Global M&A: Shifting the global chemical industry balance 

While the global chemical industry endured one of the most turbulent periods in its history, a dramatic shift in M&A activity also occurred from 2007 to 2010.

Steady recovery in 2010

Source: Thomson One Banker, accessed on should be 10 January 2011

The numbers speak for themselves. Total global deal value in the chemical industry fell from a peak of US$136 billion in 2007 to barely US$46 billion in 2009. Actually, this fall would have been even greater without the acquisitions of Rohm and Haas (by Dow) and Ciba (by BASF) that were announced in 2008 but actually closed in early 2009.

In 2010, however, as chemical industry demand recovered, so too did M&A activity. In an analysis performed by KPMG, 2010, total global deal value shot up over 100 percent, relative to 2009. The number of transactions year over year increased more than 50 percent.

Although certainly impressive, these figures should be understood in comparison to 2007 levels. While the total number of chemical industry deals in 2010 exceeded those in 2007, total deal value was actually US$60 billion below the 2007 peak. Average deal size in 2010 was US$60 million compared to US$113 million in 2007. This size reflects a reluctance in the industry to undertake larger, debt-financed deals so close to the end of the recession. Deal sizes were also constrained by limited financing, at least in the first half of the year.

We also saw the return of the financial player in 2010 with over 30 percent of deals involving entities such as private equity (PE) firms. This percentage increased towards year end, with some non-strategic buyers cashing out while other PE firms acquired assets in anticipation of rising equity prices.

The large deal still had a significant impact on the M&A landscape as 5 percent of the announced deals accounted for 45 percent of the 2010 value. That said, the strategy of the "bolt on" transactions was also pronounced with 75 percent of the number of announced deals involving the purchase of less than 100 percent of the acquired, although that 75 percent accounted for less than 50 percent of the deal value.

A dramatic shift also occurred with the relative percentage of cross border deals doubling in 2010 relative to 2009. Moreover, two thirds of these cross border transactions took place in the last half of 2010. Emerging markets played a significant role, indicating a likely trend for 2011 and beyond.

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Based on current conditions, M&A activity in the global chemical industry is likely to increase throughout 2011 and 2012. However, deals are taking longer to complete than they did before the crisis because companies are taking a much more cautious approach resulting in longer, more detailed due diligence.

We are also seeing more deals falling at the final hurdle. Corporates are being highly disciplined and walking away from transactions that they do not feel make complete financial or commercial sense, whereas in the past, they may have completed the deal and sought a way to trade out any issues, post transaction.

This caution is encouraged by several factors. In the Eurozone, countries such as Ireland, Greece, Portugal and Spain are still faced with sovereign debt issues, and Europe in general is dealing with the threat of commodity inflation and other stresses to the economy. Other factors affecting M&A include continued weakness in a number of key end markets for chemical products, most notably, construction spending in the US. According to the American Institute of Architects, US non-residential construction spending will most likely not recover until 2012. In February 2011, the US Commerce Department reported that home sales had dropped 28 percent y-o-y. McGraw- Hill Construction (MHC) has predicted a modest 8 percent increase in spending for construction overall, but that figure is still a quarter less than 2008 totals.

In addition, political instability in the Middle East and North Africa have the potential of generating a significant and long-term impact on oil prices and hence the global economy. As a result, many chemical companies are adopting a wait-and-see attitude for deal making in the region.

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BICME countries (Brazil, India, China, Middle East) will increasingly dominate chemical industry M&A activity in the years ahead, supported by growth in end markets, government policies and access to funding. Already, M&A in BICME countries have increased from 5 percent of deal value and 17 percent of deal volume in 2007 to 30 percent of deal value and 28 percent of deal volume in 2010.

M&A activity in the BICME chemicals industry, 2007–10

Source: Thomson One Banker, accessed on January 18, 2011

Several key chemical end markets in the West are continuing a shift to the East. For example, the textile industry has been firmly based in the East for many years, and now suppliers from the West are being acquired. In 2010, the German company Dystar, one of the world's largest producers of dyes, was bought by Kiri Dyes & Chemicals from India.

China foreign exchange reserves (US$ billion)

Note: Figures as of December 31, 2010 Source: China State Administration of Foreign Exchange

The automotive industry appears to be rapidly following suit. In 2009, China overtook Japan as the world's biggest carmaker and in 2010, overtook the US as the biggest automotive market. Sales growth in China is forecast to average 15 percent over the next few years. This is affecting chemical producers through the eastward relocation of some of the established OEM's, such as Ford's new assembly plant in Chongqing. Another factor is the rise of new, emerging market manufacturers, with the recent acquisition of Volvo by Geely of China being a notable example. In India, local auto manufacturers will add almost 1 million units of new vehicle assembly capacity before the end of 2011, clearly providing new opportunity for local chemical producers.

The construction industry in emerging markets also shows tremendous growth potential. Construction spending in China continues to be driven by mass urbanization with tens of millions of people moving from the countryside each year. The Chinese urban population is likely to reach 600 million by 2025. In Brazil, the World Cup of 2014, followed by the Olympics of 2016, will generate massive infrastructure growth and new demand for chemicals used in construction.

Emerging market growth for pharmaceuticals, agrochemicals and consumer products is also on the increase, driven primarily by a rapidly expanding middle class, particularly in India and China.

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Fuelled by local market growth and government support, many emerging market chemical companies are now undertaking large-scale, transformational M&A.

The key driver for this transformational strategy is the quest for new technology. Many emerging market chemical companies lack the technological and operational expertise required to fully capitalize on the growing demand in their markets, particularly at the specialty end of the chemical value chain. As a result, M&A activity is increasingly being used as a tool by BICME chemical companies to acquire the requisite technology, particularly in downstream areas, to achieve their development goals.

In some cases, these goals are in line with the local government's economic planning. For instance, Saudi Arabia is focused on acquiring technology to help support a number of planned downstream industrial clusters (more on that in the next edition of Reaction) to provide opportunities for their growing population of young college graduates seeking employment. Similarly, state-owned Chinese chemical majors enjoy the availability of vast amounts of government funding as well as a national policy of selfsufficiency in chemicals. As a result, Chinese companies will likely increase their outbound M&A activity. The key question is whether they can act quickly enough to be successful in the fast-paced auction processes common in the established markets.

As a result of this technology drive, we expect M&A activity to accelerate in BICME countries over the coming years. However, clearly there is only a limited amount of proprietary technology available, so emerging market companies essentially find themselves in a race to be the first to acquire technology, either through outright acquisition or through joint ventures and long-term partnerships with chemical companies in Europe, Japan and the US. The companies (and countries) that win the race will be best positioned to benefit from the huge growth in emerging chemical markets over the coming years.

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The average cash position of the ten largest established market chemical companies improved through the downturn as they focussed on cash management and cost optimization to strengthen their balance sheets. However, they continue to hold a significant amount of long-term debt – an average of US$11.3 billion dollars each at the end of the third quarter of 2010, although many have capitalized on favorable corporate bond markets over the last twelve months so the "maturity cliff" (debt that was to come due over the next couple of years) is no longer a concern.

Cash reserves and long term debt (US$ billion) for the 10 largest chemical companies by revenue

Source: Annual Reports
Note: Cash position of the 10 largest (by revenue) listed chemical companies from the Chemical Week Billion Dollar Club of September 2010. Excludes ExxonMobil Chemicals, Ineos and Shell Chemicals, as data not available.

Despite this improved financing position, established market companies apparently have little appetite to engage in transformational M&A. Instead, they are focusing their M&A activity on portfolio optimization – particularly by leaving bulk and commodity areas so they can concentrate on high-value, highly specialized chemicals – providing innovative solutions to respond to critical challenges like climate change, food and water shortage – as well as attaining access to the high growth markets in emerging regions.

This will continue the trend we have seen established over the last few years, with the likes of BASF exiting business units in styrene and fibers, whilst acquiring in areas such as pigments, plastic additives (Ciba) and care chemicals (Cognis) at the same time as establishing over 20 JV's in Greater China. In 2011 already, Clariant has acquired 95 percent of Sud-Chemie to access high margin opportunities outside of its current markets; while DuPont is acquiring Danisco to boost its industrial biotechnology arm with science intensive innovations that address global challenges in food production and reduced fossil fuel consumption and Ashland will buy ISP to expand its business in less cyclical high growth markets.

Other established market companies are pursuing similar strategies of moving closer to the customer and sourcing where they sell. Asian chemical markets, in particular remain highly fragmented, providing attractive takeover targets for many chemical players based in the US and Europe.

For example, PPG announced its plans in 2010 to acquire Chinese packaging coatings producer Bairun Chemical Company, helping to strengthen its position in packaging coatings in China and other parts of Asia. Also, the company has opened an aerospace application support centre in Tianjin, China. This facility is one of 16 around the world that supply PPG products and technical support to the Pittsburghbased company's aerospace customers.

Hexion Specialty Chemicals, Inc., and Shanxi Sanwei Group Co., Ltd., formed Sanwei Hexion Chemicals Limited, a JV to build a new manufacturing facility in Shanxi Province, China, that will produce VeoVa monomer. VeoVa monomer is a key building block ingredient used in water-based decorative coatings, re-dispersible powders and adhesives.

US, European and Japanese chemical companies are also entering into cross-border deals in China and the Middle East to gain access to feed stocks.

Dow announced plans in November 2010 to form a JV with the Shenhua Group, in Yulin City, China. Dow plans to utilize easily available coal in the region. The JV will incorporate the latest technology in order to optimize the use of natural resources.

In February 2010, Arabian Amines Company (ACC) – a 50-50 JV of Huntsman Corporation and Zamil Group Holding Company – completed its new ethylene amines plant in Saudi Arabia. The plant has a production capacity of 27,000 tonne/year. Huntsman will have exclusive sales, marketing and technical service rights for the plant's output.

Such bolt-on acquisitions and small JVs are likely to continue to dominate established market M&A, allowing chemical companies to quickly enhance equity value, establish a local presence, increase revenue and enter new markets.

FMC announced plans to pursue bolt-on acquisitions to extend its biopolymers food ingredients business into other texturant products, strengthen its position in emerging markets and look for opportunities for entering into the specialty ingredients market.

Eastman Chemical has announced that it is looking at several small to medium sized opportunities that will form a strategic fit; PPG is planning to accelerate earnings growth through bolt-on acquisitions, especially in the coatings segment in emerging countries; and Dow has announced M&A plans with a focus on small sized deals aimed at growing globally.

When we do see established market chemical companies getting involved in deals at the higher end of the M&A market, they are likely to focus on asset-light joint ventures with emerging market chemical companies, leveraging their technological capabilities to gain access to cheap feedstock and highgrowth markets. Recent examples include the Sumitomo JV with Saudi Aramco (Petro Rabigh) and the planned JV's by Dow (also with Aramco) and Ineos (with PetroChina).

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Over 1,500 chemical companies globally now operate under private equity ownership. Many of these, particularly those bought at the top of the cycle in 2007 came under severe pressure during the downturn as reduced earnings weakened the funding and covenant positions on highly leveraged deals. Many of these private equity backers are now seeking an exit as margins recover.

At the same time, as margins continue to strengthen through the up-cycle, under-exposed private equity investors are trying to gain an entry to the industry. A particularly interesting dynamic is underway in the US, following deals such as the acquisition of Dow's styrene business (Styron) by Bain Capital and the acquisition of Cytec's Building Blocks Chemicals business by HIG. With capacity taken out during the downturn, the US commodity chemicals sector is perhaps as well rationalized as it has ever been, moderating long-term cyclicality. As a result, financial backers are taking an interest in commodity chemicals assets in the US, which they believe can now be run for fairly fixed long-term returns.

As many of the majors seek to exit commodity areas, PE is likely to offer an attractive exit route. However, with financing conditions significantly different to before the downturn, such PE activity is likely to be mainly focused in the mid-market.

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Recent KPMG research suggests that over US$100 billion in deals could be transacted for global chemicals in the next two years. Much of this activity will have a deeply transformative effect on the industry.

Possible new majors by 2020

Source: KPMG analysis, 2011

In the 1990s, major companies worked to achieve a high level of integration and value chain coverage. Today, the industry is characterized by a more diversified landscape with different value chain coverage and the emergence of new integrated players focused on downstream opportunities in emerging markets.

The world's chemical producing regions are starting from different positions in the race to capture this downstream demand. The established companies in the West will continue to leverage their traditional strengths in technology and expertise. Asian and Middle Eastern companies will take advantage of their relatively strong cash positions, government funding and proximity to feedstocks and high-growth markets. At the same time, competition between emerging market companies is likely to increase as players in both areas seek to acquire the same assets.

However, one trend applies to the industry as a whole: the continued rise of global chemical players in emerging markets. In 2009, only two of the ten largest companies by revenue in the Chemical Week Billion Dollar Club were based in emerging markets. By 2020, if we continue to see the rapid growth of companies such as SABIC, Sinopec, Sinochem, Reliance, Saudi Aramco, Braskem and others, up to seven of the ten largest chemical companies could be based in BICME countries as the current largest players pursue profitability over scale. Recognizing this trend will be imperative for chemical companies developing long-term M&A strategies now and in the years ahead.

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