Chemical Week • March 25/April 1 • On the way up?: M&A market nears inflection point

Chemicals M&A market stalled out in 2023 after an extended strong run. Announced deal value fell 14.2% last year, to about $70 billion, according to Chemical Week data. Total number of announced transactions fell 5.4% in 2023, to 264; not a dramatic decrease, but the smallest figure since 2016 outside of 2020, when the pandemic ground dealmaking to a halt for several months.

The chemical M&A market slowed last year as strong headwinds from higher interest rates and weak performance chilled deal activity. For private equity firms, “the sheer velocity of the interest rate shock was something few … had ever experienced, and the impact on value has driven a wedge between buyers and sellers,” according to a report by Bain & Co. (Boston), a consultancy. Interest rate increases by the US Federal Reserve in 2022 and 2023 proceeded “at the fastest pace since the 1980s,” Bain added, contributing to uncertainty.

But while rising interest rates have been a negative for M&A across the board, for chemicals it was broader uncertainty about the industry’s performance that further dragged down activity. Many producers saw earnings whipsaw in late 2022 and 2023 due to inventory destocking, and the European industry continues to be hampered by high energy costs and tepid growth.

Last year saw a “not-so-perfect storm of earnings pressure on businesses, the impact of energy prices in Europe rippling through, and a slowdown in China,” said Ranga Covindassamy, managing director with Evercore (New York), an investment bank, said during a Chemical Marketing & Economics (CM&E) Group webinar in early March.

M&A transactions were hampered in 2023 more by “the underperformance of businesses, and sellers not wanting to sell at the bottom,” said John Televantos, partner with Arsenal Capital (New York), a private equity firm. “Anyone who could, said, let’s wait a year and see if there’s an improvement.”

The challenging environment had a chilling effect on possible sellers, which may not necessarily be reflected in asset valuations. “If everyone who wanted to transact did [last year], you would’ve seen a huge decline in asset values,” said Anthony Giorgio, managing director/specialty chemicals with TM Capital (New York), an investment bank. “In the past twelve months, many sellers have not even attempted to put businesses on the market because it was a challenging year and companies were coming off depressed EBITDA. They also recognized they didn’t want to go through a sale process that could fail.”

For the broader M&A market “price multiples, which tend to move inversely to interest rates, have tipped downward over the last year, but only slightly so far,” Bain said. In chemicals, “multiples have cooled down,” Covindassamy noted.

Signs of a turnaround have emerged in the past few months. On a year-to-date basis through March 25, chemicals M&A volumes and values are up 7% and 40%, respectively, from 2023 levels, according to CW data.

There are also some signs that business performance bottomed out or started to turn positive in the fourth quarter. In a survey of 50 chemical makers by CW, the average company reported adjusted earnings of about 85 cents per share, slightly ahead of analysts’ consensus estimate of about 83 cents per share, as reported by S&P capital IQ.

“As we enter 2024, we expect near-term demand to remain pressured by elevated inflation, high interest rates and geopolitical tension, particularly in building and construction and durable goods end markets,” Dow CFO Jeffrey Tate said during the company’s fourth-quarter earnings call on Jan. 25. “That said, we are seeing some initial positive indicators.” These include relatively low inventory levels, moderating inflation and resilient US consumer spending, according to Tate.

This cautious optimism has flowed through to M&A. “There is some optimism that we are at a point now where things could move,” Covindassamy said. “It’s about seller expectations and buyer willingness to pay.”

“We are seeing deals … not at the speed that you saw in 2021, but you are starting to see deals get done,” said Paul Greenfield, managing director with Moelis & Co. (Washington, DC), an investment bank. “Interest rate cuts could be helpful, we’ll monitor that, but people are getting back into the business of doing deals.”

Greenfield cited IFF’s sale of its pharma solutions business to Roquette for $2.85 billion (p. 13), which was announced on March 19. The deal had an EBITDA multiple of 13x, indicating that buyers and sellers can start to bridge gaps.

“Business is improving, the pipeline is coming back, pitch activity is percolating,” Giorgio said. “These are leading indicators of a slightly better M&A market.”

With inflation in the US continuing to exceed the Federal Reserve’s 2% target, expectations for interest rate cuts have shifted in recent weeks. Many M&A market participants are not expecting rate cuts until the second half of this year or later. Still, stable rates — even if relatively high — are vasty preferable to increasing rates.

“There is comfort that rates are not going to go higher and will gradually come down, ‘gradual’ being the operative word,” Televantos said. So, while capital costs will remain high relative to the 2008–22 period, “at least we know what it is, and it’s not likely to go higher,” he added.

“I think rate cuts are coming, maybe a little later than we had previously thought,” Greenfield said. “But the key thing is that we’ve been in this high-rate environment for a while now … the market is more used to it.”

Despite higher rates, the window for financing is open. “Debt availability is up [compared with last year], but not what it was at the peak,” Televantos said. “The cost is higher, but you can plan for that.”

For most borrowers, “the window is open,” said Thomas Watters, managing director at S&P Global Ratings. For investment-grade companies, capital market access was never really a problem, but for speculative-grade issuers, “it could be dicey and with higher rates,” he added. “They’ve had higher interest expenses, so have had to solve for that.”

The gulf in valuation expectations between buyers and sellers is starting to narrow, although buyers have moderated their expectations first, bankers said. “Buyers have realized that this is the rate environment, they’ll price that in and the real movement now to open up M&A is that sellers need to move a little closer to where buyers are,” Greenfield said. “I think you see that in some of the deals that have gotten done in the past few months.”

Sellers may still have to adjust expectations, according to Ryan Meany, managing partner with Edgewater Capital Partners (Cleveland), a private equity firm. “We have not seen bid-ask spreads narrow a significant amount just yet,” he said. “I think they should, that would be part of the outcome of the higher cost of capital … its mainly due to sellers, expectations are still a bit elevated in the current environment.”

Acceptance of a new normal is gradually taking hold, according to Giorgio. “Sellers are reluctantly accepting that this is the new pricing dynamic,” he said. “And there’s a recognition that 2022 [valuations] were abnormally high. Unsustainable EBITDA for many businesses and very fulsome multiples combined to create a very robust environment a couple of years ago, which set expectations for sellers that were unrealistic.”

Valuations are settling for nonpremium assets, according to Greenfield. “Our view is that premium assets will still go for premium multiples,” he said. “But in chemicals, you see a divergence between premium assets and the next tier down … you will see lower valuations for the next tier down. It shows things are getting more back to normal,” compared to the inflated environment of the immediate post-pandemic era, he added.

One consequence of a weak M&A market in 2023 — and the roller coaster ride that has been seen this decade — is that private equity firms have held onto many assets for longer than a typical hold period of five years or so. A survey by CW found over 40 chemicals assets acquired by private equity in 2019 or earlier that are still held by those same private equity investors (table; note that some of these assets are minority investments). Average hold periods for private equity “have ticked up to six-plus years,” compared with about five years historically, Daniel Bruck, principal/industrial growth with Arsenal Capital, said during the CM&E Group early-March webinar.

Some private equity firms, such as SK Capital Partners (New York), may adopt a holding-company-like strategy for investments, and have historically been comfortable with longer hold periods. But most do not operate this way, and many firms are facing pressure from investors to unload assets that have been held for several years or more. “Exit activity fared even worse than dealmaking in 2023, as rising interest rates and macro uncertainty left buyers and sellers at odds over valuations,” Bain said in its report on private equity. “Buyout-backed exits came in at $345 billion globally, a 44% decline from 2022.”

Difficulty selling assets can even redound to fundraising, as private equity needs to sell assets to show investors a return and attract the next pool of capital. “The exit conundrum has emerged as the most pressing problem, as [limited partners] starved for distributions pull back new [capital] allocations from all but the largest, most reliable funds,” Bain said.

“Today you have a lot of private equity firms that have not been very active for the past 18 months, and they have investors and returns they need to hit and money they need to put to work,” Greenfield said. Bain estimates total “dry powder,” or capital to invest, was about $1.2 trillion for the whole private equity industry at the end of 2023.

“We have businesses that are of a vintage where we need to consider a sale,” Arsenal Capital’s Televantos noted. In February, the firm announced the sale of Seal for Life Industries LLC, a protective coatings maker that Arsenal acquired in 2019, to Henkel, in what will likely be the first of multiple exits. “Several more [sales] are in the works,” Televantos said. “We feel the performance of these businesses is strong enough to get an adequate return, so we are preparing to take them to market. Many other [private equity] firms are doing the same, so we are seeing a significant increase in deal flow.”

CW’s survey found six chemical businesses owned by Arsenal that were acquired in 2019 or earlier. Some other businesses were acquired in the early 2020s.

However, while there are clear pressures to exit for many private equity firms, and many such deals are in the pipeline, this pressure has yet to translate into a spate of announced transactions. Just three chemicals M&A transactions announced so far in 2024 involved a private equity seller, including Arsenal’s sale of Seal for Life, according to CW data, compared with 14 deals that involved private equity on the buy side.