Mergers Retreat From Heights

AMID THE ACRIMONIOUS breakup of the Hexion-Huntsman Corp. engagement, the bankruptcy of the freshly merged LyondellBasell, and Dow Chemical's troubles with the Kuwaiti government, the environment for chemical mergers and acquisitions in 2008 seemed almost poisonous. But obscured by these dramas is the fact that 2008 was a year when M&A did get done.

In fact, the value of chemical M&A in 2008 was the third-largest ever, according to Young & Partners, an investment banking firm that provides merger, acquisition, divestiture, and other services to chemical and life sciences firms. While a recession of historic proportions hit the global economy, $40 billion worth of deals were completed, compared with the record $55 billion in 2007. The slowdown did curtail the number of deals; the year boasted only 55 closings, down from 81 in 2007.

Looking closer, the pace of M&A activity reflected the observation of many chemical executives that 2008 was like two years in one. All but two of the 10 largest deals were completed in the first half of the year, when the impact of the recession had not yet slowed the momentum carried over from 2007. AkzoNobel's purchase of ICI was the first to close and the largest deal of 2008. At $16.5 billion, it represents almost half the year's total M&A value.

Even when the economy ebbs, merger activity never really goes away, says Saverio Fato, global chemical industry leader at PricewaterhouseCoopers (PwC), a tax and advisory services firm. "In the surveys we've done, executives in the industry believe M&A will continue to play a role" in business strategy. But as 2008 drew to a close, the desire to seek out new deals decreased, Fato acknowledges. "There was a sharp falloff in the fourth quarter. What we're seeing is that we've got this lull now and a level of uncertainty about what will happen next, which is not surprising."

Last year, chemical executives favored specialty chemical deals over ones involving basic chemicals, causing the proportion of basic chemical deals to fall to 44% in 2008 from 54% in 2007, according to Young & Partners. The rise of specialty deals reflects differences in which segments were most affected by 2008's bruising economy. "Not everyone was hurt the same way," Young & Partners President Peter Young says. "Personal care and specialties were not hit as much as basics, which were also hurt by new capacity coming on-line in the Middle East."

The megabucks deals that defined 2007 decreased in 2008. Eight deals worth more than $1 billion were made in 2008, compared with 2007's 11. Two big deals that were expected to close in 2008 fell through. First, Hexion canceled its acquisition of Huntsman Corp., claiming that Huntsman's increased debt and lower than expected earnings would make the combined firm insolvent. Then, Dow saw its $9.5 billion petrochemicals joint venture with Kuwait's Petrochemical Industries Co. crumble. After renegotiating a lower price in December, Dow was stunned when the Kuwaiti government canceled the deal.

Both deals suffered in an economy that headed downhill rapidly before the final papers were signed. "Anytime there is a long lag between signing and closing, there is a risk that unforeseen events can put a deal in jeopardy," says Bruce Chalmers, chemical industry transaction services director of PwC. "It is in the best interests of everyone to close a deal quickly. Changes in demand and raw material prices are two of the many moving pieces that must be taken into account and updated in the financial models."

When circumstances change, Chalmers says, buyer and seller need to go back to the negotiating table. The purchasing company is likely to reassess what it is willing to pay and may also hear from its financial partners. "Those financing the transactions certainly have a role in that they have money at risk," he points out.

The role of creditors in deal-making has evolved as the economic crisis has increased scrutiny of purchasers' creditworthiness. "Creditors are more focused on a company's future plans, their amount of leverage, and impact of any additional debt on a company's credit," Fato reports. This can limit how large of an acquisition a company can afford, especially as financing gets costlier.

Problems with the credit markets did not stop mergers from happening, notes J. William Breen, a managing director at investment bank National Capital. "It's been a truism in every economy: Every company has an orphan or two that it should not own, and always there is another company that should own it." The credit freeze's biggest impact has been on the ability of private equity buyers to complete deals, although they were still "moderately active," according to Young. Private equity firms were responsible for two of the top 10 deals in 2008.

EXPERTS WHO OFFER M&A advice to chemical companies report that sale prices are coming down as more firms are forced to sell noncore businesses to shore up weak balance sheets. However, the recent collapse in demand has made determining the value of a target much more difficult. The offering price is usually formulated as a multiple of earnings before interest, taxes, depreciation, and amortization. "But the question is, 'multiple of what?' Do you use 2008 earnings or 2009 forecasts?" Breen asks.

Chalmers agrees that valuation has become tougher. "In the middle of this environment, it's hard to use historical trend analysis to predict future value," he says. "With a severe downturn of long length, you have to use different measurements." Companies that have been studying the market for a small, strategic acquisition have an edge, Chalmers adds. "Very knowledgeable buyers can separate the short-term noise of macroeconomic events from fundamental changes in the business."

The forecast for chemical M&A in 2009 is one of caution, according to insiders. "In 2006 and 2007 there were a lot of large, cross-border deals," Fato says. But the deals of 2008 stayed on the smaller side and within the same region. "I think a lot has to do with tolerance for risk," he says. PwC anticipates a slower pace of consolidation with a high level of deal activity but lower deal values.

Meanwhile, Young & Partners' Young forecasts that lending is not likely to embolden buyers anytime soon. "There is no end in sight for the financing downturn," he says.

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