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Will growth end mega M&A deals?
Posted on June 23rd, 2017 by John Baker in Chemicals Industry News and Analysis
The mutually agreed merger of Huntsman and Clariant to create a specialty chemical company with $20bn enterprise value is the latest in a string of major consolidation deals in the sector. Leading chemical producers have been seeking ways of achieving growth during an extended period of sluggish global economic expansion, and mergers and acquisitions has been the go-to strategy.
But the deal might just mark the high-water point of this active M&A period that has seen mega-deals agreed between Dow Chemical and DuPont, Bayer and Monsanto, ChinaChem and Syngenta, Praxair and Linde, Sherwin-Williams and Valspar, and Potash Corp and Agrium. Waiting in the wings, and getting somewhat aggressive, is the approach made by PPG Industries to purchase AkzoNobel.
The task of driving top-line growth in these companies has been made more difficult as the areas they are active in are relatively mature and concentrated in terms of market share. Many of the deals above cover agrochemicals, fertilizers, industrial gases and coatings; areas where the top five players have over 50% market share, and in some cases well over this percentage.
SIGN OF STRENGTH
Joachim von Hoyningen-Huene, partner in A.T. Kearney’s energy and process industry practice, explains that he sees an acceleration of the trend towards greater scale in chemical value chains and segments. M&A not only brings scale and enhanced opportunities for growth, but synergies and the ability to cut costs.
“These mega-deals are a sign of strength showing that the [company management] has a clear vision and really wants to own the space in the value chain. They can focus more effectively and serve the customer better.” However, he adds that they are also driven “by the lack of alternative growth opportunities in the market.”
There is today, he says, greater readiness and confidence to meet anti-trust requirements to divest businesses as required by merger authorities, and a higher level of confidence that synergies can be achieved once the deal has been done.
The active M&A market is throwing up plenty of potential buyers for these required divestments – largely in the form of strategic buyers looking to strengthen their existing portfolio and expand into new areas – but also buyers from emerging economies such as China, India and the Middle East.
But the climate is beginning to change for these mega-deals. There are signs that economic growth around the world is beginning to strengthen – reducing the imperative to consolidate and buy-in growth. The prospects of rising interest rates will also impact access to cheap debt finance for such huge deals.
Although, at present, debt levels in the industry are low and finance is not generally an issue, the industry is seeing slightly lower levels of cash, with return on sales declining in the first quarter of the year in some segments, such as fertilizers, consumer chemicals and inorganic chemicals, according to research by Accenture.
Paul Bjacek, research principal director in Accenture’s chemicals practice, believes the M&A flavour may alter going forward. “With improved economic performance, M&A activity may change towards more strategic acquisitions, with companies looking for smaller, incremental purchases.”
He does, however, see two major exceptions. These are emerging market players, who may buy for market position, geographic expansion and technology, and integrated oil companies, who may buy petrochemicals and downstream capacity, driven by reduced oil revenues due to the low to moderate oil price.
Dan Schweller, global M&A leader of Deloitte & Touche’s chemicals and specialty materials sector, also thinks the year of the mega-deals may be drawing to an end. “I wonder when we will have a slow down – it is very challenging to do these really complex mega-deals. It is daunting to the companies involved and there are concerns over losing focus.”
But, he argues, we will continue to see solid M&A activity. “The search for growth and innovation are huge drivers and companies will continue to want to focus on core competencies. In North America and Europe there is also the pressure from shareholder activists who are keen to challenge companies seen to be stepping too far from their core areas.”
And, he adds, there is still a big emphasis on top-line growth. One indicator, he notes, is that companies setting up joint ventures are today very keen to see sales consolidated into their own profit and loss statements.
“It’s a change from the former asset-light approach in the sector – more these days towards a revenue-heavy model.”
Marcus Morawietz, partner at Strategy&/PwC and global leader of its chemicals sector, also argues that strategic deals will continue to play a big part going forward. “Companies have identified that cutting prices and being aggressive in chasing market share are not the best or fastest ways to achieve growth.”
So how do they achieve the challenge of moving to the next growth and performance level? Says Morawietz: “They are intensifying M&A. First, by classical consolidation of their core segments, such as in crop protection, coatings, etc; and second, through capability-driven deals which address adjacent or downstream businesses or new areas where they have the necessary capabilities, for example in dealing with complexity, product and service innovation, etc.”
The result, he argues, is that “the capability-driven M&A strategy can provide growth with confidence and security, with few anti-trust issues. Companies have a good idea of the synergies they can achieve as they know how to run the type of businesses they are acquiring.”
As examples, Morawietz gives the LANXESS acquisition of Chemtura and the downstream focused deals of ChemChina.
EMERGING M&A TRENDS
All four consultants point to two other major trends in chemical industry M&A at the present time: the huge M&A activity in China and its growing involvement in cross-border M&A, and the efforts by North American and European companies to move into the digital era, by acquiring IT, software and digital service start-ups and companies.
The China story is part of a wider move that is seeing producers in non-Western economies, such as China, India and the Middle East becoming increasingly involved in M&A activity to acquire market position and/or technology. Saudi Aramco, for instance, acquired a half share in LANXESS’s rubber business and Novomer’s CO2 technology recently.
A recent survey by A. T. Kearney amongst industry executives shows that top drivers for future M&A activity include emerging market players seeking access to advanced technologies or application knowhow (given by 82% of respondents); the resurgence of the US chemicals industry because of low-cost feedstock (61%) and downstream integration of Middle East petrochemical producers (58%).
- T. Kearney’s von Hoyningen-Huene notes that its analysis shows that China accounted for a quarter of all chemical sector M&A activity in 2016 by number of deals – double the proportion just 10 years ago. Much of this activity is within China, where the market is very much more fragmented than elsewhere and there is thus more room for consolidation. This is, he adds, also being driven by overcapacity in the country in many products.
But China is also becoming increasingly relevant on the global scene, he adds. ChemChina is not only in the process of buying seeds and agchem specialist Syngenta, it has recently bought Krauss Maffei in the plastics processing sector and tyre-maker Pirelli.
These “quite astonishing” deals have left the company highly leveraged and there are now rumours of a merger with Sinochem to create a major chemical presence. The Chinese will acquire good assets, he adds, and run them at high operating rates, with less regard to margins than European or US owners.
- T. Kearney expects the China trend to continue. As it says in its latest M&A report: “Government-driven consolidation in supply industries such as coal, steel and chemicals is creating more national champions that in turn pursue international growth strategies through M&A.” It adds that it expects the same trend to continue in India, though to a lesser extent.
Figures from Accenture show that China was the third largest origin of M&A buyers in cross-border deals during the period 2012-to date, while it was virtually absent from the market over the period 2007-2012. Western Europe and Japan have been leading buying areas since 2012, with these three areas accounting for close to 45% of all deals done.
Says Bjacek: “Chinese companies have been the largest acquirers over the past four years and China has also been the location of the largest number of target companies. In cross-border terms, China is now the third largest acquirer in terms of the number of deals.”
This cross-border activity is being driven by the search for technology and market position but also growth, as China’s GDP advance slows. It is also a result of capital flight as Chinese investors look for somewhere to put their money as the Chinese economy slows.
On the digital front, there has been growing M&A activity as companies seek to build capabilities quickly so they can take advantage of big data and analytics in their offerings to customers and in support of their operations.
Deloitte notes in a recent report that “greater use of digitisation may also lead to growth and additional deal flow, as the industry turns to technology to help drive innovation and enhance operational effectiveness.”
Deloitte’s Schweller believes 2017 will see continued deal flow around digitalisation and innovation, in order to drive additional growth and differentiate acquirers in the marketplace. He points to uses in farming/agriculture and self-medication in pharma, not to mention uses in remote operations and track-and-trace functionality on customer orders as examples of where companies are looking to derive benefits from digitalisation.
Morawietz from Strategy& also comments on the rise of M&A in the area of digitalisation by chemical players. Figures from the consultancy show that one in 10 M&A deals by chemical companies in 2015 was done to acquire digital technology, up from just 4% in 2011.
But buying a digital company, he warns, is not the usual acquisition a chemical company is used to. Companies will need to ask whether it makes sense to buy the company or to try and build the capability in-house or to establish a network of digital service providers – the type of digital capabilities and speed are key levers and criteria for the best option.
“The rationale is completely different and the evaluation and due diligence are not so easy. The management, staff and capabilities are not the same as in the chemical sector, so integration and staff retention are also an issue – an acquisition of a digital target is primarily capability driven. Also, there will be very limited cost synergies with existing operations – it is typically a top-line case.”
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