered in countries with strong investor protection
  • Small firm size
  • Low valuation 
  • Low profitability
  • High leverage
  • Low liquidity (lowest correlation)
Figure 3: Average calculated takeover probability for 2020 and degree of industry concentration of all chemical companies with sales exceeding US$100m by subsector
Figure 3: Average calculated takeover probability for 2020 and degree of industry concentration of all chemical companies with sales exceeding US$100m by subsector

Also, we consider low industry concentration to be a major driver for M&A activity. The main reasons lie in lower antitrust regulations and higher competitive pressure. A review of past transactions (Figure 4) shows that the low industrial concentration in different subsectors can be explained by a limited amount of realized transformational transactions.

Figure 4: M&A activity in relation to the respective market size and industry concentration by subsector, 2010–19
Figure 4: M&A activity in relation to the respective market size and industry concentration by subsector, 2010–19

The COVID-19 pandemic pressures paints and coatings

We expect an acceleration of the ongoing consolidation in paints and coatings due to a COVID-19 pandemic demand shock in transportation equipment as one of its major end markets. Consequently, the declining profitability and liquidity and the increase in debt are expected to extend and accelerate. These characteristics increase the takeover probability; in this respect, the COVID-19 pandemic acts as a catalyst for consolidation. We still predict high M&A activity for the fertilizers and plastics processing subsectors, but with a more moderate impact due to the COVID-19 pandemic.

The COVID-19 pandemic will affect the other specialty subsectors (Figure 5), particularly the catalysts subsegment with its high dependence on automotive. The strong demand shock in transportation equipment and consumer durables and apparel is driven by the fact that both private and industrial customers are postponing cash-intensive investments. Demand in transportation equipment and consumer durables and apparel is expected to decline by more than 10% and 5%, respectively, in 2020.

Figure 5: Sales of chemicals subsectors by end-user industry, 2019
Figure 5: Sales of chemicals subsectors by end-user industry, 2019

Oil down …

Since the beginning of 2020, oil prices have plummeted around 35%, driven by the COVID-19 pandemic demand shock. Even more unprecedented, the WTI price went negative in the spring in the middle of oil disputes between Russia and Saudi Arabia (Figure 6). The COVID-19 pandemic is expected to impact the time at which the oil demand will peak.

Figure 6: Crude oil price in US$ per bbl
Figure 6: Crude oil price in US$ per bbl

The oil price collapse will only reinforce the ongoing trend of oil companies shifting away from hydrocarbon dependency toward future-proof business models. One option could be to move downstream — a strategy suggested by pure-play petrochemicals, which have been less severely hit by the crisis than the oil majors with integrated petrochemical subsidiaries (share prices: BP and Shell at –40% and –45% year to date, respectively, vs. –18% at pure-play petrochemicals, as shown in Figure 8).

… M&A up

The movement away from hydrocarbon dependency can take different shapes and is likely to trigger M&A. BP divested its petrochemical units and focused on low-carbon ventures. Another example of a major M&A-driven downstream integration is the Saudi Aramco/SABIC merger last year.

Investors benefit from chemicals slump

The devastating effects of the COVID-19 pandemic on business have caused significant decreases in company valuations. We predict that well-funded investors will benefit from the drop in chemicals valuations that hit particular commodities (Figure 7) and US companies (Figure 8). These investors will range from strategic buyers, PE (as soon as debt financing returns to quasi-normal) and hedge funds, to state-owned enterprises.

Figure 7: Market capitalization between 2 January 2020 and 28 June 2020, as a percentage average of the largest 700 public chemical companies (by subsector)
Figure 7: Market capitalization between 2 January 2020 and 28 June 2020, as a percentage average of the largest 700 public chemical companies (by subsector)
Figure 8: Development of market capitalization as an average of the 700 largest public chemical companies per region, change in percentage compared to 2 January 2020
Figure 8: Development of market capitalization as an average of the 700 largest public chemical companies per region, change in percentage compared to 2 January 2020

However, we see the current market more as a sellers’ market (compared with other sectors), as chemicals has not been hit as hard as consumer services or aviation, for example.

Opportunities still exist, with chemical majors streamlining their portfolios, in the small to midsized markets. It is here that we find companies, already under financial pressure before the crisis, with the COVID-19 pandemic intensifying their distress. On the buyer side, there are many interested investors. A study among PE managers conducted by the Finance Private Equity Panel showed the value indicating their tactical positioning (1 equals seller, 10 equals buyer) rises to 6.8 points, the highest value since mid-2010.⁹ As the past shows, crisis years are often the best time to buy. Buyout funds reached, in 2000–02 and 2009–10, the highest net money multiples of the last 20 years (Figure 9).

Figure 9: Net money multiples of buyout funds (global, all industries)
Figure 9: Net money multiples of buyout funds (global, all industries)

Daniel Riegler, Dr. Otto Schulz, Gabriela-Maria Baum-D’Ambra and Vladislav Kulikov of EY-Parthenon authored this article.

  • Show article references

    1. EY-Parthenon analysis, 2020.
    2. EY-Parthenon analysis, 2020.
    3. EY-Parthenon analysis, 2020.
    4. The analysis includes M&A deals with the status closed or announced. The time of a transaction refers to the date of the announcement.
    5. EY-Parthenon analysis, 2020.
    6. We have identified the factors that influence the probability of a chemical company to be acquired. The results are based on regression analysis on transaction data from 1999 to 2019. We calculated the influence of these factors on the takeover probability for every chemical company.
    7. Factors are at significance levels of 10% or better.
    8. Source: Finance Private Equity Panel — Spring 2020.

Summary

EY-Parthenon summarize global M&A activity in the chemicals sector over the past year and preview what deal activity might look like in 2020 and beyond. Overall, EY-Parthenon expect a significant decline in megadeals and cross-border-related M&A due to COVID-19. However, financial distress has historically been a major driver of M&A activity because of attractive company valuations.

About this article

Authors
Otto Schulz

Partner, Strategy and Transactions, EY-Parthenon GmbH

Physicist with 25 years’ experience in chemicals strategy consulting. Focused on delivering value potential through innovation, growth and sustainability.

Daniel Riegler

EY EMEIA Sell and Separate Leader

Strategic consultant with great enthusiasm for his work. Enjoys spending time with wife and three children. Loves to go fly fishing in the Alps.