PERSPECTIVE: SHALE GAS’S IMPACT ON U.S. CHEMICAL INDUSTRY

I believe that the Shale Revolution presents a once-in-a-lifetime opportunity unique to the United States that will have a profound impact on the chemicals industry.  Nearly 100 projects announced as of Q1-2013, $72 billion in potential chemical industry capital investments, $67 billion in additional output by 2020 (with new & permanent federal, state, and local tax revenue of $14 billion from increased chemical industry output by 2020, according to ACC)!

The Shale Revolution will create 17,000 new high-paying and knowledge-intensive positions in the chemical industry, will result in a $32.8 billion increase in United States chemical production, will cause $16.2 billion in capital investments to build new petrochemical and derivatives capacity, and will lead to $132.4 billion in United States economic output related to increased chemical production and capital investment.  The Energy Information Administration estimates that shale gas production will grow 113% from 2011 to 2040 and that its share of United States natural gas production will grow from 34% to 50%.  The primary end market consumers during this period will be the electric power generation end market and the industrial end market. 

The shale gas benefit to some of the specific chemical manufacturing industries is most pronounced to the following: resins and synthetic material manufacturing grew by 1.7% in 2012, but is projected to grow by 8.1% in 2025, basic organic chemical manufacturing grew by 1.5% in 2012, but is expected to grow by 9.5% by 2025, agricultural chemical manufacturing grew by 1.2% in 2012, but is expected to grow by 7.7% by 2025, and plastics and rubber products manufacturing grew by 1.5% in 2012, but is expected to grow by 4.6% by 2025.

Due to the shale gas boom, in which the ACC expects a 25% increase in ethane supply, 99% of which is used for ethylene purposes and 82% of ethylene is used for plastic resins, the United States will be the lowest-cost ethylene producer.  As such, the ACC anticipates the additional chemical industry output generated by this 25% increase will result in an additional $18.3 billion from bulk petrochemicals and organic intermediates, $13.1 billion in plastics resins, $1.0 billion in synthetic rubber, $0.3 billion in man-made fibers, and $0.2 billion in carbon black.  These outputs are expected to require a new capital investment of $16.2 billion in the forms of debottlenecking, brownfield projects, and greenfield projects.  As a result, there is the potential for a raw material cost advantage of up to 60% for products in the ethane-ethylene value chain.

In addition to the shale gas impact on ethanol supply, production of ammonia will become more domesticized as well, leading to large growth possibilities in the agricultural chemical manufacturing industry.  Further, the increased shale production has led to increased United States capacity for methanol, which could lead to a significant opportunity because presently accounts for half of the world’s consumption.  Hundreds of chemicals are also used in the fracking process, where roughly 2.5 million gallons of water and 1.5 million pounds of sand represent 99.5% of the fracking mixtures, and the remaining 0.5% of the mixtures is made up of chemicals.  Projects directly synthesizing heavier derivatives will also benefit from increased shale gas because they are experiencing greater returns due to being in shorter supply because of cracker conversions to ethane.

The input cost advantage in North America that is being led by an increasing abundance of nat gas and helping both organic chemical producers through NGLs as well as the inorganics through lower energy costs (Middle East being the one exception), the North American chemicals landscape looks to be the most promising world-wide for years to come, justifying the heavy domestic investment that the industry is set to see.  Key questions would remain in our ability to manage typical risks for a complex industry, such as environmental, regulatory, specialized credits and equity investment approach, proper tax treatments, infrastructure and access to realize the Shale gas driven potentials. What are your thoughts?

Looming Wave of Maturing Debt

The Wall Street Journal recently reported on more than $550
billion in debt taken on by European companies acquired in leveraged buyouts
which will be reaching maturity within the next five years.

This massive wave of approaching debt repayment obligations is a significant issue for a number of reasons. The PE firms backing many of these highly-leveraged companies have been grappling with the task of adding value in the throes a challenging economic environment, as well as with a reduced ability to exit via secondary deals and IPOs.

In the U.S. we haven't yet experienced the same types of debt problems because of the appetite for high yield bonds in this country. The buyout peak of 2007, which saw nearly $1.6T in deal volume by middle of that year in the U.S. alone, also spurred the creation of a lot of debt in PE-backed companies. We are beginning to see the maturity of that debt. Again, the problem here is that many of those companies haven't grown in the way they were expected thanks largely to a battered global economic landscape. The fallout in the U.S. is a trend of PE companies buying themselves more time on their obligations by refinancing. And these companies are avoiding exorbitant interest expenses in a high yield debt market which, fortuitously, is experiencing low premiums. Last year, KKR alone extended or refinanced nearly $60 billion of debt for its portfolio companies.
But banks across the pond are wary of refinancing the half-trillion in burdens coming due over there, and there is no robust debt market, as in the U.S., which is helping to alleviate the situation. Clearly, all of this debt crashing down at once will lead to a lot of scrambling and, most likely, a lot of restructuring. To exacerbate matters, some analysts are forecasting a growing and sustained debt aversion scenario, even here in the U.S. This situation, as with any, cuts both ways. The multitude of steeply-leveraged companies and those with meager earnings will continue to struggle to find financing opportunities. And this is could very likely spell the end for many of the zombie companies which have been hobbling along for the past several years. The upside may come for those who will be splitting up the remains.

Specialty sector focused private equity with flexibility and
cash position will do well as credit dries up and an acquisition environment
looms. And unique funds will have the opportunity to contribute to the type of
reorganization that can allow the true economic therapy to begin - putting an
end to the zombies and building real commercial and investor value going
forward.

Perspectives on Clean Technology (Follow-on)

In 2009 I shared some thoughts here on clean technology development. After some positive feedback I thought it would be appropriate share additional perspectives to do a follow-on piece for 2012.

Clean technology is not a phenomenon that is going away, and that is becoming clearer with each passing year. A few pervasive fundamental drivers exist:

• The same motivating factors that were driving clean tech five years ago still exist, and some (emerging market demand and environmental stress) are even getting stronger
• Clean tech is an incredibly diverse industry and the term reaches into a broad array of business segments
• There is systemic inertia which continues to push toward greater efficiency and reduced environmental impact – not just in energy, but across the spectrum
• Need for sustained innovation and the effect of cost arbitrage
  

While folks are concerns about sovereign debt, regulatory changes, and increased competition, 2011 was a record year for clean technology deployments and I believe 2012 will be even a better year as capital flow increases and emerging dynamics continue to make the case for clean technology as a worthwhile industry. From energy, to materials, to natural resources, and even governmental and regulatory action, developing clean technology is a mindset that a host of players are caught up in. And one issue that is frequently misunderstood is the utter scale and pervasiveness of what this area encompasses. To put it simply, clean tech is in play virtually everywhere that matters (e.g. water, smart or renewable materials, clean transportation, electric vehicles, energy storage, etc.)

Energy issues do not seem to ever go away. Today, there is a lot of regulatory action which is setting out with the goal of correct arbitrage and imbalances between technological development and commodity pricing (think of the corn ethanol subsidy/drawdown). It serves as an impetus for new tech growth, and that is what is important here. Appropriate regulatory action is certainly not slowing down development, as clean tech is also a politically popular and viable economic movement.

As I have said before, this is a different animal that what we saw in the 90s with the dot-com era (high initial capital infusion followed by a network of low cost start-ups to develop value). Rather, the clean tech industry is one that driven by “tech innovation AND implementation.” That is to say – the dissemination of innovative technology on a broad scale and the ability to ramp up production and utilization sooner rather than later. It is important to balance that point by saying that technology is the driving concern here, and a capital-intensive asset-driven business is not. Technology developers should be implementing strategies which allow them to advance their developments with lighter asset burdens. Partnerships with manufacturers and high-infrastructure companies while focusing on research and development is a smart play – one which will see faster commercial realization. Once again, a savvy industry focused investor (e.g. specialty venture capital or private equity investment firms) should understand the difference of “asset plays vs. new technology play” and consider review both the immediate capital cost of deployment of a new technology as well as the long-term cash flows and liabilities that can be inherent in such investment consideration.

Nowhere is the implementation need more conspicuous than in sustainable and renewable energy. Traditional energy sources, especially fossil fuels, are creating incentives for their own replacement – both economic and environmental. To scale this sector to the point of wholly replacing traditional energy is far from a realistic proposition in the foreseeable future. What is important at the present moment is to scale deployment of new energy technology while reducing associated costs. The goal is to grow an important supplement to traditional energy, which will mitigate its costs. We are seeing this more every year (think of growth in wind and solar, as examples). Efficiency is another key theme in energy – one that can be addressed by clean tech advancement (but which necessitates the incentives to do so). Regulators can play an important role here.
Certainly one of the biggest areas for clean tech development moving forward is powered transportation. Here we see some of the greatest energy consumption (again, particularly fossil fuels) coupled with high environmental impact. This is particularly true for emerging markets, where we see exploding industrialization and associated demand. The impact of these areas cannot be ignored. Much can be done to improve the industry on a technological basis. Fuels, materials, drivetrains, and motors are all components that are ready for innovation. Again, incentives must be in place.

The central theme of my view on clean technology is that it’s an expansive industry, which will provide consistent economic development opportunities moving ahead and chemical and specialty materials industry players are at the forefront of this movement. An innovation in “business of chemistry” could translate into an innovation for “clean technology industry”, and vice versa. What are you views?

Update: M&A Landscape Q1 2012

2011 was an interesting period for M&A. The first half of the year saw the bulk of activity, with total global deal volume of about $1.27 trillion, benefitting from a better credit outlook and accelerating economic recovery. The second half of 2011 slowed down for just $875 billion according to Bloomberg, with an overall y-o-y deal volume growth of about 9%. European debt worries and macroeconomic issues, like the natural disaster in Japan, were contributing impediments. Despite these hurdles, however, 2011 was a fairly strong year for M&A.

Where does this leave us for 2012? There is a lot to consider, but the overall outlook is for another robust year. The biggest challenge currently, and one that U.S. firms are monitoring closely, is the European debt crisis, which poses some systemic concerns for the coming year. European problems could become American problems if Europe falls into a recession. U.S. exports are not currently growing, and a European downturn could exacerbate this if demand for U.S. products drops. Higher oil prices are another factor which is holding the U.S. back from stronger GDP growth. Q4 2011 alone saw crude oil prices jump nearly 25% over the previous quarter. Turbulence in producing countries like Libya and increasing demand in China and other emerging markets are the culprits.

The American housing market is still in a slump. Mortgage rates are extremely low but potential buyers are wary of further drops in home value. There are still a lot of inexpensive homes on the market which means less new construction. One piece of good news here is that foreclosure saw a sharp decline last year. Unemployment is another headline issue for the U.S. economy. While joblessness seems to be improving at a modest rate, underemployment is actually increasing according to Gallup, showing that more people have given up looking for work or have taken substandard positions. Faltering job growth has been a persistent remnant of the fading recession. We are still experiencing unemployment over 8% after 10 consecutive quarters of GDP growth.

But don’t be put off by these difficulties. There is plenty to be enthusiastic about, and 2012 looks to be busy for M&A. To begin with, there is upwards of $500 billion in dry powder that is expiring soon, so financial sponsors should be chasing targets very aggressively. Lending markets are looking more attractive, as well, particularly for larger firms with lower risk profiles. Cash is available. 2011 also saw better U.S. real GDP growth rates with each passing quarter. Q4 ended with the fastest growth rate since early 2010. And consumer spending (one the chief drivers of our economy) jumped to 4.4% growth over 2.7% in Q3. This is the fastest pace in over five years. Manufacturing is picking up speed and U.S. economic recovery is accelerating. Prospects in the middle market are particularly promising, and this is where the action is. The lower middle market is most active. 79.5% of middle market deals in 2011 were under $100 million. Most of these deals are being done in cash. Total enterprise value to trailing 12 month EBITDA ratios are also on the rise in the middle market: averaging 7.6 in 2009, 8.6 in 2010, and 9.2 last year. Higher valuations are coming in the wake of higher corporate cash reserves, suppressed interest rates, and more M&A activity. The middle market is particularly active in the private equity segment, as well. In the first half of 2011, 75% of deals in PE were valued under $250 million. Deals under $500 million made up nearly 80% of deal flow for the year. Much of the deal-making here is in acquisitive growth (making up as much as 50% of PE acquisition in 2011). Business products and services was the most active industry segment for private equity, while the energy sector saw a drawdown, particularly in Q4.

Please feel free to review “M&A Outlook 2012”:
http://www.slideshare.net/ennovance/ma-outlook-2012

Perspective: The Marcellus Shale Boom as an Impetus for Technology Development

Strengthening domestic energy production has been a very hot topic for some time now, and for good reasons, such as drilling affect in the communities and environment, opportunities and consequences of developing an economy. American dependence on crude oil reserves from traditional foreign sources has become a more precarious situation with diminishing supply, skyrocketing demand, and geopolitical instability. To meet the energy needs of coming generations the charge is being led to bolster U.S. production, particularly with alternate and
non-traditional energy sources. The natural gas extraction in the Marcellus Shale is an extremely valuable asset to petrochemical, which can convert ethane into a feedstock for their manufacturing processes in the downstream of the value-chain. Many chemical related business could indeed achieve lowest cost position in the world; thus strengthening our economic engine. Remarkably, many of the concerns and challenges associated with “Marcellus Shale” could be solved thorough chemistry related innovations and technology development.

One of the biggest windfalls for American energy in recent years has been the discovery of expansive natural gas reserves in the Marcellus Shale region of the Northeastern United States. Many of the most recent estimates peg recoverable gas supplies in the Marcellus at over 150 trillion cubic feet, with some experts suggesting a far more extensive untapped supply.

Of course, ongoing technological improvements in extraction methods continue to grow this figure. Much of the gas is found in shale deposits at depths of 7,000 to 10,000 feet which, in the past, made for a prohibitively high cost exploration and removal process. Areas which were not commercially viable for gas wells fifteen years ago are now able to be exploited thanks to advances like directional drilling, where bore holes can penetrate laterally at the target depth to magnify accessibility to local gas. As the promise of unlocking a torrential supply of domestic energy in close proximity to the demand-intensive regions in the Eastern U.S. has become a reality, both public and private sector investment has surged.

And with more R&D going into extraction methods, we have seen improvements in environmental impact as well as increased supply. The primary and most efficient means of natural gas extraction in the Marcellus region is hydraulic fracturing (“fracking”). Hydraulic fracturing is actually a well-established technology, coming into broader commercial use in the mid-20th century. Recent years, however, have seen an explosion in new fracturing technology. According to IP Spotlight, the U.S. Patent and Trademark Office between January 2008 and August 2011 received more than 1,100 U.S. based patent applications which mention fracturing. This is an 80% increase over the previous 3-1/2 year period. This jump is a product of the shale gas boom – one that produced 140,000 jobs and more than $11 billion in value added in Pennsylvania alone in 2010.

On a basic level, fracking involves boring deep into shale formations and using very high pressure fluids to create fractures (or expand existing fractures) in the rock. This releases the trapped hydrocarbons for extraction. There has been no shortage of speculation as to the impact of the traditional fracturing process on local communities and water supplies, and the environment as a whole. These effects must necessarily be left to the experts to determine. What is certain now is that shale gas is a mainstream concept and a booming business, and the U.S. stands to benefit from better access to cleaner fossil fuels. What matters now to business is how they can find the safest way to exploit this resource without missing the boat. The most effective way to reach that goal is through innovation and investment in new technology.

And the more recent proliferation of the extraction process, investment, research, and regulatory pressure seems to be generating plenty of tech growth and secondary industry. Shale gas is a rapidly changing landscape. Areas like western Pennsylvania and Ohio are seeing new construction for wastewater treatment plants which process used fracturing fluids from gas wells. The plants typically operate under permits from state environmental agencies, which impose standards for use of new filtration and treatment technology. A competitive field of energy producers is striving to be the leader in the region by stepping up innovation. Chesapeake Energy, one of the largest gas producers, recently announced a new process which will allow used fracturing fluids to be recycled for new drilling at up to 100% efficiency, reducing both the burden on local water supplies and the need for wastewater processing installations. A new type of fracking method is also emerging, development from oilfield and shale gas giants like Halliburton and Schlumberger. “Super fracking” is based on several improvements to the existing process. New materials are being used to hold open shale cracks at the site of the fracture which allows a greater flow of hydrocarbons for a longer period of time. New types of pipe fittings for wells are making extraction much less time intensive and sparing about half of the surface water needed in the traditional process. And traditional plastic “valve” materials
which, in the past, have had to be recovered in an expensive process after drilling are being replaced with new disintegrating materials. A Texas company called Jadela Oil is even experimenting with a waterless fracking process.

Natural gas itself is cleaner than other hydrocarbon fuels, which makes growing supply even more attractive and conducive to new tech. Burning natural gas for heat energy emits 30% less carbon dioxide than petroleum and 45% less than coal. Nitrogen oxides are reduced by two-thirds and sulfur oxides by nearly 99% compared to coal combustion. A rapidly growing supply of a cleaner hydrocarbon fuel is spurring new technology. Research is progressing in fuel cell technology which could expand on already robust electricity generation applications. Transportation is another promising sector. The U.S. is seeing growing fleets of government, public transit, and shipping vehicles powered by compressed natural gas. The Department of Energy speculates that a switch to natural gas in the U.S. transportation segment would reduce carbon-monoxide emissions by at least 90%, carbon-dioxide emissions by 25% and nitrogen-oxide emissions by up to 60%. There are even expectations to use natural gas in aviation, with estimates of 60% improvement in efficiency while decreasing harmful emissions.

Technology and innovation is developing very rapidly and is touted to present serious cost savings, as well as a reduced environmental impact. Developments like these are interesting, but also raise some important questions. In such a rapidly evolving business, what will gas producers have to do to stay relevant? The next few years should prove to be very exciting, as new technology and investment fleshes out alongside a developing regulatory scheme and a better understanding of the industry. Chemistry is necessarily at the forefront of tech expansion stemming from the Marcellus boom because the natural gas industry is chemical intensive. As natural gas becomes more prevalent, the broader chemical industry is presented with a great deal of opportunity. It will continue to benefit from access to clean, domestic energy, as well as the demand for innovative technology. Recycling and wastewater treatment is highly dependent on chemistry, as are the new technologies in extraction. The high ethane content in Marcellus Shale gas has led to plans for ethane crackers in the region. Renewable Manufacturing Gateway and Aither Chemicals recently reached a deal for a $750 million petrochemical facility which will use shale gas as its feedstock. Clearly, energy development is a sector where chemistry continues to be relevant and our success in energy independence or economic prosperity is still INNOVATION!

Perspectives: What impact higher commodity price has on a chemical company?

Whenever we discuss potential chemical investment, we frequently ask about the possible impacts that may result from higher prices for commodities such as oil, gas and other raw materials. As I am writing this blog, oil prices are around $98/bbl; a decade ago, oil prices were merely in the teens. Not surprisingly, some companies’ financial performances are impacted by their exposure to oil, gas and petrochemical-derivatives, yet many others have relatively limited and/or low exposure and are therefore better able to weather the storm - the trick is the ability to know the difference!

Few inputs impact the world economy to the same extent that the price of oil does. Oil powers cars, trucks, boats, airplanes, and even power plants, which make up the backbone of the global economy. Needless to say, higher energy prices will have an impact on consumers, as well as a company’s ability to invest in capital equipment and grow the business. Increased commodity chemical prices will place downward pressure on a company’s finance/debt as well as negatively effects consumers’ credit. From the feedstock to the commodity producer to the ultimate consumer, everyone suffers.

However, the magnitude of the impact depends on the company’s pricing power, business model, location in the value-chain, and uniqueness of their products and services. During an economy where commodity prices are rising, chemical companies’ financial performances may depend on their ability to pass along the increasing costs to customers (e.g. price escalators) and ultimately to the end-users. Hence, the management team’s ability to execute the company’s risk management strategy plays a crucial role!

The above chart provides a useful reference guide, illustrating the potential impact that certain commodity prices have on various products. Commodity chemical producers (e.g., SABIC, LyondellBasell), diversified chemical producers (e.g., Dow, Dupont, 3M), specialty chemical producers (e.g., Lubrizol, Milliken, Ferro, Solutia), agricultural/fertilizer producers (e.g., Monsanto, Potash), chemical formulators and service providers (e.g., Ecolab, Nalco), and chemical distributors (e.g., Univar, Brenntag) are influenced differently and to varying degrees of their margin. Some could even benefit from rising commodity prices. To say the least, the chemical industry is complex. Companies typically have a very long value chain, and very rarely can a company be found containing only one product line with just one end market. A savvy investor needs to possess a deep domain expertise in order to gain visibility into the value chain, take a broader view and appreciate the supply/demand dynamics.

One silver lining in this high crude price environment is that many commodity chemical producers are benefiting from relatively cheap natural gas, which is a key raw material for many products manufactured in the United States. Higher natural gas prices, in particular, severely diminish the competitiveness of the industry, as it uses natural gas not only as inputs for fuel and power, but also as a raw material and for feedstocks. Feedstocks for most petrochemicals are typically derived from either oil or natural gas (the U.S. chemical industry is the largest industrial user of natural gas, consuming one-eighth of the total natural gas demand). Oil prices, including heavy liquids (e.g., naphtha and gas oil), are determined in the global market. The price of natural gas (as well as liquid gas such as ethane, propane, and butane) is driven by local/regional supply and demand since it has inherent physical limitations moving over long distances. Many large energy companies are heavily investing in order to find ways to help alleviate this issue, for example, building liquefied natural gas (LNG) terminals. Overall, the price of a feedstock is largely determined by the price of oil and/or natural gas.

Another silver lining is that alternative energies like wind, solar, and geothermal, as well as alternative fuels like biofuels, ethanol, cellulosic ethanol and fuel cells, all see increases in demand when the price of oil increases, since oil is their principal competition – also keep in mind that fossil fuels are the main sources of environmental pollutions. Many chemical companies’ products and technologies will, in fact, benefit from an environment with higher oil or energy prices, since chemical companies produce critical materials for solar panels (e.g., PV thin-film, pastes, encapsulants, coatings, metallization, shingle roofing), components for wind energy system (e.g., carbon fiber, infusions, fiber glass, pre-impregnated materials/prepregs), materials for energy storage devices/systems, various solutions for next generation’s electric vehicles, biofuels, etc. High energy prices also spark other innovations, from industrial biotechnology and bio-plastics to fuel cells.

Arguably, chemistry is the essence of modern life, and as a result, the chemical and chemical-related industries will continue to thrive in any commodity-priced environment, so long they remain flexible.

Even Warren Buffet likes the "business of chemistry" ….another stamp of approval for chemical industry thorough acquisition of Lubrizol

During the last few years, Berkshire Hathaway Inc. has made many investments in chemical and chemistry related businesses such as Nalco, Dow (Rohm and Haas), Great Lakes Chemical (GLK), Kaiser Aluminium & Chemical Corp. Sealed Air Corp, GSK, J&J etc. along with some petrochemical companies like ExxonMobile, ConocoPhillips, PetroChina and so on. Mr. Buffet’s notable commitment to the chemical industry is illustrated thorough Monday's announcement to purchase Lubrizol (LZ) for $135 a share, 28% above Friday's closing price! The consummate value investor, Mr. Buffet is expected to pay $9.7bn (which includes $700m in net debt) for the transaction. Even after paying a $30 premium (i.e. 28%) over the $105 closing price on Friday, Lubrizol transaction is priced at approximately, 7x 2011’s EBITDA and 5.4x 2012’s EBITDA.

Now if you consider today’s availability of cheap money in the capital structure, the WACC is no more than 8.5% (assuming at least 2x interest coverage with a realistic leverage 4.7x - 5x), Mr. Buffet is expected to generate top quartile returns (with a minimum Internal Rate of Return (IRR) percentage in the 20s within 3-5 years!).

We can talk all day long about the public market anomalies, various deal dynamics, and business related topics such as sustainability of margins in the lubricant additives value chain or excessive swings of commodity feed stocks (e.g. energy price, oil and petroleum derivatives). However, a company’s success will continue to depend on the management’s ability to control risk and take advantage of perceived market risks. For example, Lubrizol is a well managed company that poses an excellent profile of a “very good” specialty chemical company, growing its revenue consistently (for example: $3.4B in 2004; $5.4 in 2010), generating very strong cash flows and returns on capital, displaying a strong balance-sheet and flush with cash. We should also realize that Lubrizol has been increasing earnings at a compounded growth rate of 16% (at least for last 10 years; and Lubrizol's earnings growth has accelerated to over 25% per annum during the last 5 years).

Lubrizol continues to maintain its specialty status in a “so called commodity risk” environment by focusing on: its proprietary product (not necessarily patent protected product), mastering its product application for their customers’ system/process, delivering process/system monitoring services and maintaining overall strategic focus etc. (note: Relatively speaking, Lubrizol is neither capital intensive nor over reliant on R&D expenditure). Ultimately, Lubrizol’s strong performance over the years coupled with an excellent new owner should position Lubrizol to be even more successful as it moves forward. What are your thoughts?

Private equity environment continues to improve

The private equity deal market has been quick to rebound in 2011. According to Thomson Reuters, merger and acquisition deals are already over $36 billion for the year-to-date and the value of deals are up 88% from last year. Analysts not only expect private equity investments to continue but they also expect the size of deals to increase as well, since the credit crisis hindered the purchase of cheap debt. Although the entire private equity market has vastly improved over the past year, the investments leading the way have been in the industrial industries (including chemical & chemical related businesses), health care, and real estate.

If we measure the composition of global transaction volume, capital raising, the dollar value of private equity exits, and total equity investment. Collectively, these four key components illustrate the most fundamental elements of the private equity market, and when they are indexed, one can observe that in the 3rd quarter the global private equity industry continued to rebound from the 2008-2009 recession as total equity investment in private equity transactions increase to a record $40.1 billion ($36.4 billion reported in the 2nd quarter and $17.8 billion reported in the 1st quarter). However, PE activity has not yet returned to pre-recession levels and the industry is evolving for the better as many funds/PE firms are winding down their operations.

The biggest benefit of economic downturn is that private equity firms or companies tend to lose focus or ignore inefficiencies in go-go days. A few new private equity firms continue to emerge and a few existing firms will emerge even stronger, but many will go away. A generalist investment approach for very large funds might have some particular relevancies today (return of cheap money, access to resources due to larger fund fees/scale), while the middle-market (and certainly lower middle market) needs more specialized and focused investment approach because resources are limited and the middle-market contains structural inefficiencies that are absent from larger, more liquid markets. Isn’t this a good opportunity for both private equity investors and business sellers working with specialized professionals?

Synergistic acquisition to promote innovation

In January, BASF and LKCA (a subsidiary of Linde Group), announced that they would jointly market licenses and plants for the capture of CO2 from flue gases, and recently, with assistance from RWE Power, they have created (and successfully tested) a major breakthrough in carbon capture technology. The new innovative technology captures CO2 by means of utilizing new chemical solvents that can reduce energy input by about 20 percent. Furthermore, the new solvents feature superior oxygen stability, which reduces solvent consumption significantly, which consequently improves efficiency.

In the future, climate-capture technology will likely play a key role in generating climate-compatible power from coal, and this new technology process, once scaled up to large power plants, will reduce power plant waste gases and facilitate clean energy generation. In addition, as this technology should capture more than 90% of the CO2 contained in waste gases, a vast supply of recycled CO2 can be created and used for inputs in chemical transformations such as production of fertilizers. New plants demonstrating this technology are scheduled to be in operation by 2015, and the technology should be expected to be utilized commercially in coal-fired power stations by 2020. Ultimately, once this technology expands, there will be a significant reduction in the release of climate-damaging CO2 due to its successful capture and transport for recycling or sequestration.

So, why is this development relevant in the chemicals industry? And why is it relevant within the private equity industry? First, this development illustrates the strong motivations within the chemicals industry to become more environmentally sustainable while simultaneously reducing costs and improving efficiency. Furthermore, this new technology derived directly from the pooling of knowledge and resources from various firms with different areas of expertise; individually, the companies would likely have found development of this technology exceedingly difficult, however, when their resources were combined, breakthroughs were managed in rapid fashion. Similarly, in the private equity industry, companies are strategically acquired so as to enable such synergies to promote swift innovation and long-term value creation, and as this particularly example clearly illustrates, the broader chemicals industry provides a viable forum in which to initiate such developments.

Partner up with the seller: Preserve and Grow Capital!

For the last 2-3 quarters, we have been experiencing the greatest psychological recovery in the recent history of economics and frankly, it’s hard to pinpoint the “Real Why”. While the stock market has improved to the benefit of some, the majority of Americans continue the struggle to meet their daily needs (for as expected, job recovery is slow). Recent market activity has been surreal; however, if you looked into the dreadful realities of bankruptcy proceedings during the last few years, last month’s “Flash Crash” in equities markets should probably have been expected. Moreover, “amend to extend” loans have surfaced, seemingly pushing the inevitable off well into the future.

Unfortunately, the fact remains that access to capital continues to be tight and typical private equity firms have heaped tens of billions of debt onto companies acquired from 2004 to the end of 2007—debt that is likely difficult to service, and certainly not cheap, which ultimately begs the question whether a traditional PE firm can afford such an increase in debt (or so called financial engineering). Therefore, we expect to see lots of opportunities in the middle market, certainly in the lower middle market; however, the real difficulties lie in determining how realistic the valuations of certain companies are. Valuations for bankrupt companies are often well below the ultimate auction rates of assets for many reasons. However, unreliable and yet attractive valuations could potentially open the window to big bargains; although there still exist enormous hazards if the buyer really does not know the business and its operational complexities, the opportunities are there for the picking.

It’s critical that PE firms look carefully into protecting the principle investment (downside) as the basic guarantee, without compromising the upside for all parties involved. This “win-win” approach could be achieved through implementing a creative structure for a deal. If the PE investor understands the business and its assets, it would still make a lot sense to go for straight equity deals. An industry focused, specialty PE firm could potentially move into growth/late-stage investments where growth capital is critical for a company’s success. In these cases, industry specialization will not allow a firm to negotiate better with the market, but will also provide a perspective that enables deeper understanding of market variability, condition, the visibility of a company within the market, and general day to day operations from a business perspective. For example: one could choose a convertible structure to get the coupon for 2-4 years, then convert them into equity at a pre-decided price and include an exit structure (with a built-in clause for claw-back, earn-out, etc., if the company does not perform as promised by management/owner/i-banker; … structuring is always specific to the business and market peculiarity of the deal) under which the PE fund’s stake is bought out by the promoters (or investment banker/ placement agent) or other investors. A structured deal could be a valuable tool when a PE investor is not comfortable with a sell-side investment banker’s projection on revenue and returns. The fact is that there are many ways to get things done so long as all parties take a “partnership approach” and a PE investor has deep understanding of a business and its operating domain!

Dealing with a PE investor who has deep understanding of a domain and its business operations allows a seller to get the well deserved full value of a business, to get the deal done quickly and to sustain a long-term relationship with all parties involved.

Lyondell Basell: Phoenix From the Ashes

If there was a major blight on the outlook on the chemical industry in recent years, it was LyondellBasell Industries US operations filing for Chapter 11 bankruptcy protection in January of 2009. Although the company officially emerged from bankruptcy in May this past year, it was LyondellBasell’s reported second-quarter earnings that left little doubt as to the health of the company and the health of the industry. Time to time, a good company can get stuck with a bad balance-sheet (often imposed by so-called financial engineers), with disastrous consequences; as is often the case, these financial engineers do not fully appreciate the complexities involved in the operational facets of the chemical industry and are incapable of implementing changes that can truly benefit the company stakeholders.

LyondellBasell reported second-quarter net income of $203 million as well as sales of $10.4 billion (+7% QoQ and +40% YoY up), cash increased to $3.8B from and total liquidity is now ~ $5B and the EBITDA was $1.4 billion (Net Debt / LTM EBITDAR of 1.1x). All five reporting segments have done well; however, improved olefin and polyolefin margins coupled with a better cost structure have driven attractive results!

Evidently, LyondellBasell has emerged from Chapter 11 restructuring a much stronger company, particularly operations in the US; operating income in the company’s olefins & polyolefins in the Americas segment was up 123% from the year-ago quarter. Looking forward, LyondellBasell expects similar positive performances as the US ethylene market rebalances following several turnarounds. It will be interesting to observe how operating rates and margins going forward will be influenced once the increased capacity comes online in the Middle East and Asia. LyondellBasell is one of the world's largest independent petrochemical companies that resides in the commodity end (upstream) of the value-chain. However, one can nonetheless appreciate LyondellBasell’s remarkable rebound, which ultimately reflects the good health of the broader chemical industry and could potentially illustrate why now is the opportune time to invest within the industry: specific markets within the industry are rebalancing and opportunities for growth are widespread and plentiful.

Chemical Industry Merger and Acquisition (M&A) Activity Gaining Momentum

In the first half of 2010, there has been a noticeable pickup in the level of M&A activity in the core chemicals industry. In fact, in the first half of 2010, there were more deals than there were in all of 2009; to date, there have been 23 closed deals in 2010 whereas 2009 saw only 20 deals for the whole year (and only 7 for the first half). In terms of actual value, the 23 deals in 2010 represent $29 billion whereas 2009 saw $25 billion in deals for the whole year. Median valuations multiples (i.e. EV/EBITDA multiple) are on the rise for deals within the industry this year, that is significantly higher than the 2009, 2008; however, actual transaction value remains lower than 2007. It seems that sellers are more focused in achieving their strategic objectives and buyer are more focused on the value (instead of multiples or price)....Everyone wins!!

Semiconductor industry (early in the supply chain) seems to experience a further gain along with the global manufacturing and chemical sectors’ continued advancement (at a slower pace). Housing and job growth was disappointing and employment recovery may take a very long time. On the other hand, inventory rebuilding of manufactured product is moving into a moderate growth phase. All of these data coincide with the major upswing in reported second quarter revenues and profits across the industry.

Not only has there been an increase in the number of deals, but they have been more focused towards smaller-scale transactions as opposed to large, transformative deals. This can be attributed to several factors, among which include the European Union’s Reach legislation, an expected increase in the US capital gains tax, as well as banks’ predilection to favor smaller deals that focus on add-on acquisitions as opposed to massive transformations. Furthermore, a good deal of M&A activity has been conducted by financial buyers as opposed to major industry players; in the first quarter of 2010, financial buyers accounted for only 6% of the M&A dollar value, which has since risen to 48% in the second quarter.

So, what does all this information mean for the industry as a whole and how can investors capitalize on these conditions? In terms of the chemicals industry, these figures convey a strong underlying value and demonstrate the beginnings of a vibrant recovery for the industry. Furthermore, in terms of capitalizing on investments, the data indicates that the market is leaning towards smaller, operational value-adding deals for numerous reasons, and it is an ideal time for investors to take advantage of this new, and probably lasting, development in a recovering market.

1H-2010 M&A Update Slide Link: http://www.slideshare.net/ennovance

Deadline for innovation or profit? An issue in venture capital world…

Ennovance Capital is NOT is VC firm (i.e. Ennovance is a PE investor). However, I could not resist the temptation to share my perspectives on the VC landscape. Currently, numerous venture capital (VC) firms are experiencing the problem of facing end-of-life fund deadlines in a market that has seen difficulties in recent years. Many of the funds facing this problem were created during the dot-com bubble; from 1999-2001, over 1200 venture funds closed on approximately $179 billion. Many of these funds facing end-of-life deadlines retain companies they believe hold much potential and seek extensions of their funds for a year or two; however, many investors in Wall Street would rather exit as quickly as possible and take their losses from venture bubble investments. Apart from loss of potential profits, what are the other possible effects of closing these funds without extensions?

One impact of decreased investment that many neglect to mention is the adverse affect on multifactor productivity (MFP). In economic terms, multifactor productivity is a concept that measures the changes in output per unit of input. In other words, MFP exists when the output is greater than the sum of its input. In real terms, MFP reflects factors such as managerial skill, technological developments, reorganization of production, etc; in essence, it is a measure of innovation. If this venture funds are required to close and let up on companies with significant potential, we would witness a noticeable decrease in MFP, for these funds would be unable to commercialize novel ideas and innovations, create synergy between existing companies, restructure and reorganize companies to operate more efficiently, etc. Many bright ideas and innovations that could potentially transform industries will never see the light of day, which will prove to be a dire consequence towards society as a whole.

Just as Rome wasn’t built in a day, companies cannot be transformed overnight. Although the market as of late, although improving in some regards, has been less than comfortable for investors, they should not give up on funds with potentially valuable assets too quickly. The key questions to ask are: Will novel ideas will remain novel ideas despite capital market conditions? Isn’t innovation made America great? If so, how big of a “real loss” would we see as innovation fades away due to general uneasiness within the market for VC?

Chemical Industry Going Green By the day

Recently, chemical industry leaders BASF and Dow Chemical Company have received recognition from the U.S. EPA’s annual Presidential Green Chemistry awards for creating economically viable and sustainable technologies. Specifically, Dow and BASF won the Greener Reaction Conditions Award for their joint development of an environmentally friendly process for producing propylene oxide via hydrogen peroxide, which reduces waste water by about 75% and energy use by 35%. In the past, BASF has won the award 3 times, Dow Chemical 6 times, and other leading companies such as Merck & Co. have also received this award.

You may be asking why this is important and what impact does it have at all in the chemical industry? True, receiving this award will not likely have a significant impact on the companies themselves; however, it serves as an indication as to the direction of the broader chemicals industry and helps rectify pervasive misinformation about the industry. If you were to ask the average individual what they imagine in association with the words ‘chemical industry’, they will likely imagine immense factories spewing endless amounts of smoke. However, people fail to realize that the interests of chemical companies often align with what is best for the environment. Most importantly, folks fail to recognize that chemistry is essential to modern life;… sectors like pharmaceuticals/healthcare, electronics, personal & beauty care, home and building material, battery and energy storage system etc. depend on the basic science of chemistry. Many innovations that stem from this mentality often end up being beneficial for the environment in terms of fewer by-products, less usage of oil and gas inputs, and more. I am not saying that chemical industry processes are good for the environment in general, but that there is a conscious effort within the industry to become as efficient as possible and minimize impacts to the environment.

In essence, the industry has been ‘going green’ per se, and this effort by leading companies to innovate so as to develop environmentally sustainable and benign processes and products is exactly the mentality required, and will ultimately lead to greater efficiency and more sustainable/consistent growth within the industry, given the proper investment into these novel ideas.

Apollo's hunt for Pactiv

Pactiv is in talks to be acquired by Apollo. The packaging company is estimated to be valued at over $4 billion, and its sale would be one of the largest deals in the packaging sector in recent years. Georgia-Pacific and New Zealand’s Rank Group are also reported to be in the bidding. The packaging sector had been consolidating over a decade and the question is whether cost synergies would be enough to warrant a merger and longer-term holding period or it’s a game of oligopolistic pricing model?

Anyway, the potential winner could be Apollo because of the synergy benefit with its current portfolio company Berry Plastics (current sales ~$4.1 billion) and massive nature of consolidation to provide better economies of scale! In 2006, Apollo has Berry for $2.25 billion (~7.1x EBITDA), which have been built through 29 acquisitions, most recently Covalence Specialty Holdings and Pliant Corporation (for 7.6x EBITDA). Berry is the #1 producer of injection molded products for the packaging industry and the #2 film and sheet producer (yes, the combined company would be the largest user of polyethylene ~1.3 billion pounds annually!!). Commoditized plain vanilla packaging industry, Apollo wanted to double Berry’s revenue every four years, and it might be possible given its acquisition history and sector specific characteristics such as: participating companies' currently have high cash flows, historically low debt levels and are trading at relatively low valuations etc.

Apollo could potentially buy many other candidates in this sector such as Silgan that has a low debt level and stable cash flow, though one third of its shares are owned by its founders. The question is, couldn’t a private equity firm generate extra-ordinary profit for its investors, with longer-term holding period, if the organization has specialized knowledge about a particular sector and understand profit chain? How important is the true multiple expansions?

Solvay- using its cash hoard for an acquisition?

While its outlook remains challenging, Solvay reported a strong set of results for Q1-2010, especially a volume jump in its Plastics division and good progress in pulp & paper, construction business etc. Solvay has cash to spend after selling its pharmaceuticals business last February and a redeployment of its cash proceeds likely near-term. The question is where?

There are many possibilities for Solvay’s acquisition: Croda International and/or Symrise which are relatively stable; on the other hand, Solvay could buy one of the struggling companies like Arkema, Clariant, Rhodia, and Umicore etc. The real question is: would Solvay act to transform the company (risky) to be a major long-term value player or will it just satisfy the street/market by looking at the short-term (safe) benefit?

Quick perspectives on chemical related M&A deals: uptick in Q1-2010

The economic downturn has adversely affected almost every industry and the shrinking demand for acquisitions depressed valuations for selling companies to their lowest levels in recent history that drove M&A activities to crawl. While no one can be certain what the immediate or long-term future holds for M&A activity, we are beginning to see empirical and anecdotal evidence that 2010 might get better for chemical and related industry deals. Until the general economic climate improves, or at least stabilizes, there is little reason to believe that financial and strategic buyers will jump back into acquisition mode. Here are some perspectives to consider:

Both the volume and value of deals within the chemical industry has increased markedly from the fourth quarter of 2009 to the first quarter of 2010. As measured by value, deal activity during the first quarter of 2010 increased by $15 billion, from $7 billion to $22 billion. While this increase was fueled mainly by five large deals, which accounted for 80% of the total activity, deal-making across the value spectrum is expected to increase throughout 2010. Cross-border deals are also expected to increase from 2009 to 2010, as the global economy continues to recover.

Two hundred sixty deals were announced during the first quarter of 2010, representing a 33% increase from the same quarter of 2009. While the number of deals announced dropped from 292 in the fourth quarter of 2009, the 262 figure does not accurately reflect the true deal volume during the first quarter, as it has been taking longer for interested parties to reach the announcement phase of deal negotiations.

During the first quarter of 2010, the proportion of deals by value involving financial investors continued to drop– 11% compared to a peak of 20% in 2007. By actual deal size, finical investors were only involved in $2.6 billion worth of transactions, as compared to $26.1 billion in 2007.

As access to credit continues to improve, private equity buyers are expected to reverse this trend. In fact, one of the largest deals of the first quarter, valued at $1.63 billion, was the acquisition of Styron Corp by Bain Capital, announced in March. However, for the moment, strategic buyers still retain a competitive edge over purely financial buyers.

Consolidation and increased competition within the industries are expected to be the key drivers behind strategic deals, with a focus by acquirers of achieving cost and operational synergies in their core businesses. Additionally, the opportunity to acquire companies that remain financially distressed is still present.

As a result of the focus on strategic deals, many sales have either resulted from direct discussions between the two participants or have been conducted as auctions in which the number of bidders has been intentionally restricted. Due to the effects of the recession on reported earnings over the past few years, the complexity of conducting an accurate analysis of potential targets has increased significantly. Combined with the private nature of most recent deals, it is of the utmost importance that prospective acquirers conduct thorough up-front research and have the experience to fully understand the industry, so that they are ready to act when deal opportunities present themselves.

Looking forward, the need for a complete understanding of target companies’ operations will be amplified by increasing uncertainty in the chemical industry. This uncertainty will be driven by commodity price volatility, as well as government actions concerning health-care and climate change.

We may agree after this latest downturn, private equity firms and traditional strategic/companies should be keen to understand the target’s business fundamentals, it’s relevant market/customer to avoid next disasters. Operational intelligence, domain expertise and alignment of interests would be the critical “must have catalyst” for sustained success. The question to ask, if a generalist PE firm have the necessary skills to produce higher IRR that LP/investors are demanding?

Deal, deal and more chemical deals….. "relationships and domain expertise are the key!"

M&A activities has slowed down compare to 2006/2007, the glory days of PE firms. The interesting thing is that most M&As are considered to be unsuccessful when we examine the write down (FASB 157 effect for PE firms), goodwill, amortization, cash crunch etc. for larger companies. Why or why not is the same old topic that I shall avoid for this discussion. The thrill of M&A transaction and being in the press can become a seduction for many managers and doing the deal then becomes a success in itself to boost his/her own ego. The fact is that if you know the underlying asset and business operational fundamentals, M&A could be profitable growth accelerator and high IRR for LP/investors.

In order to have a robust deal pipeline, one has to have a deep domain knowledge, expertise and relationships….

Just, knowing about a deal doesn’t do the trick, because really understanding the business and having meaningful relationships are vital. Here are a few recent deal/M&A dynamics in chemical industry:

1) Sell of Cognis is on the rumer mills for a very long time. There are many companies could have a strategic fit with Cognis such as Lubrizol. However, BASF is at an advanced stage of talks to acquire Cognis and may make a bid for the company next week, German press reports said. This follows last month's news that BASF and Lubrizol have separately expressed interest to Goldman Sachs Capital Partners and Permira, Cognis' owners since 2001, that they would be interested in buying the company. BASF has appointed financial advisors to assist with the potential transaction, sources say. Financial Times Deutschland reported that BASF's supervisory board has given the go ahead to bid for Cognis, citing people familiar with the situation. Analysts say an outright sale of Cognis, rather than the previously considered IPO, would be the right strategy for the owners. Private equity companies do not generally hold on to assets for 10 years and, in the case of Cognis, would favor a sale to a strategic buyer. The deal would be worth about €3 billion ($4 billion), reports say. Cognis, whose sales last year reached €2.6 billion, is the former oleochemicals business of Henkel. It is active in care chemicals, nutrition and health, as well as functional products. Cognis' main competitors in Europe are Evonik Industries, Croda, which in the past acquired ICI's Unichema oleochemicals operations, and BASF. All have had discussions about buying Cognis, reports say. Cash-rich Solvay could also be interested, following the sale of its pharmaceuticals business and its quest to expand into areas with a lower CO2 footprint. "I think it would make sense for BASF to buy Cognis," said Andreas Heine, an analyst with UniCredit Research. "This year is a good year for acquisitions.” In the case of BASF, the company has done most of the work integrating Ciba Specialty Chemicals already, he said. Cognis' portfolio would fit well with BASF's, he added.

2) Ticona Engineering Polymers, Celanese’s advanced engineered materials business, said it acquired two product lines, Zenite-brand liquid crystal polymer (LCP) and Thermx-brand polycyclohexylene-dimethylene terephthalate (PCT), from DuPont Performance Polymers. Financial terms were not disclosed. “This acquisition will continue to build upon Celanese’s position as a global supplier of high performance materials and technology-driven applications as we continue to expand our innovative offerings in growth-oriented segments to support our customers,” said David Weidman, chairman and CEO of Celanese. “These two products broaden the company’s Ticona Engineering Polymers offerings, enabling Celanese to respond to a globalizing customer base, especially in the high growth electrical and electronics application segments.” Zenite LCP and Thermx PCT posted revenues of about $40 million in 2009. “DuPont Performance Polymers has concluded that this opportunity to divest Zenite LCP and Thermx PCT is in the best long-term interests of our portfolio and customers,” said Diane Gulyas, president of DuPont Performance Polymers.

3) Chemtura said it has completed the previously announced sale of its polyvinyl chloride (PVC) additives business to Galata Chemicals for a price of $16.2 million and the assumption by Galata of certain liabilities including certain pension obligations and environmental liabilities. Galata is a partnership between private equity firm Aterian Investment Partners and textiles, metal finishing and chemicals company Artek Surfin Chemicals (Mumbai). “This divestiture was the best way for us to maximize the value of the PVC additives business,” said Craig A. Rogerson, chairman, president and CEO of Chemtura. “It is part of our plan to focus on maximizing the total value of our portfolio of businesses.”

4) Eastman Chemical is now reviewing options for its PET business. Eastman, once the world's largest manufacturer of this plastic, has been looking to largely exit this competitive and oftentimes oversupplied market. Eastman has

Eastman Chemical said it has completed its previously announced acquisition of Genovique Specialties, a global producer of specialty non-phthalate plasticizers, benzoic acid, and sodium benzoate. The acquisition includes manufacturing assets at Chestertown, MD and Kohtla-Järve, Estonia as well as a plasticizer joint venture site at Wuhan, China with Wuhan Youji Chemical Corporation. The operations will now become part of Eastman’s Performance Chemicals and Intermediates (PCI) segment. The transaction is expected to be accretive to Eastman’s full-year 2010 earnings per share. Terms of the transaction were not disclosed.

5) Many folks thought TPG, formerly called Texas Petrochemicals Group, might be a good target. Well,… it may not be viable anymore. TPC, said it has been approved to list its common stock on the NASDAQ Capital Market. The company’s shares are expected to begin trading under the symbol “TPCG” on May 4 when the market opens. “Achieving a national securities exchange listing was a key goal for TPC Group,” said Charlie Shaver, TPC Group’s president and CEO. “As we continue to successfully execute on our business plan, we believe this listing enhances value for our shareholders, as it should provide increased visibility within the investment community and improve the trading liquidity of our shares.” TPC, which is currently traded on the over-the-counter market, filed a registration statement with the U.S. SEC last January. The company recently amended and extended its revolving credit facility from $140 million to $175 million in late-April.

6) Ineos, haha ….

Ineos will raise funds through a bond issue, despite disturbance in the global money markets. Here are some interesting perspectives, according to some folks, I know: although the notes are senior secured, the bond weak since there is a significant amount of debt that is permitted to be incurred which will rank ahead or pari passu with these Notes, thereby diluting the collateral package granted to the Note Holders on the date of issuance. The notes are senior secured, but effectively subordinated to indebtedness under the revolving credit facility and the other first priority debt. As of June 30, 2009 the Notes are structurally subordinated to $7.1mm of debt of the non-guarantor subs. The notes are effectively senior to the other senior debt of the Company (including the outstanding senior notes) to the extent of the value of the Collateral. The Liens covenant is rated weak since it permits a significant amount of debt to be secured on a first priority basis ahead of the Notes. The Company has flexibility to incur additional first priority debt which will rank ahead of the notes and even greater flexibility to grant liens which are pari passu to the Notes, thereby diluting the Note Holders collateral package. You can get a pretty good idea if you see the Lien Covenant for Ineos.

The issue is intended to raise cash to refinance existing debt, Ineos said. The company announced plans to issue bonds in March to pay down debt. Ineos will offer a two-part bond issue, due in 2015. The aggregate principal amount is €740 million ($945 million): $570 is priced at 9%, and €300 million is priced at 9.25%. "The market is clearly encouraged by the recent performance reported by the company and its delivery ahead of its business plan," said Ineos Capital SFO John Reece. Ineos divested its ChlorVinyls and Ineos Flour businesses, which is expected to produce a total increase in liquidity of about €300 million, and a total reduction of net debt including pension funds liabilities of about €600 million. Ineos reported full-year 2009 historic cost Ebitda of €1.2 million compared to €594 million in 2008. The company expects its financial performance to continue to improve through 2010.


7) LyondellBasell: It’s good to see that LyondellBasell emerged from bankruptcy protection on April 30. The company is still highly levered with S&P rating being B. It’s worth of considering that the company’s total adjusted debt is $9.3Bn when you capitalize operating leases of $1bn, taxt effect and unfunded postretirement obligations, and environmental liabilities etc. There were some churn with senior management during the transition process.

LyondellBasell entered into bankruptcy with net debt of about $24 billion; it will exit with about $5.2 billion of net consolidated debt, reflecting about $2 billion of cash and cash equivalents; and about $2.4 billion of lending commitments under an asset backed lending facility in the U.S., as well as a European revolving trade accounts receivable securitization. A new parent holding company, LyondellBasell Industries N.V., was formed as part of the reorganization. It will be a public limited liability company incorporated in the Netherlands. Stock of the new parent company is expected to be publicly traded on the New York Stock Exchange in the third-quarter. About 563.9 million shares of common stock will be issued under the plan.


8) According to PEHub, Coskata Inc., a Warrenville, Ill.-based developer of technologies for processing biorefuse into ethanol, has secured an undisclosed amount of new equity funding from French oil company Total. The company previously raised over $76 million from Blackstone Group, Advanced Technology Ventures, Globespan Capital Partners, General Motors, GreatPoint Ventures and Khosla Ventures. The proceeds of the financing will support Coskata’s bio-ethanol commercialization activities while ensuring advancement of new product technologies. Also participating in the transaction was a number of Coskata’s prior investors. According to PEHub, Joule Biotechnologies, a Cambridge, Mass.-based developer of technology to convert carbon dioxide into ethanol, has raised $30 million in Series B funding led by Flagship Ventures.

9) Agriculture, fertilizer industry is on a role, especially in BRIC countries and most players have enjoyed up swing. UralChem, a leading Russian fertilizer producer, has postponed plans for a previously announced IPO in London because its "management and shareholder believe that in the current market conditions the offering cannot be priced at a level, which reflects a fair value of the company.” Dmitry Mazepin, chairman of the board of UralChem Holding and 95.5% owner, says that the IPO generated considerable demand by international institutional investors but the company was not satisfied with the valuation that could be achieved in the current market conditions. The company recently said that it was planning to float 40% of UralChem in the form of global depositary receipts (GDR), each GDR representing two UralChem shares. The London float would have raised up to $642 million and would have valued the whole company at $1.2 billion-$1.6 billion. The proceeds would have been used to pay down debt built up by a series of acquisitions since 2007. Reports claim that the prospectus failed to disclose significant legal actions against the company, and that the U.K. regulatory body, The Financial Services Authority (FSA), would not have approved it, which means that it could not be published.

10) A. Schulman, Inc. announced today that it has completed its acquisition of ICO, Inc., following the approval of the ICO stockholders at a special meeting on April 28, 2010. The transaction, first announced on December 2, 2009, provides for total consideration of $105 million in cash and 5.1 million shares of A. Schulman common stock. ICO is a global manufacturer of specialty resins and concentrates for rotomolding, and provides specialty polymer services, including size reduction, compounding and other related services. Its products are used to manufacture plastic bags and films, household products, toys, water tanks and other rotational molding applications. With the addition of ICO's operations, A. Schulman will strengthen its presence in the U.S. masterbatch market, gain plants in the high-growth markets of Brazil and Malaysia and add facilities in Australia. The acquisition also will allow A. Schulman to expand its presence in Europe by adding rotomolding and size reduction to its capabilities and further leveraging its existing facilities serving high-growth markets such as Poland, Hungary and Sweden.
11) Clorox announced its intention to divest its STP and Armor All brands, most likely through an auction. The two divisions last reported combined sales of $300 million, and it is thought that Clorox is looking for upward of $800 million. Deutsche Bank analyst Bill Schmitz commented that Clorox is, ”Looking at selling off slower growing brands to focus on building or acquiring faster-growing businesses, or to accelerate its share-repurchase program.”

12) Polymer Group (PGI) announced that it is “evaluating strategic alternatives” for the company, including a sale, merger, or recapitalization. PGI expects 2010 top line growth of 9-12%.

13) Total sold its Mapa Spontex consumer specialty chemicals business to Jarden for $449 million. Mapa Spontex is a manufacturer of baby-care and home-care products with leading market positions in Europe, as well as Brazil and Argentina. The deal forms part of Total’s strategy to refocus its chemicals portfolio on materials science, with products such as polymers, adhesives, rubber processing, and electroplating, the company says.

14) Battelle (Columbus, OH) and start-up firm Ferratec (St. Louis MO) say they have developed a manufacturing process that slashes the cost of potassium ferrate from about $100/gram to as low as $2/gram in research quantities. Ferratec is able to produce pilot-scale quantities of kilograms of the salt per day, but determining the capacity of a commercial-scale project will depend on how quickly markets adopt the new chemistry, says Andy Wolter, CEO at Ferratec. According to Wolter the “holy grail” of applications is the multi-billion dollar municipal water and wastewater treatment sector, but that is a highly commoditized market still out of reach, even at potassium ferrate prices of $2/gram. Walter states that, “Long before we get to price points competitive with chlorine or permanganate, [potassium ferrate] can be used as an oxidizer or biocide.” In this form, it has military, Homeland Security, pharmaceutical and Superfund decontamination applications, and can be used as a replacement for hexavalent chromium in conversion coatings

15) Sumco has put its Cincinnati, OH semiconductor wafer manufacturing facility up for sale and has hired consulting firm Atreg (Seattle) to facilitate the sale. The company, a JV between Mitsubishi Materials Corporation and Sumitomo Metal, is selling the facility because the industry is “moving away” from the wafer technologies produced at that facility. Atreg says it expects potential buyers to be alternative advanced technology users, including defense firms and battery and solar manufacturers.

16) Arch Chemical often viewed as the odd ball in the industry and getting smaller and smaller in foot prints …. They had some management churn in recent quarters and thankfully they were able to sell their money-losing coatings business (primary business is in Europe, Sayerlack-brand industrial wood coatings business, headquartered at Pianoro, Italy) to Sherwin-Williams in February $54 million. The unit reported sales of $147 million last year, and it will join SW’s global chemical coatings division.

Water - a mega trend and multiple opportunities

There is a plenty of water, but not where people want it. At the same time, the between surface water (renewable) and water from aquifers (may not be renewable) tends to be blurred. The fundamental driver for water related investments is the opportunity to ease the pressure for people migrate as water availability changes and the associated cost by easing the access of water! Water demand tends to grow 2x the pace of population growth and the supply of freshwater is relatively fixed and unevenly distributed.

Water sector is very complex and investors are drawn in by combination of large markets and powerful secular themes such as: population growth, rising water consumption per capita (e.g. USA personal consumption increased approx. 10x per capital in 20th century), aquifer depletion, increasing scarcity of supplies of fresh water and even climate change as the recent hot topic! There are many chemical and related companies are making big bats to benefit from the water needs and the question is who would be future winners? Would not keep your eyes open to the disruptive technologies and unsustainable trends that may turn a leader into a loser?

Shortage of water is creating an active consideration for the placement of chemical facilities. For example, water intensive operation such as coal-to-olifins (in China) or ethanol (in USA Midwest) could create water stress that will create a significant cost component for many industrial companies. Now, this could create opportunities forward thinking companies who have clear strategy on water savings as a broader value proposition (e.g. ability to extract methane from dairy firm wastewater may provide an attractive opportunity to benefit from reducing both downstream pollution and dairy farm energy cost!).

Chemical companies who are in Agricultural business could also change the game if they can create a winning value proposition “…more crop per drop”

Infrastructure related water companies would also benefit such as storm-water system, smart water metering and loss prevention solutions. Rising energy cost is threatening the economics of desalination and innovation in high yielding plant, process might be important. New technologies particularly using reverse osmosis membranes appear to be more competitive than previously.

Industrial water treatment would have to focus more on energy efficiency, process optimization and conservation. The unique ability to combine chemical treatment, mechanical equipment and services, and/or emerging technologies might open opportunities for new entrants for this market. The big question is, how will the supply-demand be balanced in light of global politics?

Perspectives on Clean Technology

In recent times, there is buzz on “Clean Technology” and everyone chasing to get their slice of the pie. I thought, it would be nice to share some perspectives. Shifting political incentives, credit concerns, funding pressures, persistent energy price volatility, capacity concern and pace of innovation would be the continued theme for 2009!

Climate change threatens to derail development, while business-as-usual development threatens to destabilise the climate. While the debate over climate change appears largely settled, managing this tension will involve a lot more reflection about the trade-off between growth, the mitigation of climate change, adaptation to its effects and delivering alternate/clean-technologies.

Clean Technology is often viewed as a euphemism for alternate energy (i.e. oil or fossil fuel substitute), the fact is “Clean-Tech” includes a wide range of industries and business models that could potentially benefit from secular trends in favor of more efficient use of resources. Effective and efficient use of natural resources are critical due to the global mega-trends such as population growth, climate change, high demand for food, water and energy etc. Chemistry is the essence of modern life and the key players in chemical industry could benefit significantly in “Clean-Tech” in supplying key components or technologies. The key areas to focus on: Solar, Biofuels, Bioplastics, Fuel Cells, Water, Wind, Green Chemistry in general, Battery Technology, Carbon Sequestration, nano-tech or nano-scale high performing materials, and project base financing model etc.

Clean-Tech is not similar to “internet or dot com” where each new user at low incremental cost added more value to whole (after the initial heavy capital deployment); in contrast, dominant players in Clean Technology will be the companies who can execute successfully on a “project basis innovation”. Of course, there are few exceptions life biotech traits or smart metering etc.

A few thoughts on the clean technology arena: (i) I believe, speedy innovation oriented companies will benefit more than manufacturing (high asset) oriented companies. For example, ethanol plant operators versus enzyme suppliers. (ii) Carbon sequestration is a long-term play and the success will depend more on political climate, competing claims on invested capital and available alternates of technology (iii) As a general rule, regulatory initiatives should be the main driver for the financial return or performance of “Clean-Tech” participants (iv) Consumers price of traditional energy (e.g. electricity, gas, diesel, coal price) would dictate the viability of alternate energy or “clean-tech” (v) Arbitrages of elevated commodity price and alternate new technology has to balance out. Government policy will play a key role in commodity price such as corn price to gold price to hydrogen price! (vi) New technology could seduce people like (or, you), “Clean-Tech” funding arrangement are highly uncertain due to high level of capital intensity or ongoing financial commitments for many of the focus areas (not much difference than the feed-in tariff subsidy model). Clean-tech industry and their investment are undergoing a period of transition. Capital markets providing financing to the industry have pulled back in light of ongoing global macroeconomic, credit and liquidity issues. For example, in the first quarter of 2009, they invested only $154 million in 33 young companies, a drop of 84 percent from the last quarter of 2008 when, despite the crumbling economy, they invested $971 million in 67 start-ups, according to PWC/NVCA National Venture Capital Association. This reversal has led to a debate about whether market forces see little future for alternative energy and other green technologies on a large scale, or whether the economic downturn is taking its toll on this industry as well. The debate comes down to this: has the green bubble burst?

The debate over regulatory initiatives in only the beginning and low-carbon or energy-efficient technologies could see an accelerated adoption cycle in the appropriate environment. The Senate Energy and Natural Resources Committee last month approved the American Clean Energy Leadership Act by a vote of 15-8, clearing the way for the bill to come to the Senate floor for debate. While the bill is unlikely to pass in its current form, a few changes found to be relevant for the clean tech industry (i) Overall renewable targets are the same as in prior versions, starting at 3% by 2011 and climbing to 15% by 2021. It appears that energy efficiency can still be used as an offset to renewable target obligations at levels close to those previously discussed (e.g., 26.67%), suggesting that the net renewable requirement for 2021 would be about 11%., next (ii) the Act that was reported out of committee appears slightly watered down from a prior version, which was already not very aggressive on renewable compared to the House bill (Waxman-Markey). However, the bill does include a key positive for energy-from-waste and its exit from committee does set the stage for a bill to move the debate to the Senate floor, where additional changes could strengthen renewables requirements, possibly with more concessions to
nuclear energy and fossil fuels. (iii) The issue on combining the bill with carbon cap-and-trade legislation and it would be interesting see the final outcome!

As we observe various players in “clean-tech” arena, some of the questions I would ask:
Ø Can the “Clean-Tech” companies deliver sustainable profit in absence of without ongoing government/regulatory support? (Note: Clean-tech companies bears most of the risk instead of the suppliers. Many chemical companies are component and technology supplier to the so-called “Clean-Tech” companies such as enzyme to ethanol supplier, Photovoltech or thin-film supplier to Solar Panel Manufacturers )
Ø Are the new clean technology companies competitive in absence of scalability or migration to next generation?
Ø How sustainable is their pricing power? Can they capture their fair share of value, volume and market?
Ø Can “Clean-Tech” companies de-risk project for high capital intensity? In absence of “de-risking” the project, can they continually originate their financing?

Why doesn’t a PE firm do well in Chemical business?

Chemical companies were always considered a very good credit risk, given their cash flows and fixed assets as well as diversification through their cross-border activities. Except for liability lawsuits, very few large chemical companies ever went bankrupt. Even highly leveraged large transactions were successful — from Union Carbide in the 1980s to the Gordon Cain transactions and the more recent acquisitions of Nalco, Celanese (lucky deals) and LyondellBasell, Hexion/Huntsman (not so lucky deals).

The fact is typical private equity firms (even Bulge Bracket firms, let alone middle-market buy-out firms) do not do well with chemical company investment due to their: i) short-term focus [“catch me if you can” mentality] ii) lack of understanding of complex chemical business where financial engineering may not be enough iii) timing the economic cycle often difficult and IPO may not be an easy exit strategy.

I believe, one of the key criteria to be successful in chemical industry is to maintain TRUST and long-term relationship. Traditional private equity often only focus on low price of a chemical business (say 4 to 6x EBITDA range) instead of the long-term value of a business. At the same time, the level of distrust among traditional Wall-Street players are more than ever, causing problem to raise reasonable debt. While many other sector players are paralyzed and remain static, the chemical industry folks are busy in debt raising or financing due to good fundamental and here are a few examples.

Ashland Chemicals (ASH) announced a few weeks ago to issue $600 million of unsecured senior notes due 2017. ASH will use net proceeds from the offering along with free cash flow generated (which we estimate to be $383 million in 2009) to retire the $750 million 9% bridge loan facility that is set to mature and roll over to an exchange note (at a likely even higher interest rate) in November of this year. By taking out the $750 million bridge loan before maturity, ASH can prevent it from potentially being rolled over to an exchange note that we believe would likely bear interest in the 12-14% range. While the ultimate impact of the pending debt offering on ASH’s interest expense is yet to be decided, we believe that it 1) reduces ASH’s financial risk, 2) eliminates the near-term maturities that were weighing on the stock, and 3) could potentially even result in a lower interest expense going forward.

Nalco Chemical Company (NLC), has issue $500 million aggregate principal amount of 8 1/4% senior unsecured notes due 2017 (the "Notes"). The notes will be issued at 97.863% of the principal amount to yield 8 5/8%. Nalco Company intends to use the net proceeds from the offering, along with proceeds from new credit facilities, comprised of a seven-year $750 million term loan credit facility and five-year $250 million revolving credit facility, to repay outstanding debt.

DOW Chemical (Dow) reduced its financial leverage, shrunk its near-term debt obligations and eliminated its extremely expensive perpetual preferred notes with the issuance of $2.25 billion of equity as well as $6 billion of longer-term debt.

Rockwood Specialty (ROC) has successfully completed an amendment to its credit agreement, allowing the company additional financial flexibility through its covenants, and extended maturities of its Term Loan E and Term Loan G, however all this did come at a price. Rockwood has amended its leverage covenant definition and level from Total Debt/ EBITDA of 4.25x to Senior Secured Debt / EBITDA of 4.40x, stepping down to 4.00x by the end of 2010. I believe, the credit agreement was little pricy, $8.7mm in one-time upfront fees (keep in mind that ROC was owned by KKR and it was highly levered during IPO…. Very similar to Nalco). This adjustment leaves the company significant room under the covenant--well beyond what is needed in this economic/earnings environment and gives them room for acquisitions if the opportunities arise. 2009 EBITDA estimate (excluding FX gains and losses) is $530.1mm. Next, Rockwood will extend maturities of $1.22 billion of Term Loan tranches E and G to May 15, 2014 from July 30, 2012.

More hunger ….; Are agri/food prices more likely to rise or fall?

While prices have stabled/reduced, we all can remember (or hope not to remember) 2008’s extra-ordinary price hike of food/agri products due to the imbalance in supply and demand. We blamed the commodities like corn, energy etc.; however, the prospect for rising prices is still relevant today. I believe, there is a structural change story in the agricultural sector that will probably continue to affect food price, let alone world’s continued hunger issue. The bottom line is that we think agricultural prices are more likely to rise than fall.

While we recognize global demand for agricultural produce will likely suffer a cyclical downturn this year (a contraction of 1–2% in near-term) as both food and biofuel demand falls; however, the degree of the likely supply-side contraction will outstrip because falling planted acreage, lower fertilizer application and adverse weather conditions may drive a 3–4% fall in crop production over the near-term that is in contrast to the optimistic view of supply held by the USDA. Global population growth is expected to be 1.2% p.a over the mid-term (say 5 yr.) and continued increase in calorific intake and shift in dietary trends (greater meat consumption), which adds a further 1% p.a to global food demand. The UN estimates that some 1.9bn hectares of land worldwide have been affected by land degradation. The main causes are soil erosion, loss of nutrients, damage from inappropriate farming practices and the misuse of agricultural chemicals. Urbanization is eating into
agricultural land and reducing the workforce available to farm it. The average population size of the world's 100 largest cities grew from around 0.2m in 1800 to 0.7m in 1900 to 6.2m in 2000. Currently, half the world’s population lives in urban centers, compared with less than 15% in 1900. By 2030, the UN forecasts that 60% of the world’s population will live in urban areas. A major exporter like Brazil is increasing agri production; however, there is limit due to the major cap being poor infrastructure.

In the medium term, the supply/demand balance is expected to be fairly well matched (i.e. relative down-cycle again). All the participants in the value chain tend to be clearly very pro-cyclical when it comes to financial performance (e.g. crop processors and producers, Crop protection and seeds producers, fertilizer company, food retailer, Agri machinery producers), the key question is, what are we doing different now, structurally, to deliver cost-effective food/agri supply to feed the world’s growing population?

… Saga of Apollo/Hexion and doing wrong to Huntsman Chemical

You may remember, the takeover of chemical maker Huntsman Corp (HUN.N) agreement struck in July 2007 was among the last major leveraged deals signed during the boom ($6.5 billion deal). When the global credit markets froze up, it became impossible for Deutsche Bank and Credit Suisse to syndicate the deal's heavy debt load. Apollo sought to cancel the deal, and Huntsman later sued to complete the sale. Huntsman sued Wall Street's biggest players and already won a lawsuit and later agreed to settle the dispute with Apollo for a $1 billion payment. Huntsman is now suing Credit Suisse Group AG (CSGN.VX) and Deutsche Bank AG (DBKGn.DE) for more than $4.6 billion in damages for their role in the deal.

Those of us know, Peter Hunsman, could understand that he never would have agreed to sell company founded (1982) by his father if he thought the banks and Apollo would wiggle out of their commitment.

If you dig deep, Huntsman never trusted Apollo (or any private equity in that matter), but went along with the deal since two of Huntsman's primary lenders were chosen to back the financing (and Huntsman had a great deal of trust with these two banking institutions Credit Suisse and Deutsche Bank). On the other hand, these two banker were chosen by Apollo to woo Huntsman management away from Dutch chemical company Basell (a formative contender). The trial of Huntsman against two banks has begun on last Monday and it would be interesting to see the outcome? Will the justice be derailed in cumbersome legal process?

Can main-street folks trust Wall-Street? Do you ever wonder, why most private-equity firms do not do well in chemical industry transaction?

Is Biodiesel market marked by uncertainty?

The biodiesel market in the U.S. faces important issues; however, biodiesel is a key component of a sustainable future, and the industry will have overcome many challenges. U.S. and global demand for biodiesel has soared in recent years, but growth slowed in 2008 as energy demand and petroleum-based diesel prices fell. U.S. biodiesel production in 2008 rose nearly 40% to 683 million gals, as soaring U.S. exports, mainly to Europe, more than offset a drop in U.S. demand, according to the Energy Information Administration (EIA; Washington). Considering current economy, it’s not a surprise that U.S. domestic demand fell 8% year-over-year in 2008, to 320 million gals. A surge in biodiesel capacity and production was caused by biodiesel mandates under the U.S. Renewable Fuel Standard (RFS), higher fuel prices over the last few years, and a $1/gal biodiesel tax credit, EIA says. The European Union recently imposed tariffs on biodiesel imports from the U.S., which could limit U.S. exports, and EPA has not issued rules for implementing biodiesel blending requirements under RFS, which creates uncertainty for market players. While world capacity and consumption of biodiesel grew on average by more than 50%/year from 2002–07; however, the outlook for the biodiesel market this year remains highly uncertain!

Evonik Starts Up Operations at U.S. Biodiesel Catalyst Plant (May 4, 2009), at its 60,000-m.t./year sodium methylate unit at Mobile, AL. Sodium methylate is a catalyst used to manufacture biodiesel produced from sources such as rapeseed or soybean oil.

On the other hand, a number of Biodiesel/Ethanol producers have filed for Chapter 11 protection; such as:

White Energy Inc. : (Reuters) - Ethanol producer White Energy Inc filed for Chapter 11 protection in a Delaware bankruptcy court on Thursday, citing adverse market conditions, court documents showed. In court filings, the company said that while cost of raw materials to produce ethanol were high, excess supply of ethanol in the market has kept ethanol prices low, resulting in “minimal or non-existent profit margins.” White Energy listed assets and liabilities in the range of $100 million to $500 million in its Chapter 11 filing.

Aventine Renewable Energy (April 08, 2009): Aventine Renewable Energy Holdings Inc. of Downstate Pekin became the latest U.S. ethanol producer obliged to seek Chapter 11 bankruptcy protection Wednesday, as the industry’s once-fat profit margins continue to shrink. Ethanol, an alcohol product made from corn and used as a gasoline additive, got a major boost a few years ago from government regulations designed to encourage use of the product to reduce the nation’s dependence on petroleum. ….

Panda Ethanol (Jan. 28, 2009): Dallas-based Panda Ethanol Inc.’s Hereford Biofuels subsidiary filed for Chapter 11 bankruptcy protection in U.S. Bankruptcy Court for the Northern District of Texas.

According to the company, it intends to sell its major asset—a 105 MMgy ethanol facility currently in the late stages of construction in Hereford, Texas—pursuant to a Section 363 sale process, pending approval by the bankruptcy court. The bankruptcy filing doesn’t include the parent company of the Hereford subsidiary, Panda Ethanol.

Verasun (Nov. 5, 2008): VeraSun files for Chapter 11 bankruptcy protection; The recent retreat in corn prices caught one of the nation’s largest ethanol producers offguard. VeraSun Energy Corp. and its 24 subsidiaries filed voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court in the District of Delaware on Oct. 31, allowing it to enhance liquidity while the company reorganizes.

According to the company, the filing was “precipitated by a series of events that led to a contraction in VeraSun’s liquidity, impairing its ability to operate its business and invest in new and expanding ethanol facilities.” In a statement, the company said it “suffered significant losses in its third quarter financial statement,” citing that a dramatic spike in corn prices attributed to its corn procurement and hedging arrangements resulted in “unfavorable operating margins.”

Many other biodiesel producer are struggling to survive and the the question is what is next!

Refinancing shortfalls could trigger more M&A (and a lot more acquisition opportunity)

Many companies need to divest assets for additional liquidity; innovative and brave entrepreneurs could pick up good business with a reasonable valuation. There are some interesting financing aspects to trigger more M&A activities in chemical market. In normal times the debt markets typically favor the chemical industry, because it has good cash flows. For this same reason, many bulge-bracket / larger private equity firms enjoyed acquiring chemical manufacturing companies. However, the continued credit crunch and related liquidity crisis are causing problems for many chemical companies that need to refinance or restructure debt. General industry is affected by several issues such as: earnings and cash flows are down because revenues/volumes are down due to the economic downturn, limited credit availability to adequately finance of ongoing operations, working capital, refinance of existing maturing debt, and the capital market is reluctant to deploy equity for weaker companies. Companies with decent credit that couldn¹t roll over their debt are the real tragedy, because they wouldn¹t be having such problems if not for the credit crisis. Getting either debt or equity financing currently is challenging for all but investment-grade companies, because the economic downturn has been more severe than usual and the credit crunch is exceptionally severe. Overall chemical debt issuance is down dramatically (e.g. $18.8 billion in 2007 to $11.1billion in 2008), and willing banks are seeking terms that are much tougher and expensive than in the past. For example, the high-yield debt rates could be in the range of 17%-18% (a historic high)!

Some high-profile chemical industry bankruptcies, most notably those of Chemtura and LyondellBasell Industries, demonstrate the difficulties facing chemical makers as profits and debt financing options disappear. Highly leveraged companies are in the worst position, but the difficulties are widespread.

It would be interesting to see what happens some of the high levered chemical companies like Hexion, Momentive, Rockwood and so on.

W.R. Grace is probably having difficulties in obtaining credit may force it to delay its exit from bankruptcy if current funds are not sufficient to fund its operations until its bankruptcy plan is approved.

Ineos has requested an extension to the debt covenant waiver that the company agreed to with its creditors last December for an extension of the waiver until July 17, because the original waiver agreement was for six months and is due to expire this month. Creditors will probably comment on the request by May 22.

Chemtura get a little help on credit because U.S. Bankruptcy Court for the Southern District of New York has granted final approval of Chemtura’s $400-million, debtor-in-possession (DIP) credit facility, allowing the company access to the facility. The company also received approval of an amendment to the DIP facility that allows it to provide liquidity to foreign subsidiaries if needed. The financing will allow Chemtura to continue to operate as bankruptcy proceedings continue.

JLM Industries (Tampa) has files for Bankruptcy. The general assignment will likely result in the liquidation of the company’s assets as an alternative to Chapter 7 bankruptcy. The equity fund providing collateral for JLM’s credit line went out of business, resulting in the withdrawal of the credit line and the need to liquidate!!

LyondellBasell’s U.S. operations and a holding company in Germany filed for Chapter 11 protection in the U.S. in January after ongoing negotiations with lenders failed to result in a credit extension agreement. Recently, LyondellBasell has added its European holding company to its U.S. filing for Chapter 11 bankruptcy protection. LyondellBasell Industries AF (Luxembourg) has been added to the filing to protect it against claims by certain financial and U.S. trade creditors. The Company will continue to conduct business worldwide while the company develops its reorganization plan as part of the Chapter 11 process.

These are a few interesting stuff in chemical space and the question is how could you benefit from it?