INSIGHT: Weak volumes, geopolitical uncertainty hold back chemical M&A

NEW YORK (ICIS)–The lack of a meaningful recovery in volumes amid a weak macroeconomic backdrop along with geopolitical uncertainty are key factors hindering mergers and acquisitions (M&A) activity, panelists said at a recent meeting of the Societe de Chimie Industrielle in New York.

“Right now, it’s all about volume in our businesses. That’s the number one issue, because we have operating leverage in our businesses where small increases in volume will lead to meaningful increases in profitability,” said Scott Wolff, managing director at private equity firm American Securities.

“Fortunately, our portfolio companies – mostly specialties businesses – have maintained real pricing power during this inflationary period. So, our margins across portfolio companies are really strong,” he added.

Wolff is also chairman of US-based specialty chemical companies Hexion, Meridian Adhesives and Vibrantz (combination of former Ferro, Chromaflo and Prince businesses).

On the macroeconomic front, “China is struggling and is not going to hit 5% growth while Europe is clearly struggling with Germany potentially in recession. The US has been remarkably resilient,” said Peter Young, CEO of investment bank Young & Partners.

Panelists at the Societe de Chimie Industrielle meeting from American Securities, DC Advisory, Young & Partners and ICIS.

COMMODITY VS SPECIALTY
“Demand is soft but there’s a bit of a split personality. If you talk about specialty chemicals, weaker demand is not helping but at least they’re not facing overcapacity,” said Young.

“Commodity chemicals is a very different story. There is a massive increase in capacity in China of commodity chemicals and plastics, coupled with the Middle East trying to add capacity because they want to diversify away from [fuel], he added, pointing out that an “irrational amount of capacity” is coming online.

He doesn’t see global capacity utilization improving for commodity chemicals until 2028.

“For specialty chemicals businesses, the lower cost in commodities works to our advantage because our companies are buying those raw materials at favorable prices,” said Wolff from American Securities.

DEALS PUT ON HOLD
This widespread weakness in volumes has curbed M&A activity as many potential sale processes were delayed or put on hold.

“Profits in 2023 dipped for a number of companies, so a number of processes that were started in 2023 got pushed back or put on hold because people were concerned about lower 2023 results and did not have enough visibility on 2024 numbers,” said Federico Mennella, managing director and US head of chemicals at investment bank DC Advisory, a unit of Japan’s Daiwa Securities.

Today, in contrast, players are now focused on improved 2024 results and have more confidence in 2025 figures, he noted.

“At the beginning of the year, we expected volumes in 2024 to be significantly higher than in 2023. In fact, the M&A market was weaker than expected in H1 2024, although we still expect an increase in transactions in the months ahead and in 2025,” said Mennella.

The banker attributes the slowdown to difficult credit conditions, geopolitical factors – including elections in a number of countries, the war in Ukraine and Middle East uncertainty – high energy costs and logistics considerations.

Data from Young & Partners show chemical M&A activity market is down significantly, with only 20 deals above $25 million in size closing in H1 2024 versus 75 for all of 2023 and 86 for all of 2022.

And among the 20 deals closed in H1 2024, 55% were in Asia – mainly in China with Chinese buyers.

“That makes the accessible market even smaller for Western players because private equity firms are not lining up to do LBOs (leveraged buyouts) in China,” said Young.

“Chemical deal volume has gone down, mainly because of uncertainty. And Europe volume has just plunged because Europe is in trouble. Their energy sources have changed and are much higher cost, and in general it is a high-cost place to make chemicals,” he added.

On a geographic basis, Europe is certainly being eyed more cautiously and critically in terms of investment by private equity firms, Mennella from DC Advisory pointed out.

There are less cross-border deals coming from China while the US remains a key area of interest. M&A activity in the US could pick up with interest rates easing, he added.

“We are also seeing increased M&A activity in and from Japan, as well as from Southeast Asian and Middle Eastern companies and entities,” said Mennella.

Meanwhile, chemical companies themselves are more active in restructuring, repositioning and refocusing their businesses, which in turn drives M&A activity among strategic players as well as private equity groups, he added.

PROCESSES TAKING LONGER
Private equity firms bought “a lot of companies in the 2015-2019 period which they need to sell soon. Other private equity groups are raising funds and want to show good returns on prior investments,” said Mennella.

“But processes often take longer because of gaps between sellers and buyers. We expect a catch-up once we have confidence in 2024 earnings and projections for 2025.” he added.

“You see that every time we go through a peak and valuations start to come down – volumes start to drop because buyers and sellers can’t agree on price,” said Young from Young & Partners.

In 2023, for American Securities, in approximately 75% of the deals evaluated by the investment team, there was no transaction. This compares to around 30% in a typical year, Wolff pointed out.

“Broadly speaking, there has been a buyer-seller disconnect, and there are various factors [contributing to this] including interest rates and destocking in 2023. So while we were able to close a number of transactions, there is no question that the pace of dealmaking has been slower for us and the industry at large,” said Wolff.

GOOD TIME FOR BOLT-ONS
Certain private equity firms are continuing to make bolt-on acquisitions to existing platform companies rather than taking on major new deals on the buy side.

“From an M&A perspective, the market is active right now. That’s not necessarily the case for platform investments. But for add-on deals, there continues to be an abundance of opportunities. We are really active on that front,” said Wolff.

In August 2024, American Securities’ portfolio company Vibrantz acquired US-based Micro Abrasives, a producer of specialty alumina for automotive refinishing, optics polishing and industrial lapping markets.

In June 2024, portfolio company Meridian Adhesives acquired specialty adhesives producer Bondloc UK, which makes anaerobic adhesives, cyanoacrylates, epoxies, UV cure adhesives, and structural acrylics.

On the sell side for American Securities, Hexion in April 2024 announced the sale of its PVA and EPI Emulsions business to Franklin International, a US-based producers of adhesives, sealants and polymers that supplied that Hexion business for over 40 years.

Also in April, Vibrantz sold its Onda, Spain ceramic floor and wall tile manufacturing operations to Xphere Global Specialities, an affiliate of Vidres India Ceramics.

TARGETED PROCESSES AND FLEXIBLE DEAL STRUCTURES
In a challenging deal environment, players are engaging in more targeted buy or sell processes rather than putting an asset out for auction. Deal structures are also becoming more flexible to bridge any gaps.

“A number of transactions include targeted processes that do not involve a broad auction. In other cases, a strategic or private equity group with sector knowledge targets a specific asset and approaches the owner directly,” said Mennella from DC Advisory.

One case in point was Germany-based Henkel proactively approaching Arsenal Capital Partners for the acquisition of US-based protective coatings and sealants producer Seal For Life industries ($250 million in 2023 sales) and closing the deal in April 2024, he noted.

“In another situation, instead of a broad auction, we targeted five logical buyers before going through any process. Two of the five submitted bids, and one was accepted. It never went to the broader market,” said Mennella.

Earnings growth and macro assumptions are much fuzzier today, often requiring flexible or hybrid M&A models to get deals done.

“A lot of the acquisitions made in the past were based on a variety of optimistic assumptions – the EBITDA was going to increase, the exit multiple was going to remain or even increase, interest rates would continue to stay low, and everything was going to be on a consistent and predictable trajectory,” said Mennella.

“Given the recent post-pandemic market dynamics, many buyers are more flexible and innovative in structuring and executing their deals,” he added.

In certain private equity sell-side deals, the seller is retaining a portion of its stake rather than exiting 100%.

In August 2024, H.I.G. Capital announced a deal to sell water treatment solutions company USALCO to private equity firm TJC (formerly The Jordan Company) while retaining a minority stake.

“The willingness of private equity and strategics to utilize flexibility and inventiveness helps bridge gaps and gets transactions done,” said Mennella.

Or private equity firms could simply stand pat and hold onto their portfolio companies for longer, especially for those firms with longer fund lives.

“We’re excited about the investment thesis of our companies and their long-term potential. Fortunately, we can be patient,” said Wolff from American Securities.

“We’d rather realize the earnings growth we see in these companies before exit, and if that means holding for longer, that’s fine,” he added.

CHALLENGE FOR MANAGEMENTS
Amid all the uncertainty and weak demand backdrop, what should other chemical company managements do?

“It really depends on who you are and where you are because the nature of the problem and the opportunity and the solution are going to be dramatically different,” said Young of Young & Partners.

“First, take a real look at the asset and try to characterize it. And then the solution will be driven by the nature of that asset – in terms of its competitiveness, who and where its customers are, etc.,” he added.

Obviously, a commodity chemical producer in the US will have very different options than those in Europe and Asia because of cost competitiveness.

“Most CEOs are quite nervous these days because the landscape has changed dramatically and become much more uncertain. In the US presidential election, there is going to be a huge difference in policy depending on who becomes president – on tariffs and so forth,” said Young.

“It used to be CEOs could do a base case, have two or three scenarios, and plan around them. Now they don’t know what their base case is, much less what the scenarios are to consider,” he added.

The path to zero carbon emissions and greater circularity are additional challenges for managements, as technologies are all over the place and return on investment is far from certain, the banker pointed out.

“Most of these CEOs are saying – I’ve got to do it. I may not get a return on capital, but I don’t really have much choice because if I don’t do anything, five years down the road… I’m going to be in trouble,” said Young.

LYONDELLBASELL EXAMPLE
Some companies are taking decisive action. US-based LyondellBasell, for example, is using strong cash flows from its core cost-advantaged commodity businesses to invest in plastics recycling and bio-based chemicals – its Circular and Low Carbon Solutions business – both organically and through M&A.

LyondellBasell in August 2024 agreed to acquire full ownership of Germany-based APK which uses solvent-based technology to recycle low density polyethylene (LDPE). Earlier in February, it bought US mechanical recycling operations from PreZero.

The company has a goal of producing over 2m tonnes/year of recycled and renewable-based polymers by 2030 and taking 20%+ market share in North America and Europe for these plastics.

In the meantime, LyondellBasell is also conducting strategic reviews of six European assets in its Olefins & Polyolefins (O&P) and Intermediates & Derivatives (I&D) segments for potential sale.

By the end of the decade, if the company follows through on its strategy, it will look very different from where it is today.

Insight article by Joseph Chang

Thumbnail photo source: Photo source: Taidgh Barron/ZUMA Press Wire/Shutterstock