2021 will see large numbers of deals brought to closing
You expect Covid-19 to drive consolidation in specific sectors of the chemicals industry. To what extent does this concern paints and coatings?
Dr Otto Schulz: The paints and coatings sector is a prime example from within the chemicals industry. It is composed of many medium-sized companies, with only a few major multinationals, and overall debt levels there have grown continuously in recent years. This represents a combination of ingredients that will lead to increased M&A activity. On one hand there are the potential buyers and an “end game” scenario for the sector. In this scenario, the industry continues to consolidate as market leaders bulk up with a view to generating growth and reducing costs. On the other, there are many takeover targets in this sector that have insufficient revenue-generating power of their own. We have analysed the chemicals industry from top to bottom, and the paints and coatings sector is right up there. It ranks second in the list of sectors within the chemicals industry that are ripe for takeover.
What has been the impact of consolidation in 2020?
Dr Schulz: Covid-19 is an accelerator of trends. Companies now finding themselves navigating in shallow waters are more likely to become takeover targets. We are also seeing investment pressure building in the market, with a lot of companies ready to pounce. This applies both to large companies from within the sector and to investors.
We see four acquisition scenarios for the investors. The first is to acquire a coatings manufacturer in order to be in possession of this type of company. The second is to buy the asset, improve its profitability and then to sell it on to a bigger coatings’ manufacturer. The third is to merge with other companies and then take that bigger company public. And the fourth is to do a trade sale, i.e. to sell the acquired company to another private equity firm. So, to the extent that consolidation momentum is building within a sector, private equity firms often act as the lubricant.
If you look at previous crises, you will see that they are usually accompanied by a decline in valuations. Investors therefore can often do good business, to some extent regardless of the quality of the given takeover target. That is why we believe that Covid-19 will bring about a further acceleration of M&A activities.
What are the factors that favour consolidation?
Dr Schulz: Acquisition activity has been picking up strongly since the summer break. And deals are now being readied. When the pandemic broke out, Companies initially acted cautiously because there was so much uncertainty. They focused their efforts initially on their employees and their ongoing business. Liquidity, too, was an issue. As more clarity emerged in the second half of the year, the focus turned towards determining whether to consolidate or whether to continue with the deals that had been put on hold from the first half of the year. A company that needs cash will start thinking about divesting marginal businesses. This business activity is also being fuelled by low interest rates and the availability of liquidity for acquisition financing.
Overall, there is a big trend in the chemicals sector towards divesting non-core activities and concentrating on core businesses. This has recently been happening in the paints and coatings sector as well. There is a growing trend in specialty sectors to organise more by customer industry rather than by technology. These, too, are drivers of consolidation. As a result, there are hardly any paint and coatings manufacturers left belonging to chemical conglomerates. And the same can also be said increasingly of key ingredients, such as pigments.
Which consolidation scenarios do you consider to be likely?
Dr Schulz: I believe that the “end game” scenario will play out in which the industry is dominated by big players. They will be organised by customer sector rather than by complementary technologies. The focus will be on individual customer segments, e.g. wood, automotive and so on. Full-service providers may emerge from within the ranks of commodities suppliers. The stronger these commodities are, the more likely it is that these will be pure plays. Titanium dioxide being one example.
Private equity firms will play a big role in the next step, acting as lubricant or interim owner, with a short holding period. If the big industrial players hold onto their money now, investors can buy good assets and then sell them to the conglomerates later, with the hope of higher valuations. That’s where the high post-crisis money multiples come from. You can buy low and sell high. But transactions will still take place between companies. In theory, an industrial company always pays a higher price, because such companies can also achieve synergies. In practice, however, SMEs tend to be risk averse. SMEs in Germany focus particularly on high equity ratios in order to be less reliant on banks. This suggests that companies willing to take a risk are now more likely to swoop.
How do you see the situation developing in 2021?
Dr Schulz: 2021 will see large numbers of transactions brought to closing. The trend among divesting companies will be to focus on their core business. If a company is active in different industries, it will often concentrate on the one that offers the better prospects and therefore has the better valuation.
In the chemicals industry, industrial gases currently have the highest valuation multiples. The market there is already highly consolidated, and the business model is narrowly focused on long-term stable partnerships with customers. The publicly listed coatings majors already have relatively high valuations. Therefore, we expect investors to focus accordingly. The prices paid last time around were decent.