Chem M&A seeks to turn corner

After a difficult H1, a new reality is setting in, with 2023 earnings expectations reset lower and interest rates stabilising, although at high levels.

“We may be turning the corner towards a more active M&A market,” said Ariel Levin, managing director and global co-head of chemicals investment banking at Piper Sandler.

The number of chemical M&A transactions are down around 35% year-to-date compared to H1 2023. In terms of deal value, the dollar volume is down about 55%, he pointed out.

“We have recently seen the start of several divestiture processes, primarily from corporates looking to prune portfolios for various reasons, including deleveraging, improving cash flows, increasing compliance with ESG profile and reducing portfolio complexity and cyclicality,” said Levin.

Given the relatively challenging profile of many of these businesses, private equity has been the key buyer universe. Some of these assets have been in the enterprise value (EV) range of $100-300m, making them relatively digestible, even in the current financing environment, he noted.

Even smaller chemical deals are in demand.

“While deal volume in the chemical space is down, we have seen a continuing interest in selected strategic deals as well as in smaller deals in the $30-50m EBITDA range - those less dependent on large financings and that are relatively solid and attractive businesses,” said Federico Mennella, investment banker and board member of the Societe de Chimie Industrielle.

The global chemical M&A market slowed considerably late last year and continued to slow in early 2023 with only $8.6bn in deals closed in Q1, a pace well off the $52.4bn in transactions closed in 2022. Only 16 deals over $25m in size closed in Q1 compared to a quarterly average of 21.5 through 2022, according to Peter Young, president and managing director of Young & Partners.

The investment bank is working on compiling Q2 figures.

“The continued slower pace has been driven by higher interest rates, weaker profitability, economic and geopolitical uncertainty, the lower availability of leveraged financing, the pricing and volume downturn in the commodity chemicals industry, and concerns about operating chemicals businesses in Europe,” said Young.

Private equity acquisition volume in Q1 for disclosed deals greater than $25m in value dropped to zero as higher interest rates, lack of available debt financing, and business concerns held them back. European chemical M&A volume also fell dramatically, he added.

“Most of these factors will continue for the rest of 2023, so a significant recovery of the global chemical M&A market is unlikely,” said Young.

“The only factors that may cause a few larger deals to close are the divestitures of European chemical companies trying to get out of commodity chemicals and the efforts of ADNOC (Abu Dhabi National Oil Co) and others to add chemical operations in Europe and the US to diversify. However, these are clearly not part of mainstream trends,” he added.

For businesses with a high exposure to more challenging end markets and which are small to mid-size, buyers as well as sellers may need to be open to more structured solutions for financing, including seller financing, earnout structures or the seller retaining a minority stake in the business.

“Structured solutions like vendor loans, earn-outs or retention of equity positions are an alignment of interest mechanisms that can also serve as insurance policies,” said Levin from Piper Sandler.

“They can also be very effective mechanisms to address the recent vulnerable financing environment by reducing third party debt requirements or buyer equity commitments,” he added.

In the current financing environment, private equity buyers have also been over-equitising transactions with an eye on refinancing when credit markets improve, he pointed out.

For those challenged, third-tier assets, demand seems to have “evaporated,” said Ruf from KeyBanc, who noted that values have fallen to levels that reflect anemic demand as opposed to the actual value of the businesses.

“That’s simply reflective of buyers being cautious when they don’t have clear visibility on the sources of, and outlook for growth,” he added.

Private equity owners will also be under increasing pressure to sell assets, as they must show results for investors after years of holding businesses.

“Buyout funds alone are sitting on a record $2.8tr in un-exited assets – over four times the level held during the global financial crisis,” said Bain & Co in a 17 July report on private equity. And investors in these funds are clamouring for liquidity.

Private equity groups overall have around 26,000 companies in their portfolio, nearly a quarter of which they’ve held for over six years, over 50% which have been held for more than four years, according to the Bain & Co report.

“They’re getting more interesting in proceeding with a sale mandate rather than waiting for an additional half turn (0.5x EBITDA) a year or year-and-a-half from now,” said Mennella.

“It’s been an unprecedented amount of time holding assets and that’s going to increase the pressure to sell, even if it means accepting lower returns than what was expected,” said Harrs from Houlihan Lokey.

Private equity firms can also engineer partial exits to gain some liquidity while retaining upside for better times, Mennella pointed out.

In a deal adjacent to the chemical sector announced in July 2022, Bain Capital put together a joint ownership agreement with BC Partners for one of its portfolio companies – Italy-based self-adhesive labels and fibre-based packaging company Fedrigoni.

With private equity under pressure to sell assets and with financing costs elevated, corporate buyers with strong balance sheets have an advantage on the buy side.

“Strategics have an advantage against a pure financial sponsor as they don’t have to raise expensive debt to finance an acquisition. If they can do it off balance sheet cash, they have a natural advantage right off the bat. That advantage didn’t necessarily exist 12 months ago,” said Harrs.

“If they want to flex their muscles, they’re going to have an easier time of it now because the financial sponsors are not going to be able to come in as hard,” he added.

However, there are early signs of activity in H2 as earnings expectations are reset lower.

“There is a growing stream of M&A processes that have been in backlog just beginning to release into the market,” said Ruf from KeyBanc.

“The floodgates haven’t opened for deal flow yet, and whether they do or if they just come out in a trickle over time remains to be seen,” said Harrs from Houlihan Lokey.

“The only thing that’s going to help is time – when you get to a more normalised level of earnings that people think are bankable,” he added.

“The valuation gap will close. Many sellers, particularly of assets with no clear ESG strategy, have to get comfortable with an - on-average - lower and more moderate valuation environment given where interest rates are. Private equity buyers increasingly face challenges arranging attractive debt financing for those businesses,” said Bernd Schneider, managing director and global co-head of chemicals at Stifel.

“Waiting for great times like we saw in 2011-2021 might not be the right strategy. Sellers might have to adapt to a new valuation environment,” he added.

There are exceptions when it comes to valuations with assets such as in adhesives as well as bio-based or green platform chemicals such as isobutanol and bio-based plastics in high demand, the banker noted.

“There’s big momentum in the world toward making everything green or circular. It’s on every CEO’s agenda right now,” said Schneider.

A very active earnings warning season for the chemical industry portending difficult conditions throughout 2023 could also lead to more M&A activity, particularly on the sell side.

“Companies will need to focus on M&A in order to shed businesses that are less strategic, so they can de-lever and also help get investor confidence back up fairly quickly,” said Levin from Piper Sandler.

As Clariant warned of a Q2 and full-year 2023 earnings shortfall on 7 July, it also said it is actively evaluating strategic options for its sunliquid celluslosic ethanol business.

“The longer the crisis prevails with sluggish demand as well as uncertainty with regard to investment decisions, there will be more restructuring. The number of restructuring deals will increase,” said Schneider from Stifel, who sees more distressed deals coming to market in the next 6-9 months.

“That pent-up supply of new deals that start to come into market will coincide with buyers who have been waiting to see that supply,” said Ruf from KeyBanc.

Corporates have healthy balance sheets and are well positioned to make small to mid-sized bolt-on acquisitions, particularly where some may not have a lot of visible organic growth, he noted.

LyondellBasell has been active in bolt-on acquisitions of recycled plastics assets. In July, it closed the acquisition of Mepol Group which has recycled plastic compounds plants in Italy and Poland. In April, LyondellBasell agreed to take full control of Quality Circular Polymers (QCP) which has plants in Belgium and the Netherlands, by buying out 50% joint venture partner Veolia.

Author:

Joseph Chang is Global Editor of ICIS Chemical Business, a weekly publication covering game changing trends in the chemical industry and analysing drivers of chemicals prices worldwide. This includes feedstock and price developments, supply and demand trends, new project activity and sustainability. He has been with ICIS and one of its predecessor publications for over 25 years, specializing in coverage of key developments in the global chemical sector as well as financial topics such as macroeconomics, capital spending, equity and debt markets, and mergers and acquisitions. Joseph has a degree in Finance and International Business from New York University’s Stern School of Business.