Specialty Chemicals

C&EN Business Group

IT WAS JUST WEEKS AGO that Dow Chemical completed its acquisition of Rohm and Haas and BASF wrapped up the purchase of Ciba. These multi-billion-dollar acquisitions by the world's two biggest chemical companies are clear signs that the industry's top executives see specialty chemicals as a growth business.

They may be right, but the evidence from the past few months is that specialties are no panacea in an economic downturn. Fourth-quarter 2008 earnings at specialty chemical makers such as Ciba, Albemarle, and Cytec Industries fell as hard or harder than at diversified or commodity chemical companies. Early signs are that the first quarter of 2009 was no better.

This downturn has been like no other. Matthias L. Wolfgruber, chief executive officer of the German specialties maker Altana, was shocked by the ferocity with which it hit last fall. "It has been an absolute first for us—how surprising and sudden that we were affected," he says. He adds that his discussions with peers indicate the situation was the same throughout the European chemical industry.

And in contrast to previous recessions, Wolfgruber says, "specialties were not protected." It seems that in the global financial downturn, companies and chemicals were pummeled without discretion.

Chemical company managers across the globe are now dusting themselves off and assessing the damage that the economic storm has wrought. For the most part, they are sobered by what they see. But in keeping with the essentially optimistic nature of their breed, most executives see reasons to be hopeful.

While they cut jobs and pare down businesses to survive, they are keeping an eye on future months and years, when business will no doubt rebound. They know that the financial crisis will leave winners and losers, and no executive wants to end up in the latter category.

Looking at the recession's impact so far, Albemarle CEO Mark C. Rohr says chemicals that go into big-ticket items have been the hardest hit. "Anything that is related to durable goods, from consumer electronics to appliances, from construction to automotive, is really, really down—50%, maybe more in some areas," he says. "It is hard to see that pop back any time soon. I think it is going to take several years to come out of the recession."

Albemarle and its peers are responding with severe cost-cutting measures. The program Albemarle launched in December to cut $40 million in costs includes elimination of 5–7% of the firm's workforce of about 4,130. Rohr hints that more job cuts are possible. "We have taken other steps to further pull costs down," he says. "We are likely to do more."

EVEN SOME European firms, usually loath to confront unions over job cuts, are resorting to layoffs. Last fall, Swedish specialty chemical producer Perstorp saw enough warning signs that it began negotiations with union representatives about employment, CEO Bo Dankis says. As 2008 came to an end, the company let go approximately 200 people, about 8% of its workforce.

Some companies are trying to spare R&D in their effort to cut costs. Altana has implemented stringent cost-savings measures, slashing discretionary spending and any maintenance that can be deferred, Wolfgruber says. The focus, he adds, is on fast-working cost savings. But the company has not reduced its spending on R&D or on training and education. Likewise, Albemarle hasn't cut R&D spending, Rohr says, although it has been "more frugal" with its R&D dollars, he acknowledges, by reducing its emphasis on the long term.

Consultants who advise the specialty chemical industry are warning clients—particularly U.S. firms, which tend to be quick to lay people off—not to cut so severely that they aren't positioned to benefit from the economic upturn that will eventually come.

Jonathan Goldhill, head of management consulting at Kline & Co., a consulting and research firm, cautions managers against a slash-and-burn approach. "I think they've done a pretty good job of trying to batten down the hatches," he says. But companies need to restructure in a flexible manner, he adds, so they don't lose the people and capabilities they will need to prosper in any future upswing.

At the same time, Kline's consultants are gently pointing out to their clients that they can't expect business as usual anytime soon—if ever. According to Goldhill, specialty chemical companies that have cast themselves as global solution providers—offering complete, albeit full-cost, services on a worldwide basis—may find that their customers are "unbundling" what they buy to find the cheapest source of each product.

"Companies are going to be looking for the products that are cost-effective, rather than the ones with the bells and whistles," Goldhill says.

First, however, customers have to buy something, and in many markets that is hardly happening at all. Albemarle's hardest hit business has been polymer additives, such as its flame retardants for consumer electronics. Rohr recently told analysts that demand for polymer additives was down 50% in the first two months of 2009. The company is running its plants at utilization rates even below 50% to reduce its own inventories. It will be years before demand returns to 2007 levels, Rohr tells C&EN.

The company's fine chemicals business has been a mixed bag. Elemental bromine has suffered from the decline in demand for polymer additives and oil field chemicals. Pharmaceutical and agricultural chemicals have fared better, Rohr says. "Those things are doing pretty well and seem to be unfazed or untouched, for the most part, by the global recession," he says.

Because of refinery maintenance outages last year, Rohr has seen some weakness in Albemarle's fluid catalytic cracking (FCC) catalysts, which turn hydrocarbons into gasoline. Catalysts for alternative fuels and hydrotreating—a process that removes impurities from fuels—have fared better. And Rohr expects improvement in the FCC area as well. "Refineries are healthier today than they were at the end of last year," he says.

THE SITUATION is no better at Altana, which, Wolfgruber says, was hit by a double whammy. Not only did demand in industries such as automotive and construction dry up, but customers started working down inventories, holding off buying new supplies as they waited for declining raw material prices to drop even further.

"If there are no orders, there are no orders, whether specialty or commodity chemicals," Wolfgruber shrugs. Moreover, he says, that state of affairs continued through the first quarter of 2009.

Even smaller companies are not immune from the downturn. Indeed, Harry Swan, managing director of British specialty and custom chemical producer Thomas Swan & Co., talks about the recession in almost personal terms.

At the moment, Swan says, doing business is not easy. "We are fighting hard and having to cope with the working off of inventories, since the order book just dropped off the cliff." Since Swan and his employees took off for their usual Christmas break, "everyone has been looking down a dark hole. Our entire workforce took a 20% pay cut for January and February to help us through."

In fighting the downturn, specialty chemical company executives are trying to leverage all means at their disposal. Swan, for example, points to his company's absence of outstanding debt. "We're in a nice position," he acknowledges.

Similarly, Albemarle doesn't have any significant debt maturities until 2013, a point of pride for Rohr. "Our maturities are way out," he says. In contrast, Albemarle's closest competitor, Chemtura, was driven into bankruptcy because of looming debt obligations on top of the economic downturn.

Albemarle has been one of the few companies of any type that has raised its dividend, from 12 cents to 12.5 cents per quarter. "It was a pretty modest raise," Rohr says. "With the free cash flow that we have, we buy companies, we invest in R&D, we buy stock, and we pay dividends. It is important to keep that trend going." In contrast, Dow, in its flurry to get the Rohm and Haas deal done, reduced its dividend for the first time in 97 years.

Altana is doing everything it can "to flexibilize our capacity and flexibilize our labor force," Wolfgruber says. The company closed its largest plant, in Wesel, Germany, for two weeks over Christmas. And in the new year, he relates, it started "short time" work under provisions of the German Federal Employment Agency to help companies avoid mass layoffs. "We implemented this very fast for about one-third of our German employees."

In Germany, Altana employees who were not put on short-time work saw their workweek reduced to 35 hours, with a corresponding 3.3% cut in pay. There will be no pay raises this year, Wolfgruber says, and variable pay, such as bonuses, will be severely impacted.

Still, Wolfgruber says, Altana has had no layoffs, except for temporary or contract labor. "We hope this is sufficient to get us through," he adds. "We have a strong balance sheet, with strong cash flow, and an owner with very long-term orientation."

Nor has the company given up its approach of complementing organic growth with small acquisitions, Wolfgruber points out. Altana recently announced the acquisition of Dystar's plastics additives business.

In fact, Eric Vogelsberg, head of Kline's chemicals and materials practice, sees the recession opening opportunities for more such mergers and acquisitions (M&A). They won't be multi-billion-dollar purchases such as Rohm and Haas or Ciba, but they could be in the hundreds of millions, he believes.

"Some companies are finding themselves in a particular state of distress," Vogelsberg says. "They made significant investments in a more friendly financial environment, took on a significant debt load, and now find themselves in a downturn." On the other side of the bargaining table, he notes, are companies that have been more conservative with their cash, as well as private equity firms that, contrary to popular perception, can tap as much as $750 million to do the right deal.

"We have clients looking for small to mid-sized deals that they're going to self-finance. They don't need a lender," Vogelsberg says. "We see a robust M&A environment in chemicals this year."

Companies are using the financial and economic dislocation to their advantage in other ways. For example, Thomas Swan & Co. is making the most of the weak British pound, which Swan says "has made us competitive for the first time in a long time. About six months ago, I was looking at moving a product to China. Now I can manufacture it in the U.K., pay duty going into our export markets, and we are still competitive."

And Swan sees some benefit from what he calls a "natural response in times of recession"—a return to a safe home harbor. "It's not really protectionism," he says, but a return to local manufacturers and suppliers. "You can keep an eye on your product, you can drive to where it is being produced and kick the tires. That's a great opportunity for us," he says.

Specialty chemical executives are also using the slower times to get out, meet customers, and pursue new products and markets they might not have bothered with in flusher times.

Swan says his managers have spent "a long time talking to customers to get a feeling of what the demand will be in the next year." There are no certainties, but he says his team got enough of a feel for the coming 12 months that Thomas Swan & Co. is reorganizing accordingly.

At Perstorp, in addition to controlling costs, "we stepped up our marketing activity," Dankis says. "It is so easy to become introverted if you just pay attention to what you read in the papers and see on TV. We put the whole management team on the road; we have been seeing more customers than ever before," he says.

John Pannucci, CEO of Pressure Chemical, a Pittsburgh-based custom chemical maker, says his executives are out visiting customers because of the "strong pipeline of potential work" now available.

In recent months, he explains, large specialty chemical firms have rationalized product lines, laid off staff, and cut back on pilot facilities. Many firms no longer have the expertise or facilities to rapidly develop promising new products, points out Pannucci, who joined Pressure in January from Chemtura. With its know-how in process development, he says, Pressure can step in and help customers speed product development.

Pannucci sees a particular opportunity in specialty chemical firms that have cut back on the manufacture of unique materials that only one or a few customers buy. These low-volume chemicals are often difficult to synthesize, but Pressure is happy to do the job. "We often work with the user of the material and not the former maker," he observes.

WITH ITS dependence on building activity, W.R. Grace's construction products business is no doubt feeling the pain of the recession more than many firms. Indeed, Andrew Bonham, president of the business, acknowledges that the slowdown has hurt Grace. But he isn't waiting for stimulus spending in the U.S. or Europe to boost demand for Grace's concrete additives and membrane systems.

Instead, Bonham says, Grace Construction Products is positioning itself to better take advantage of existing opportunities and others that will come with the eventual upturn. First, the business has initiated operational changes to be more efficient when a recovery gets under way. And second, it is actively seeking opportunities in developing countries.

Operationally, the firm is taking advantage of the slowdown by putting talented people on short- and long-term expatriate assignments. For example, Grace has sent Felek Jachimowicz, the construction unit's head of R&D, on a short-term assignment to the firm's new construction research lab in China.

Such moves, Bonham says, accelerate knowledge transfer to new employees and create personal relationships that will pay dividends when business picks up. The assignments also give executives a better sense of the opportunities available in a still-expanding market like China.

Grace's efforts in developing countries include opening new cement additives plants within the past 12 months in Bahia, Brazil, and in Ho Chi Minh City, Vietnam, Bonham says. In Middle Eastern locations such as Abu Dhabi, Qatar, and Kuwait, Grace is promoting membrane systems that shield concrete foundations from the effects of corrosive soil.

The firm is also redoubling efforts to work with designers and architects to develop construction project specifications based on Grace's materials. For example, work with an Indian design firm on a new passenger terminal at the Calcutta airport led to specifications calling for below-ground foundation membranes made by Grace.

Not even emerging countries are immune from the downturn, however. Like governments in Europe and North America, the Chinese government is injecting large amounts of cash into its economy. Last November, China announced a $90 billion stimulus package to be spent on everything from road construction to health care.

Tom Cook, head of Dow Corning's operations in the China region, says the government package will help balance the lower sales his company is experiencing in the electronics, automotive, and textile industries. Overall, he says, it's too early to tell whether the firm will experience lower or higher sales in China in 2009 compared with 2008.

Interestingly, the construction sector, usually a poor performer during economic downturns, will likely be a bright spot for Dow Corning in China. Cook says the country's effort to raise its building standards will boost demand for high-performance materials. For example, China is building highways that will need the company's silicone joint sealants.

Also helping Dow Corning is a government program announced last month to subsidize the fitting of photovoltaic cells on the roofs and sides of buildings. According to Cook, China is an early adopter of these unobtrusive cells, which make use of silicone-based materials such as encapsulants. The subsidies will also stimulate demand for polysilicon made by Hemlock Semiconductor, a subsidiary of Dow Corning.

As is happening in the U.S., China is upgrading its power grid. Cook says power line pylons fitted with lightweight silicone-based insulators instead of ceramic ones are less prone to collapse. "You need less steel to build the tower," he says. After storms in February 2008, Cook recalls, pylons throughout China collapsed under the weight of snow and ice, leading to widespread power shortages.

Cook sees encouraging signs that a recovery is already under way in China's manufacturing sector. Customer demand stalled in December and January because they were selling off their inventories instead of making new products, he says. In February and March, inventories dried up, prompting manufacturers to resume production.

Business may be starting to pick up, but the consultants at Kline caution that specialty chemical companies may emerge into a postrecession world that takes a very different approach to business and economics.

Goldhill sees three possible scenarios. Rejuvenation, in which a return to normalcy is accompanied by renewed confidence in innovation, is the scenario that best suits research-oriented specialty chemical firms. Another scenario is sustainability, in which consumption becomes less popular and governments embrace environmentalism. And the third and most sobering scenario is protectionism, with the formation of isolated trade blocs and a shift in economic power away from the U.S.

Goldhill and Vogelsberg don't know which scenario will dominate, but they are sure of one thing. As Goldhill says, "All three scenarios hold opportunities for specialty chemicals."