Chemicals Mergers & Acquisitions Review: Industry in Transition

Chemicals Mergers & Acquisitions Review: Industry in Transition

The Valence Group The Valence Group is the only global M&A advisor focused entirely on the chemicals and related materials industries. We are the most active chemicals M&A firm having advised on nearly 30 successfully closed M&A transactions worth approximately $10 billion since our formation in 2008. Our offices in New York, London and Shanghai have acted as M&A adviser to many of the leading companies in the chemicals sector including Arkema, Cytec, DSM, Eastman, ExxonMobil, Ineos, PolyOne, Solutia, Solvay and Tessenderlo. Our overarching belief is that the $2.5 trillion chemical industry, with multiple products and application sectors, each with their own complexities and dynamics, requires an investment bank with specialist knowledge and expertise. Consequently, our team combines experienced investment bankers, industry and strategy consultants and former senior executives from the chemical industry. This equates to a collective experience of more than 350 years in chemicals M&A covering more than 80 chemical sub-sectors in both public and private transactions. This level of depth gives us an unparalleled understanding of chemicals M&A. Furthermore, we are conflict free as we are solely dedicated to providing M&A advisory services. The GPCA The Gulf Petrochemicals and Chemicals Association (GPCA) is a dedicated and non-profit making association serving all its members with a variety of data, technical assistance and resources required by the petrochemicals and chemicals industry. GPCA s mission is singular and specific in that it intends to support the growth and sustainable development of the petrochemical and chemical industries in the Gulf in partnership with its members and stakeholders and be both a sounding board and a meeting point for debate and discussion. It is the first such association to represent the interests of the industry in the Middle East and it has brought a major dimension to its task by creating both a forum for discussion and a place where likeminded people can meet and share concepts and ideas. Since its inception in March 2006, the GPCA has earned an enviable reputation for steering the regional industry towards a whole new level of co-operation and raising the standard in terms of common ground interests. www.gpca.org.ae Authors Dr. Anton Ticktin, Partner at The Valence Group: Anton leads the strategy team in The Valence Group which offers an unparalleled analysis capability for chemicals M&A. The Valence Group has a global strategy and analysis team centred on London and New York. Peter Hall, Partner at The Valence Group: Peter, one of the four founders of The Valence Group, is a 25 year veteran investment banker. He has spent 20 years focussing on M&A transactions in the chemicals and materials sector globally. www.valencegroup.com New York Tel: +1 212 847 7340 London Tel: +44 (0) 207 291 4670 Shanghai Tel: +86 21 5116 7191 2 GPCA September 2013 www.valencegroup.com

The world is witnessing a fundamental structural change in the chemical industry Structural Change and M&A Activity at All Time High Mergers and acquisition (M&A) volumes in the chemical industry stand at a near all time high. Since 2004, the number of chemical transactions has more than doubled and continues to remain at a high level. Even during the 2009 downturn, M&A volumes were above historical levels. As Figure 1 shows, transaction levels remain strong and are indicative of a major shift in the global chemical industry. Figure 1 Historical Change in Chemical Transaction Volumes 3 GPCA September 2013 www.valencegroup.com

The world is witnessing a fundamental structural change in the chemical industry as North American and European chemical companies realign their portfolios to move downstream, while Asian and Middle Eastern chemical companies continue to expand their current positions. Furthermore, this is the first time in history that all the regions are expanding their chemical businesses simultaneously as Indian, South East Asian and Latin American companies have also expanded through acquisition recently. Indeed as Figures 2 and 3 show, in 2005 only ca. 15% of all chemicals M&A was outside the US or Europe but five years later this had more than doubled to 35%. The increase has been predominantly intra-regional but there has also been a significant increase in outbound activity from Asia and the Middle East. The capacity expansion of chemical companies in developing economies has also had a profound effect on the established competitors in Europe and US. With demand and capacity growth in Asia, the European/US chemical industry has been forced to shed commodity businesses and reposition portfolios to areas with higher barriers to entry. This transition from process chemistry to solution/service driven performance chemicals has pushed traditional chemical companies to acquire in areas such food ingredients, catalysts, advanced materials and other technically advanced or service-driven products. 4 GPCA September 2013 www.valencegroup.com

Chemicals M&A Review: Industry in Transition Figure 2 Global Chemicals M&A by Acquirer Origin (2007-2012) Figure 3 Global Chemicals M&A by Acquirer Origin (2001-2006) Figure 2 5 GPCA September 2013 www.valencegroup.com

However, this industry restructuring is still on-going and we are essentially only in the first phase. As Figure 4 graphically depicts, nearly all developing regions are now shifting their attention from commodity chemicals to intermediates. Product areas such as polyamide intermediates, acrylic acid, isocyanates, specific C4 chain chemicals and EO derivatives are the new targets. Figure 4 Regional Chemical Companies M&A Focus 6 GPCA September 2013 www.valencegroup.com

The intermediates area has traditionally been protected by technology barriers, but has recently been more heavily targeted by Asian and Middle Eastern companies with planned expansions as well as acquisitions of technology-rich companies. In turn, this move will trigger US/European companies to divest or shift their strategies in these traditional highly profitable product areas. This will also accelerate further M&A activity as established producers divest while also continuing to acquire in more downstream specialty product lines. This overall progression is already underway and examples such as adipic acid and fluorochemicals show the impact of Asian expansion in the market. More recently, the proposed expansion of Chinese companies in caprolactam will also likely have a significant impact on nylon intermediates competitive dynamics. 7 GPCA September 2013 www.valencegroup.com

With funds at their disposal and availability of financing, the need for growth has taken centre stage Further Drivers of M&A The chemical industry has successfully ridden through the downturn in 2008/09 and indeed even managed to increase profitability and cash flow in the following years. This is in stark contrast to previous recessions when the industry chose to maintain scale and operating rate at the expense of margins. The previous emphasis on volume has now been largely replaced by a more commercially-minded focus on profitability, with the result that many companies now have strong balance sheets and healthy cash flows. As shown in Figure 5, average profitability over the cycle does not vary as greatly as many people would assume, with EBITDA actually staying within a narrow band of 15%-22% (% EBITDA/Revenue). It is estimated that the current level of profitability in the industry (Q3 2013), despite recent economic softness, is near the cycle high. Maintaining this profitability has marked a step change in chemical industry behaviour and performance. It has also underpinned M&A activity. With funds at their disposal and availability of financing, chemical companies need for growth has taken centre stage. The desire to move further downstream for many European and US companies has become a necessity and demand for acquisitions of speciality chemicals has increased accordingly. Therefore, some performance chemicals areas have started to consolidate (Figure 6) and there are progressively fewer higher quality opportunities available. Inevitably, this has created demand for larger acquisitions in speciality chemicals as companies such as BASF, Ecolab, Solvay and Eastman begin to consolidate the market. Although this is expected to be a gradual process, it will continue to boost M&A volumes for the remainder of this decade. 8 GPCA September 2013 www.valencegroup.com

Figure 5 Chemical Company Profitability Cycle (EBITDA %) Figure 6 Specialty Chemical Consolidation Index 9 GPCA September 2013 www.valencegroup.com

This dynamic will also serve to limit the available opportunities and larger transactions linked to portfolio realignment will accompany this trend. This will particularly affect the higher growth areas as shown in Figure 7 which continue to be the main product/application targets of the chemical majors. Figure 7 Profitability and Sector Attractiveness Mapping of 230 Chemical Products/Applications (not all sectors labelled) 10 GPCA September 2013 www.valencegroup.com

...food ingredients, agrochemicals and oil and gas chemicals have become key target sectors In parallel, with the advent of low cost gas feedstocks in the US, we expect further acquisitions as companies take advantage of the raw material opportunity. This will be a spur to further investment and repositioning of companies in the chain. Larger companies may both divest some intermediates in the US while also moving further upstream. Hence the US and Europe could fundamentally diverge in the next few years, as commodity chemicals production is scaled back in Western Europe but continues to grow in the US. The result will be an increase in M&A activity in North America with companies seeking to buy assets with access to advantaged raw materials. Need for Growth Although profitability has generally been maintained despite a rather weak 2012, growth is proving to be much harder for the chemical industry to maintain. In a relatively weak global macroeconomic environment, finding products and markets with above GDP growth is perhaps the most pressing strategic imperative for many companies. Consequently, larger chemical companies have expanded their view of the industry and have now moved beyond seeking acquisitions that add to their current integration or commercial position. The broadly defined food ingredients, agrochemicals and oil and gas chemicals have become key target sectors with companies such as BASF and DuPont being particularly active. The Valence Group global chemical industry map (Figure 8) splits the industry by products and applications and shows some of the most active sectors. 11 GPCA September 2013 www.valencegroup.com

Chemicals M&A Review: Industry in Transition Figure 8: Global Chemical Industry Revenue Map 12 GPCA September 2013 www.valencegroup.com

An additional consideration for public companies especially in the US and Europe, is the desire to uphold the share price and enhance shareholder returns through increasing stock prices or even EBITDA multiple. The Valence Group analysis of 250 public chemical companies reveals that although having specialty chemical status can statistically increase EBITDA multiple by up to 2 turns, profit growth remains the main driver of valuation uplift (Figure 9 and Figure 10). Hence growth should be the overriding factor for public chemical companies and preferably profitable growth. Well executed acquisition provides a path to achieving the growth demanded by shareholders. Figure 9 Correlation of Valuation with Degree of Specialty Figure 10 Correlation of Valuation with EBITDA Growth 13 GPCA September 2013 www.valencegroup.com

With this emphasis to find growth and increase profits, companies will continue to execute on M&A. This will also include divesting lower growth businesses which the market (and some activist investors) has signalled is important to retain investor interest and confidence. By 2020 we would expect to see regional industry positioning as depicted in Figure 11. The main changes are the commodity and intermediates area where Chinese and Middle Eastern companies will dominate together with a resurgent North America. Specifically, only a few European and US companies will still be active in the intermediates area where we expect to see greater Chinese and Middle Eastern presence both through acquisition as well as expansion in their respective regions. European and US companies will move the furthest downstream, even into end products. Companies such as DSM have arguably continued to move furthest into the food/life sciences area and could prove a model for many. 14 GPCA September 2013 www.valencegroup.com

Figure 11 Forecast Future Positioning of Regional Chemical Industry in 2020 15 GPCA September 2013 www.valencegroup.com

...industry restructuring will continue to sustain M&A demand and volumes in the mid to longer term M&A Activity Increasing At the time of publication, M&A activity has again started to rise. Following a partial lull from Q3 2012 to Q1 2013 due to subdued economic conditions, the transaction volumes are approaching the highs of 2011 (Figure 12). As outlined previously, companies are beginning to realign portfolios and shed business under increased global competition while also targeting growth product areas. DuPont, Dow, DSM and Ashland have all announced strategic portfolio reviews or desire to exit upstream or low growth business. Combined with several other current or pending divestments, M&A activity is expected to remain strong in H2 2013 and 2014. Transaction multiples have also started to rise and are currently at the long term average of 8.7 (x EBITDA) having risen for the last three years (Figure 13). Combined with robust profitability, this has translated into perceived high valuation levels. Nevertheless, as both profitability and multiples are expected to increase in the mid-term, acquisition prices are forecast to rise further. Although this may put a limit to some of the larger deals in the near term, industry restructuring will continue to sustain M&A demand and volumes in the mid to longer term. 16 GPCA September 2013 www.valencegroup.com

Figure 12 Number of Chemical Transaction Monthly Since 2010 Figure 13 Chemical Company Transaction Multiples 1990-2012 17 GPCA September 2013 www.valencegroup.com

...the main impact will be the huge move downstream of the chemical majors and the locking out of developing and Middle Eastern competition Challenges for Middle Eastern Chemical Companies It is commonly assumed that recovered shale gas will be the major threat to the Middle Eastern chemical industry. Certainly, low cost competition in the US and other regions building shale gas infrastructure will dent volumes of commodity chemical exports from the Gulf. However, this will have limited overall bearing on Gulf chemicals and has distracted companies away from the real threat to Middle Eastern producers. In our view, and as set out above, the main impact will be the huge move downstream of the chemical majors and the locking out of developing and Middle Eastern competition. This will become a major impediment for the Middle East, whose ambitions are to build fully integrated and high value chemicals-to-products industries. The implications are that some regions could remain upstream in the more competitive commoditised product areas with limited higher skilled employment opportunities in the more technologically advanced products. For Middle Eastern chemical producers wanting to grow across the entire chemical industry, the structural realignment occurring in the industry will necessitate: Moving further downstream into specialty chemicals as intermediates and some engineering polymers will commoditise Acquiring larger specialty chemical companies in Europe and North America as many smaller high quality companies will be acquired or unavailable Acting quickly and decisively in the next few years before the better opportunities are acquired by established companies 18 GPCA September 2013 www.valencegroup.com

With the expansion of Chinese and South East Asian companies into intermediates, and North American companies into C1-C3 chemicals, the Middle Eastern chemicals industry will see a more competitive environment, with price erosion in core products and markets. Indeed, even some of the companies acquired in the last years are seeing increased competition. Hence, apart from acquiring positions in growth regions either through JVs or acquisitions, Middle Eastern companies will also need to move further downstream. Areas such as high performance polymers, water treatment chemicals, catalysts and oil and gas chemicals would all be possible immediate targets. Perhaps we will even see Gulf producers acquiring companies across all these products, which would certainly be a signal of intent to the rest of the world. www.valencegroup.com New York Tel: +1 212 847 7340 London Tel: +44 (0) 207 291 4670 Shanghai Tel: +86 21 5116 7191 19 GPCA September 2013 www.valencegroup.com