Hunt for Earnings Growth Reshapes Chemicals Sector

From cosmetics ingredients to pillow foam, and from paints to crop sprays, a chain reaction of deals is coursing through an industry that makes many of the world’s everyday products as well as key materials that go into them.

The list of large transactions that has spread through the chemicals sector expanded just last week, with the proposed merger between Switzerland’s Clariant and Huntsman Corporation of the US.

The combined group — valued at $20bn including debt — would aim to become a leader in the area of speciality chemicals, with products ranging from industrial adhesives to colourants for lipstick.

It follows a succession of blockbuster deals, which kicked off 18 months ago with a transaction involving the two largest chemicals companies in the US: Dow Chemical’s agreed $69bn takeover of DuPont.

Deals to buy chemicals groups that were either announced or completed in 2016 had an aggregate value of $263.7bn including debt, according to data provider Dealogic, compared with $177.4bn in 2015, when the figures were dominated by the Dow-DuPont transaction.

This slew of dealmaking is reshaping a hugely diverse sector that has struggled with weak demand due to the lacklustre economic recovery since the global financial crisis.

With limited prospects for revenue growth, chemicals companies are looking to boost earnings by buying rivals and stripping out costs. The enlarged groups are also seeking increased market power that would enable them to strike better contracts with suppliers and customers.

These motivations are apparent in two of the three recent agri-business megadeals, where chemicals groups are responding to a downturn in the farming industry that stems from a plunge in crop prices following years of bumper harvests.

After Dow and DuPont unveiled their merger in December 2015 following pressure from activist investors to cut costs, state-controlled ChemChina proposed a $43bn takeover of Switzerland’s Syngenta in February 2016, and six months later Germany’s Bayer agreed to buy Monsanto of the US for $66bn.

These transactions are aimed at beefing up the capabilities of the enlarged groups to help feed the world’s growing population — all three will have strong product portfolios involving both seeds and crop sprays.

But while ChemChina pledged to support Syngenta’s existing operations, in a recognition of the political sensitivities surrounding the deal, by contrast Dow and Bayer have sought to persuade investors of the merits of their transactions partly by outlining plans to cut costs.

“Fundamentally it’s very difficult for chemicals companies to grow faster than [gross domestic product], except in niches,” says Kirk McIntosh, partner at the Valence Group, a specialist investment bank.

And this drive to reduce expenses and gain economies of scale has rippled out to other parts of the chemicals industry.

In March 2016 Sherwin-Williams, a leading US paint maker, agreed to pay $11.3bn for domestic rival Valspar, and highlighted opportunities to trim overheads.

One year later PPG Industries, the US manufacturer of coatings and sealants for aircraft and cars, made the first of three offers for Akzo Nobel, the Dutch paintmaker that owns the Dulux brand. Akzo has rejected the offers, but is coming under pressure to engage in talks from shareholders led by Elliott Advisors, the UK offshoot of the New York-based activist hedge fund.

Activist investors are not the only disruptive force affecting western chemicals companies. Another is the rise of rivals in China.

The extent of China’s ambitions in chemicals became plain when ChemChina swooped on Syngenta — it ranks as the country’s largest proposed overseas takeover.

Bankers say an expected merger between ChemChina and state-controlled Sinochem, which would create the world’s largest chemicals group by revenue, is aimed at giving the former company the financial capacity to absorb Syngenta.

But even before the Syngenta deal, China was shaking up the chemicals industry. In certain products — notably bulk chemicals such as caustic soda — China has turned from a net importer to an exporter, says Graham Copley of SSR, an investment research firm.

This has put downward pressure on the prices of many commodity chemicals, and therefore served as a further spur to industry consolidation.

Another deal driver appears to be the tricky position that chemicals companies occupy in industrial supply chains.

Hemmed in between gargantuan suppliers of natural resources — often oil and gas groups — on one side, and large customers in sectors such as automotive, consumer goods and pharmaceuticals on the other, chemicals producers can find themselves squeezed.

“This is an effort by the chemicals industry in its entirety to match up the level of consolidation of their customers and suppliers,” says Hassan Ahmed of Alembic Global Advisors, an equity research firm. “Because of [greater] heft, you can negotiate better sourcing deals.”

Furthest down this path are chemicals companies producing industrial gases, an industry subsector that has been consolidating over the past two decades. It took another major step with the $70bn merger finalised last week between Germany’s Linde and Praxair of the US.

The enlarged group will supply industrial gases used in steel and glass production, among other things.

However, not all the chiefs of the chemicals companies engaged in deals are seeking to build empires — some are instead trying to dismantle sprawling groups that have been accused of lacking focus.

This was encapsulated by Dow and DuPont’s original merger agreement, which envisaged the combined group subsequently splitting into three discrete companies: one concentrating on seeds and crop sprays, another on materials such as plastics, and a third on speciality chemicals.

This month, Dow and DuPont said the break-up plan would be reviewed, amid investor concern it was not correctly configured. Dan Loeb’s Third Point, the activist hedge fund that called for a break-up of Dow back in 2014, said the enlarged group should be split into six companies to maximise shareholder value.

Akzo, meanwhile, is trying to fend off PPG’s interest by proposing to spin off its specialty chemicals business.

Since many of the big deals in the chemicals industry are being investigated by antitrust regulators, there is likely to be a second wave of transactions stemming from divestments required to safeguard competition.

“There’s this aftermath of big mergers we’re going to see,” says one banker involved in the sector.