Moving Forward By Bending Backward

A new company has elbowed its way into the upper ranks of the global chemical industry through the daring purchase of a firm that itself didn't shy from taking risks to become bigger. But Basell Polyolefins' acquisition of Lyondell is more about back-integration and filling in portfolio gaps than it is about size alone.

The new company, LyondellBasell Industries, is the product of a $20 billion deal completed late last year. Its combined sales of $44.8 billion in 2007 make it one of the five largest chemical companies in the world.

LyondellBasell, like Basell before it, is the chemical arm of the privately held industrial conglomerate Access Industries, led by the Russian-reared and American-educated and -naturalized industrialist Len Blavatnik. Access' other holdings include the aluminum maker UC Rusal; a 50% stake in the Russian oil company TNK-BP; and media, telecommunications, and real estate companies.

Those affiliated with Blavatnik are quick to point out the distinction between Access and the private equity firms that are active in the chemical industry. "We think of Access and Len and his ownership as more of a builder and a holder," says Edward J. Dineen, president of LyondellBasell's chemical division. Traditional private equity firms such as Blackstone Group or Apollo Management, he argues, buy companies to sell them off quickly. He considers Ineos a better comparison to Access. Ineos, also one of the world's largest chemical companies, has been assembled by British billionaire Jim Ratcliffe through the acquisition of commodity chemical businesses cast off by other firms.

Lyondell isn't the only acquisition Access attempted last year. It had a deal to buy Huntsman Corp. before Apollo-backed Hexion Specialty Chemicals stepped in with a better offer. But about a month before it made the Huntsman offer, Access had purchased an option to buy an 8.3% stake in Lyondell that had been owned by Occidental Petroleum. Access made its move for Lyondell immediately after Huntsman backed out.

Lyondell is arguably more akin to Basell than Huntsman, primarily a specialty chemicals maker, would have been. According to a report published late last year by chemical consulting group Chemical Market Resources, the new company is the world's largest polyolefin producer, ahead of giants Dow Chemical and ExxonMobil. "Already the largest global polypropylene producer, LyondellBasell will also assume the number one position in high-density polyethylene and low-density polyethylene with the addition of the Lyondell assets," the report states.

Despite the similarities, there is little direct overlap between the two companies in product slate or geographic scope. Lyondell operated an oil refinery and six steam cracker complexes in the U.S. that make basic petrochemicals such as ethylene, propylene, butadiene, and benzene. Despite being one of the largest U.S. polyethylene players, that business had no offshore operations. It was, however, the global leader in propylene oxide.

In addition to having been the world's largest polypropylene maker, Basell was also a leading licensor of polyolefins technologies. It was a major polyethylene maker in Europe but not elsewhere. It also made specialty resins like poly(1-butene).

To Volker Trautz, former head of Basell who is now chief executive officer of the combined firm, the acquisition will shore up the two firms in their respective areas of geographic underrepresentation: Europe for Lyondell and the U.S. for Basell. "It is nice to say we were global as legacy Basell, but in reality we had a relatively weak position, only one leg, in North America," he says, that leg being polypropylene.

Lyondell was one of the leading merchant suppliers of propylene in the U.S., whereas Basell was a major buyer for its polypropylene plants. Putting these two halves together was one of the key rationales for the deal, although Dineen says the integration will not be immediate. Most of Lyondell's sales are tied up in contracts, he explains. "Over time, some of these contracts may go away, some may get reduced, and some may get renewed," he says.

Trautz says Lyondell polymer plants could be directed away from commodity production and toward the specialty plastics that Basell makes in Europe. For instance, Basell catalysts could be introduced to Lyondell high-density polyethylene plants to make specialty grades suitable for applications such as medical equipment and fuel tanks. "That is a very nice synergy because it is not painful," Trautz says. "You don't have to lay off people. You don't have to invest a lot of money."

There is also potential to bring Lyondell technologies in propylene oxide/styrene and acetyl chemistry into Basell's licensing organization, which has made the Spheripol bulk polypropylene process a world leader and also offers a suite of polyethylene technologies. Dineen says one approach that has been successful for Basell is to use technology licenses to get an equity position in joint ventures. Lyondell had already done this with a propylene oxide venture in China.

Trautz thinks he can save $420 million annually by combining Lyondell and Basell???a modest target compared with other big chemical deals. Dow Chemical, for example, originally targeted $500 million in cost savings through its 2001 acquisition of Union Carbide, a purchase roughly half the size of Lyondell. Dow later aimed for $1.1 billion in savings through plant closures and the layoff of 8% of its workforce.

"The merger is not being driven by synergies you can label pure cost savings," Trautz says. These savings often mean acquiring a company with the same product slate and decimating the workforce. He says LyondellBasell's kind of cost saving includes back-office operations such as human resources and information technology and represents only about a third of the $420 million. For example, the company is moving its European headquarters from Hoofddorp to Rotterdam, both in the Netherlands. It is selling Basell's North American headquarters in Elkton, Md., and moving some administrative functions to other U.S. offices. The bigger target is operational savings such as plant integration, reducing railcar leases, and combining warehouses.

The transaction does burden LyondellBasell with a lot of debt. At the end of 2007, the company's long-term debt amounted to $21.5 billion, more than nine times the operating profits of the combined companies that year.

After the transaction closed, Fitch Ratings downgraded LyondellBasell's credit rating. However, Fitch analyst Matthias Volkmer also touted the synergies between the two firms. "The group's credit profile will be supported by potential synergies and pricing power advantages gained from improved vertical integration and size increases," he said.

"We certainly don't have a low debt load," Trautz admits. He recalls being questioned about it at a town hall meeting at Lyondell's Houston refinery. He replied by asking if a $50,000 or $100,000 mortgage is too high for a $200,000 house. In other words, Trautz believes that the debt load isn't excessive because LyondellBasell is worth two or three times more than its debt. He is confident that the company will pay its bills and have enough money left over for capital expenditures and other investments. "In the worst case, we should be able to service our debt. So it is affordable," he says.

Dineen recalls that, even as a public company, Lyondell was accustomed to high debt because of the many acquisitions it made in its 20 years of operation. Lyondell was, in fact, a major force for consolidating the U.S. chemical industry. It formed the Equistar Chemicals olefins and polyolefins joint venture with Millennium Chemicals and Occidental Chemical in 1998. That same year, Lyondell bought Arco Chemical, acquiring its propylene oxide and polyols businesses; Lyondell sold the latter to Bayer.

More recently, Lyondell purchased Millennium, consolidating Equistar under one roof. Last year, it sold the titanium dioxide business that came with that transaction to Saudi Arabia's Cristal. In 2006, it bought out an interest in its Houston refinery held by Venezuelan state oil company PDVSA.

Dineen says the refinery purchase has already yielded more than $100 million in savings. Without a partner, Lyondell had been able to fine-tune the relationship between the refinery and the firm's chemical operations. For example, it had better balanced the hydrogen output of the olefins plants with the hydrogen consumption of the refinery.

LyondellBasell continues to divest tangential remnants of previous deals. A plant in France that makes the polyurethane precursor toluene diisocyanate came with the Arco transaction. The company is now negotiating to sell it to Swedish specialty chemicals firm Perstorp. "I don't think that was a surprise to anybody," Dineen says. LyondellBasell has been clear since it exited polyols that toluene diisocyanate isn't a strategic business.

LyondellBasell plans to hold onto a few businesses unconnected to its core polyolefins operations, Dineen says. It kept the acetic acid and vinyl acetate business it acquired with the Millennium purchase, Dineen says, because it is integrated with the company's La Porte, Texas, olefins operations. "It probably should have been in the original Equistar deal," he says. "We see it as a potential growth business for us, and we have been pursuing opportunities to do just that."

Dineen is also pleased with the former Millennium aroma chemicals business, which makes terpene-derived flavors and fragrances. "It is not something we are actively looking to get out of," he says. "At some point, we might, but it is really not a business that is on our sell list." LyondellBasell is even planning $4.5 million in capital spending on the business, he says.

According to Dineen, LyondellBasell is looking at opportunities to get into new businesses. For instance, Lyondell's propylene oxide process turns out large amounts of styrene, and he won't rule out investing in styrenic polymers to help consolidate that sector, which has been chronically unprofitable due to too much capacity. "This business needs some help. As a big player in styrene and a big polymer guy, we would look at those opportunities," he says.

Even before Blavatnik acquired Basell in 2005 for $5.4 billion, the company had been no stranger to deal-making. A joint venture of Shell and BASF, Basell was formed in 2000 as the result of a merger of polyethylene and polypropylene assets from Shell, BASF, and Celanese.

After being acquired by Access, Trautz says, Basell focused on recapturing the backward integration that Shell and BASF provided. In 2006, it purchased an ethylene cracker in Münchsmünster, Germany, from owners BP and PDVSA to secure raw material for its polyethylene facility there. LyondellBasell recently completed the purchase of Shell's oil refinery in Berre, France, where it has polyethylene and polypropylene plants and where it earlier bought out a cracker joint venture.

Basell's feedstock concerns have also prompted tinkering with its far-flung plants and joint ventures. "We see a joint venture as a living body," Trautz says. "It is not something that is defined forever." For example, Basell exited a Taiwanese joint venture after 30 years of operation because it didn't have access to low-cost feedstocks. At the same time, it let Thailand's national oil company, PTT, buy into a polypropylene joint venture there to pave the way for new propane dehydrogenation and polypropylene plants.

In Brazil, Trautz says Basell was "squeezed into a corner" to exit its Polibrasil joint venture with local conglomerate Suzano PetroquÍmica. The venture's feedstock supplier, state oil company Petrobras, was getting back into petrochemicals after a decade of privatization and had taken a stake in Polibrasil's largest competitor, Braskem. Besides, Trautz claims, Suzano bought out the venture for more than Basell reckoned it was worth. "We got an offer we couldn't refuse," he says.

Elsewhere, the global run-up in construction costs had caused Basell to retrench. Higher costs killed its plans to build a polypropylene plant in Sarnia, Ontario, using its new Spherizone technology, which circulates catalyst rapidly around a loop. "We had a project and the investment cost $180 million or $190 million," he says. "When we came closer to the decision-making process and were ending up with $360 million, I said, 'Let's stop here.' " The company is shutting down the entire facility this year.

Yet LyondellBasell is going ahead with a project in Kazakhstan to build ethylene, polyethylene, and polypropylene plants with the state gas company KazMunayGaz. Trautz says LyondellBasell recently received the feedstock rights for the project and expects to move forward soon.

The company is open to building plants and perhaps even entering new businesses. But for now, Trautz says, the Lyondell transaction completes the project of backward-integrating the old Basell. "We are basically where we want to be now," he says.