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NEW YORK (ICIS)–Chemicals mergers and acquisitions (M&A) will increasingly see flexible deal structures that include partnerships, combinations of assets or sellers retaining stakes for future upside, an investment banker said.

Flexibility is particularly important during volatile economic times, as it provides optionality in financing as well as achieving synergies, said Federico Mennella, global head of chemicals and materials at investment bank Rothschild & Co.

“I see a lot of flexibility in the way private equity groups and strategics approach deals today compared to the past when most transactions were relatively straightforward,” said Mennella in an interview with ICIS.

Rothschild & Co advised Germany-based LANXESS in its joint bid with private equity firm Advent International to acquire DSM Engineering Materials for €3.7bn in a deal announced in late May.

As part of the deal, LANXESS is also merging its High Performance Materials (HPM) business with DSM Engineering Materials, for a payment of at least €1.1bn for up to a 40% stake in the combined entity.

LANXESS will receive excess cash on the businesses’ balance sheets at close, which is expected to bring its ownership below 40% – to an estimated 35-40%. LANXESS then will have the option of divesting its stake in the JV to Advent after three years.

Under this structure, LANXESS can take out cash up front, as well as participate in any upside from synergies with the DSM business, he noted.

“There are many reasons to be flexible in structuring deals, which allows people to be creative in transactions in a way that in the past was more limited,” said Mennella.

In January, Switzerland-based Clariant completed the sale of its pigments business to pigments producer Heubach Group and private equity firm SK Capital for Swiss francs (Swfr) 805m ($819m) plus a potential earnout of Swfr50m subject to the business’ 2021 financial performance. Clariant also rolled over Swfr115m to retain a 20% stake in the combined pigments business.

Under this structure, sellers can retain a minority stake and participate in any upside, hedging against “leaving too much money on the table” if the new owners achieve operational synergies and dramatically improve performance, the banker noted.

For private equity, teaming up with a strategic buyer on an acquisition not only requires less capital but provides the opportunity to realise strategic buyer synergies that might not be available to private equity on its own.

Meanwhile, overall deal activity has slowed, especially in Europe, given the rise in recession risks, higher interest rates and less financing availability. On top of that, Europe is dealing with an energy crisis – a consequence of the Russia/Ukraine war – along with additional negative impacts from the conflict.

“Companies have started and continue to have sales processes, but it’s probably going to be easier to see activity in the US than in Europe. In Europe, there have been some processes that have been slowed down or quietly put on hold,” said Mennella.

The combination of the impacts from the Russia/Ukraine war, economic uncertainty and foreign exchange turmoil is particularly hampering deals, he noted.

In addition to the impact on energy and food supplies, there are other disruptions in supply chains. For example, Ukraine is one of the leading producers of clays that are key to manufacturing high-end tiles. The resulting supply chain disruption is impacting tile manufacturing businesses in Italy and Spain, the banker pointed out.

“There are a sequential set of events, where the war has some cascading impacts that have not been fully baked in many of the 2022 projections,” said Mennella.

However, even with higher borrowing costs and a deteriorating economic outlook, certain deals that have been in the market for some time, are going through, he pointed out.

In May, SK Capital agreed to buy US-based specialty polymer additives producer Valtris Specialty Chemicals from H.I.G. Capital.

Also in May, UK-based Johnson Matthew announced the sale of part of its Battery Materials business to EV Metals group for £50m ($59m), while taking a minority equity stake in EV Metals – another example of a flexible deal structure. In June, Johnson Matthey announced the sale of its active pharmaceutical ingredients (API) business to private equity firm Altaris Capital for £325m.

In July, UK-based Croda completed the €775m ($775m) sale of the majority of its Performance Technologies and Industrial Chemicals businesses to a subsidiary of US-based Cargill. Croda retained a minority stake in the business.

“We continue to see activity and there will also be many private and private equity-owned businesses that will be sold,” said Mennella.

Certain strategic buyers, particularly those with strong corporate development teams, are being proactive and “keep shaking the tree” for potential deals, often approaching private equity firms and private companies for target assets, he noted.

HIGH BAR FOR PUBLIC COMPANIES

For publicly traded chemical companies in particular, the bar is high when it comes to making major acquisitions, given the challenging macro outlook as well as declines in their own public valuations.

“You have to be aware of the multiple you’re trading at, versus the multiple of the business you’re buying. If you are putting a good amount of shareholder money in this particular basket, you better have an airtight case on the industrial logic and the synergies,” said Mennella.

“A number of companies, when they announce major acquisitions, also quote the deal multiple after synergies which can be 2-3 turns lower than the pre-synergy multiple,” he added.

While the banker has yet to see deal multiples fall meaningfully, he acknowledges that healthy past multiples were “predicated on assumptions that are no longer as strong as they were. They were predicated on a lot of things going right – a relatively stable economy, interest rates being low, EBITDA (earnings before interest, tax, depreciation and amortisation) continuing to grow, predictable exchange rates and few of the issues we’re seeing in logistics and the supply chain”.

“But it’s not a panic moment yet. We have not seen any dramatic decrease in pricing valuation,” he added.

The banker also sees a continuing trend of smaller public chemical companies being taken over, as was the case with Ferro Corp (acquired by Prince International in 2021,) OMNOVA Solutions (by Synthomer in 2020) and Innophos (by One Rock Capital in 2020).

Interview article by Joseph Chang

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