M&A Markets remain robust
The M&A markets were surprisingly resilient through a tumultuous 2020. After a brief respite during the 2nd quarter, while the world struggled to get its hands around the impact and “new normals” created by Covid, the M&A markets came roaring back over the second half of the year. Carrying that momentum into 2021, and buoyed by both Covid fatigue for owners as well as the threat of meaningful tax reforms (i.e. higher tax rates) in the U.S., last year proved to be a record year for most involved in M&A. Based on our Grace Matthews chemical index and transaction tracker, the number of chemical transactions were up roughly 87 % in 2021 over 2020, and 2021 was even up approximately 69 % over 2019 levels (pre-Covid year).
Immense strain on buyers
The amount of chemical transaction activity last year put an immense strain on buyers and deal-related service providers. It was fairly common during the back half of last year for strong buyers to self-select themselves out of a process simply because they did not have the bandwidth to commit the necessary resources to potentially prevail. Similarly, we often saw accountants, attorneys, HR, environmental and other diligence support groups charging 2-3 times their normal rates over longer-than-normal timelines given that the demand for their services far exceeded the supply of such services.
Entering 2022, most were assuming that deal activity would maintain near its current, elevated levels. What we witnessed was that deal flow peaked in January of this year (as spillover transactions from late 2021 got consummated) and activity has since softened throughout the first 4-5 months of the year. In hindsight, the frothy M&A environment abating seems inevitable.
The redline pace at which deal activity was on has led to burnout and turnover amongst deal professionals within a lot of organizations. While 2021 produced an artificially high level of transactions, the current pace through the first 5 months is likely a healthier, more sustainable level. Activity through the first 5 months is down roughly 25 % from the same period last year. We continue to see high levels of activity in chemical distribution (almost flat year-over-year) but are showing that deal volumes in paints & coatings, resins & polymers, and adhesives are off nearly 30 % thus far in 2022.
Consistent with this, private equity funds tend to be good sources of data for deal-related activity, as most have robust internal tracking systems that closely monitor deal-related activity, such as quantity, quality, sector, size and their level of participation in new deals coming to market. Universally, through ongoing discussions, we have heard that deal flow has been meaningfully lighter in the first quarter of 2022, however they are starting to see a pick up in activity over the past month (since mid-May).
Fewer transactions launched in the last half of 2021
Part of the reason for the slower beginning of the year is that far fewer transactions were launched in the last half of 2021. With so many resources being focused on completing current transactions at that time instead of taking new projects to market. This has left a slight void, or bubble in deal-related activity, as many companies that were contemplating a sale waited to start preparing to do so in mid-to late Q1 of this year. These transactions are now getting out to market and a healthy backlog appears to be forming behind them.
On top of the deal community “catching its breath’ early in the year, as of mid-June most major market indices were meaningfully down for the year. In Europe, the Euronext, DAX and CAC40 are all down 15-16 %. In the U.S., the markets have been even more penalizing with the Dow, S&P 500 and NASDAQ each being down 17 %, 21 % and 31 %, respectively. Similarly, the 8 leading global paint and coatings manufacturers (Sherwin Williams, PPG, RPM Axalta, BASF, Akzo Nobel, Nippon Paint and Kansai Paint) have collectively lost over $80 billion in market cap over the same time frame.
That clearly weighs on the thought process and decision-making of the large paint and coatings companies as they assess options and aggressiveness in the market. When companies perform well they tend to have a strong appetite to pursue growth via an M&A strategy. When things turn the other way they often look inward within the company to pursue operational initiatives to enhance shareholder value.
Despite the volatility in the stock market, one thing that has remained consistent is that the paint and coatings sector continues to trade at higher valuations than the general chemical index. This premium started to emerge about 10 years ago and has carried through today. As you will note in the chart below, even with the recent pull back in the markets, the GM Coatings Index is trading at a premium of almost 55 % over the broader GM Chemical Index at 16.0 x vs 10.3 x based on a multiple of EBITDA (Earnings before interest, tax, depreciation and amortisation). Over the past 10 years the average premium has been roughly 29 % (14.1 x vs 10.9 x).
Valuation levels of the paints and coatings sector increase
Despite the global economic and political headwinds, the coatings market remains strong and deal activity will continue in earnest. Will predicting pace and valuation levels is becoming increasingly more challenging the following are some areas we continue to monitor as reasons for concern or optimism as we think about the M&A markets.
The markets have had a lot thrown at them over the past two years. While businesses and business owners have navigated many of the issues, there remain numerous areas of concern for companies as they manage their business and/or contemplate a sale process.