Chemicals M&A Review

Highlights

� Chemical company EBITDA trading multiples indicate high-end specialty chemicals now most fairly valued area

� M&A advisory boutiques continue to gain ground on the majors and recent court rulings regarding conflicts of interest also likely to favour independents in the future

� Chemical sectors linked to the North American economy continue to outperform the industry as highlighted by the Valence Indices

� More than 10 $1bn+ transactions in the last six months coupled with strong M&A volumes in Q2/Q3 are expected to result in 2014 being one of the most active in the last 15 years

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IN THIS ISSUE

Chemical Company Valuations

IB Conflicts of Interest

Valence Indices

Chemicals M&A Analysis

ISSUE 8November 2014

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Valuations

Public chemical company valuations and EBITDA trading multiples continue to set records. As seen in Figure 1, despite cooling of some stock markets around the world, chemical company EBITDA multiples are still at near 15 year highs.

As we have noted in previous newsletters, part of this valuation reappraisal has been related to shifting fundamentals in the industry as shale gas continues to reshape regional competitiveness and segment profitability. Clearly this is particularly relevant for North American companies active in energy intensive chemical production such as for chlorine, as well as more directly in the C1 and C2 chemicals chains. Correspondingly, valuations for US companies active in commodity and intermediates chemicals have risen strongly. On the back of this improved outlook, many other chemical companies’ share prices have benefitted from positive investor

sentiment towards the sector, as overall industry fundamentals underpin the sector’s growth.

Of course, other factors have also played a role, including record low interest rates, plentiful availability of debt and increasing M&A in the sector, as strong balance sheets and industry realignment continue. However, what is evident from Figure 2 is that the commodities through to mid-range specialties have benefitted most from this increase. Indeed high end specialities, having always been relatively highly valued, have seen their share prices/multiples rise less than the other sub-sectors which have effectively been re-rated by investors. The intermediates – mid range specialities have risen most strongly to an average of almost 11x (EV/EBITDA), an increase of almost 40% from 2012 when the average was closer to 8x EBITDA. It should be noted that the recent Eastman acquisition of Taminco (intermediates and specialities) was at 11x exactly matching this multiples analysis.

Figure 1 Chemical Company Trading Multiples

Figure 2 Chemical Company Trading Multiples by Sector

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The obvious conclusion from Figure 2 is that companies should be targeting acquisitions of higher end specialities which are on aggregate relatively better valued compared to other chemicals. However, as described in previous newsletters, profit growth remains the major determinant of multiple and although areas such as agrochemicals are seen as steady growth sectors, investors believe better short/mid term growth will be in more commodity-mid range specialties. Whether this will be borne out over the next years remains to be seen, but in the meantime, public company acquisitions in high end specialities appear an attractive option at current valuation levels, even if shorter term profit growth may be lower.

The market also appears to be polarising more between companies with higher and lower profitability. Whereas in our previous analysis overall profitability (EBITDA %) had little impact on multiple, the market appears now more focused on shorter term profitability. Much of this is being driven rightly by the expectation of shale gas. Also higher margin companies are likely to grow through additional profit enhancing acquisitions. As Figure 3 shows, the higher margin companies trade at c. 2x EV/EBITDA turns more than less profitable competitors. We believe this is a short term artefact of the higher profitability currently enjoyed by companies with feedstock or energy advantages.

As stock markets continue to be influenced by a low interest rate environment and the chemical industry adjusts to new regional and raw material dynamics, sub-sector valuations will potentially turn volatile. This in turn will create M&A opportunities for companies who are realigning portfolios and are able and nimble enough to acquire businesses which are fairly valued with strong long term fundamentals.

Investment Banking Conflicts of Interest

As large investment banks have steadily evolved into multi-line, diversified financial supermarkets, their product offerings have expanded accordingly. Today’s modern, integrated investment bank offers a broad suite of products and services, ranging from the relatively mundane to the highly strategic. And whereas investment banks once owed their allegiance primarily to their corporate clients, today’s “universal’ banks derive substantially more fee-based revenue from private equity firms and other financial sponsors, who tend to transact much more frequently and are more regular consumers of banks’ high margin financing, underwriting and advisory services. The resulting dynamics are fertile ground for the proliferation of conflicts of interest, especially in transactions which may involve one or more financial sponsors.

Figure 3 Chemical Company Trading Multiples – Link to Profitability

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A recent judicial decision issued by the Delaware Chancery Court, the leading arbiter of corporation law in the United States, highlights the practical import of financial advisor conflicts for corporations and their boards of directors. In late 2010, the Board of Directors of Rural/Metro Corporation established a special committee to evaluate the potential acquisition of a competitor. The special committee engaged RBC Capital Markets to help it evaluate a range of strategic alternatives and, ultimately, in keeping with RBC’s recommendation, run a limited auction to sell the company. Throughout the sales process and as late as the eve of Rural’s final board meeting to approve the transaction, RBC aggressively pursued buy-side financing roles. In In Re Rural/Metro Corporation Stockholders Litigation, the Delaware Chancery Court concluded that RBC had allowed its interest in maximizing fees to adversely impact the sale process. In finding RBC liable, the court also found that the Rural board breached its fiduciary duties by failing to “act reasonably to identify and consider the implications of [RBC’s] compensation structure, relationships and potential conflicts.”

The Rural/Metro decision is the latest instalment in a judicial trend toward increased scrutiny of corporate action taken under the shroud of potentially conflicted financial advice. While the court did not find that simultaneously providing sell-side financial advice and buy-side financing is per se improper, it did affirm its intention to review such engagements on a case-by-case basis. Rural/Metro is a sobering reminder that board members need to be active and informed participants in sale processes. Critically, the board is also obliged to identify, evaluate and proactively manage the real and potential conflicts of its financial advisors.

The increasingly conflict-prone offerings of the large, integrated banks are to be contrasted with the specialised, independent advisory services of high quality investment banking boutiques such as The Valence Group. The success of the advisory boutique model (see Figure 4) reflects a combination

of superior, focused service offerings, and independent perspective. Whether engaged on an exclusive basis or to supplement the advice provided by the integrated banks, and whether in the context of a fairness opinion or a broader financial advisory engagement, The Valence Group is uniquely positioned to provide boards of directors with unparalleled specialisation, depth of insight and independence. In so doing, The Valence Group will more readily facilitate a board’s informed exercise of its fiduciary duties.

Figure 4 Increasing Share of Boutiques in M&A Advisory

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Valence Indices

The Valence Indices of more than 250 chemical companies show detailed sub-sector valuations. The indices track share prices of chemical companies across 33 chemical segments and demonstrate the huge variability of segment performance.

The best performing segments in the last 12 months (Figure 5) include Pharma/Agro Intermediates, where companies such as Lonza have performed very strongly as investors have noted

the improved outlook for the sector (especially agrochemical fine chemicals and intermediates). Other sub-sectors such as Compounding, Paints & Coatings and Adhesives & Sealants continue to perform well as many companies in the US are benefitting from the relatively strong US economy.

Interestingly, Basic Chemicals & Commodity Polymers (Figure 5 and 6) has started to rise, which is usually an early indicator of improving economic outlook and GDP. This seems at odds with recent global GDP outlook, however, and could perhaps point to a more balanced economic performance in 2014 Q4.

Conversely, the Elastomers & Rubber index (Figure 5 and 7) continues to be one of the worst performing indices (almost every quarter for the last 16 months). No other index has performed so poorly. In this quarter, it mainly reflects that Asian companies such as TSRC, like several competitors, have seen some end markets come under price pressure, thereby depressing their share price.

Figure 5 Valence Indices 1-Year Performance

Figure 6 Select Best Performing Indices

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Other sectors that have performed poorly include Surfactants & Personal Care. As noted in the prior section, some high end specialities have seen share prices fall as investors believe revenue and profit growth is higher in other sub-sectors. Therefore although these sub-sectors have a healthy growth outlook, the recent share price performance, even in areas such as Food & Feed, has been below the general Valence Group Chemical Index (VGCI).

We expect to see the Valence Indices showing more regional effects over the next quarters as it is currently unclear how European and Asian economies will develop in the short term. If Europe starts to grow more strongly based on ECB stimulus, then we could see a rebound in some sectors and more robust performance of the Basic Chemicals & Commodity Polymers index. Even the laggard of the industry, the Elastomers & Rubber index, could be propelled into the higher performing indices section.

Chemicals M&A Analysis

Transaction volumes across the chemicals industry have continued to remain at a high level in 2014 with the last two quarters showing no sign of a slowdown in the number of transactions (Figure 8). At current levels, 2014 will be the strongest year since 2010.

As noted previously, the underlying structural changes in the chemical industry, combined with the need to find growth, continue to underpin M&A transaction volumes. However, the increasing number of larger transactions (above $1bn) in the last six months also shows that confidence to undertake bigger and even transformational deals has returned. Larger transactions representing an aggregate EV of nearly $40bn were announced in the last six months:

Figure 7 Select Worst Performing Indices

Figure 8 Number of Chemical Transactions – Monthly Since 2010

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� Permira – CABB � Eastman – Taminco � Merck – Sigma Aldrich � Albemarle – Rockwood � Arkema – Bostik � FMC – Cheminova � American Securities – Emerald Performance Materials � Flint Hills – PetroLogistics � CCMP Capital – PQ Corporation (47%) � Platform Specialty Products – Arysta � Platform Specialty Products – Chemtura AgroSolutions

The above list includes industrial and private equity companies demonstrating the increased availability of debt on competitive terms and appetite of financial sponsors. It also signals that financial sponsors see exiting chemical investments via different options as increasingly viable.

Additionally, there have been several larger chemical companies floating their stock on the public markets. Companies have included commodity chemicals through to distribution such as IMCD and Trinseo. The success of this broad range of companies has also encouraged others with several companies announcing potential IPOs. Most notable is perhaps Bayer MaterialScience (BMS) which is expected to trade as separate company in 2015. Whether BMS and other companies such as Univar and Axalta ultimately IPO or are acquired remains to be seen. As witnessed by the recent number of larger deals, chemical companies and private equity are increasingly willing to deploy significant capital, increasing the likelihood that companies will be acquired rather than IPO.

The remainder of 2014 is expected to remain robust and there remains a long list of deals in the pipeline for Q4. Indeed the total value of chemical transactions in 2014 is likely to be the highest since 2007.

The Valence Group, LLC, is a member of FINRA and SIPC.

This is a market commentary and is intended neither as investment advice nor recommendation for specific securities.

TVG Ltd, authorised and regulated by the Financial Conduct Authority (FRN: 505298.), has approved this as non independent research in connection with its distribution in the United Kingdom. This research is for our clients only. This document is not independent and should not be relied on as an impartial or objective assessment of its subject matter. Given the foregoing, this document is deemed to be a marketing communication and, as such, designed to promote the independence of investment research and TVG Ltd, is not subject to any prohibition on dealing ahead of dissemination of this document as it would be if it were independent investment research.

© 2014 The Valence Group, LLC© TVG Ltd

The Valence Group

The Valence Group is a specialist investment bank offering M&A advisory services exclusively to companies and investors in the chemicals, materials and related sectors.

The Valence Group team includes a unique combination of professionals with backgrounds in investment banking, strategic consulting and senior management within the chemicals and materials industries, all focused exclusively on providing M&A advisory services to the chemicals and materials sector.

The firm’s offices are located in New York and London.

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