Managing M&A in chemicals: Meeting the new challenges
The chemical industry is seeing a record
level of M&A, higher multiples, and growing
activist-investor activity. Chemical companies must strengthen their
M&A and integration capabilities to ensure they create value in this
environment.
Chemical
companies have always used mergers and
acquisitions (M&A) to grow, to change strategic direction, and to
consolidate the segments they are active in. The industry has recently been
seeing a major expansion of M&A activity, with the aggregated value of
deals reaching an all-time high in 2016. But it’s important to recognize that
besides the expanded activity, a more complicated set of dynamics is at work.
Prices and multiples are significantly up and deals are getting bigger and more
complex to execute. And the rapid increase in “merger of equals” transactions
is an important contributor to that complexity. At the same time, the
stakeholder landscape is becoming more difficult to navigate, notably with the
greater involvement of activist investors.
Chemical companies need, more than ever,
to make sure that deals are creating value. In this article, we describe how
chemical players can sharpen their capabilities in M&A and merger
management to achieve just that.
Chemical
industry M&A: More big deals, more complexity
Let’s first review the current state of
play in the chemical industry. The value of industry M&A globally has
reached unprecedented levels in the last three years, with a handful of large
deals taking the value of M&A in 2016 to the record level of $260 billion,
more than double the 2011 peak of the last cycle . The value of deals concluded
in 2017 is down from the heights reached in 2015 and 2016, but there continues
to be considerable deal-making activity across the industry.
Several trends are behind the deal-making
boom:
·
The chemical industry has experienced a slowdown of organic sales growth in most of its subsegments
and across most regions. As a result, many companies are considering M&A a
necessity to secure higher growth.
·
Pressure on margins caused
by new entrants, lack of innovation, and diminishing opportunities to
differentiate against competitors is spurring
consolidation in segments that traditionally have been high in value creation,
such as crop protection and seeds. But the trend is also touching a wider
selection of specialty-chemical areas, including pigments, additives, and
engineering plastics.
·
Many diversified companies have experienced
sluggish capital-markets returns and are trying to focus their portfolios to
capture the higher valuations that capital markets typically give more focused
companies, particularly in specialties.
·
CEOs don’t want to miss the boat: in an
environment where competitors are making moves and where capital is plentiful,
leaders of companies tend to take bolder decisions on M&A, even if the
immediate value-creation logic may not be obvious.
·
Private-equity players with deep pockets,
access to low-cost finance, and a track record of performance improvements are
often acting as catalysts for increased M&A activity. This has lifted
valuations, and it also in effect doubles the volume of transactions through
entry and exit moves.
What is happening in the chemical
industry, however, is not just a matter of more large deals. A closer look at
the nature of deals shows there has been a decisive shift in the dynamics of
M&A over the last five years.
Prices are up significantly
These peak M&A conditions are reflected
in the prices currently being paid. Multiples have risen, suggesting a sellers’
market, and this has been particularly the case for small- and medium-size
acquisitions, where prices are very high now. Average multiples measured on the
basis of enterprise value divided by earnings before interest, taxes,
depreciation, and amortization (EV/EBITDA) have risen from eight to ten since
2010, led by specialty-chemical segments where multiples have increased by
one-third since 2010, from nine to 12.
Merger-of-equals deals are rising
The number and size of merger-of-equals
deals are increasing significantly. These types of deals could indicate that
the days of pure portfolio shifts and add-on deals are waning, and that the
industry is moving to an era of full-scale consolidation. Merger-of-equals deal
making is driving consolidation in segments such as industrial gases, crop
protection, fertilizers, and coatings, and it is taking consolidation in many
sectors to unprecedented levels.
The activist investor is gaining influence
Activist investors have become increasingly important in the chemical industry. They have taken a significant
role in the restructuring initiatives that sparked a number of major deals in
the past five years, in particular activist-led moves to focus the portfolios
of the industry’s remaining large diversified companies. The number of activist
campaigns in the worldwide chemical industry has more than tripled since 2010,
from eight to 30.
The confluence of a high level of
activity, high multiples, and the presence of activist investors and more
merger-of-equals deals presents a new round of challenges for chemical company
CEOs seeking to create value through M&A. What should they focus on?
The key
to success in chemical-industry mergers
Our research shows that
in deals where best practices in merger management are employed, total returns to shareholders are at least six percentage points higher
than deals where these practices are not implemented. Based on our extensive
experience across the industry, we believe there are a few invaluable and
well-proven approaches that chemical companies can and should use to capture
the full value-creation potential of their M&A moves.
Build a strong value-creation story and communicate it clearly
When drawing up the vision for the new
company, top management should take full advantage of the discontinuities that
are presented by the deal and be bold in its plans. A compelling deal rationale
will focus on value-creation opportunities made possible by the deal, including
a clear strategic view of where the new company is heading. The aim should be
to capture the strengths of both companies and go beyond that to build a
world-class entity. Unambitious compromises that just aim to keep the new
combination operating will not resonate with shareholders.
The importance of communication in a
merger is, in our experience, often underestimated in the chemical industry.
The importance of this step has been made all the more clear by the
higher-profile role taken by activist investors in recent deals they have
deemed unsatisfactory: facing this, a compelling, ambitious, and clearly
articulated value-capture plan may serve as “shark repellent.” At the same
time, chemical companies can themselves learn from looking at deals through an
activist lens, which can bring into focus what will be gained, presenting both
the short-term benefits of the deal and also explaining its long-term
value-creation promise.
Deliver the full synergy potential, and don’t overlook the
transformation potential
As simple as it may sound, truly
understanding the full potential of the transaction is a decisive factor in
making it work. The merger should be used to fundamentally review the new
portfolio and manage it for increased profitability and growth. The merger
should also be used to open up for debate the new company’s organizational
structure and operations setup. The potential for savings and synergies should
be examined on the following three levels:
·
Combining overlapping
activities. It is essential to first identify
the savings that can be captured by combining the two businesses, looking at
overlaps in product offering, customers and markets being served, and in technological
capabilities and R&D projects. This review should also take regulatory
requirements into consideration. These are the classic synergies.
·
Stand-alone
improvements. In all companies we have looked at,
we have found potential for managing the company better. This potential could
theoretically be captured without the deal taking place, but integration
programs are well suited to triggering a holistic review of the performance of
both parties being merged and to deploy best practices from either side, and
they add significantly to the value creation of the deal.
·
Transformation. The third step is to address transformational
opportunities for the new combined company, with its broader product range and
geographical reach, and combined competences. Such opportunities often include
raising the bar for performance by building on the functional strengths of the
two prior organizations and transforming NewCo into a world-class performer in
areas such as operations, procurement, and sales and marketing. In one recent
large chemical deal, a comprehensive review of manufacturing practices that was
jointly undertaken led to substantial performance improvement on both sides,
and to value creation well above estimates at the time the deal was signed.
Build best-in-class, end-to-end merger-management capabilities
Successful merger practitioners follow
a disciplined approach. The importance of making an early start on preparing
the merger-management process and shaping the integration strategy cannot be
overemphasized: it makes it possible to move fast on capturing savings and to
complete the integration within 12 months of closing the deal. Designing the
integration should be tackled during the due-diligence phase of the
acquisition. The integration program itself should be deeply woven into the
deal rationale, with the setting of priorities for the merger program following
on from the strategic and the value-creation logic of the merger. Decisions
must be taken in advance on what to integrate, what not to, and at what speed.
As soon as the deal is signed, draw up a
master plan—an integration road map that covers the most important design
choices, particularly on the timeline and top-level appointments. If a company
can accelerate preparations before day one of the new company’s launch by using
clean teams and systematically planning how functional activities will be
integrated, it will be able to immediately capture synergies. Transparency on
performance metrics and effective performance management from day one is
another essential component for success and should be applied in selecting
candidates for appointments.
Choosing the leadership of the new
organization and communicating it early in the process is another essential
step, in alignment with progress on the deal’s regulatory-approval process.
Doing this enables those future leaders to shape their own organizations ready
to launch effectively on day one, and ensures ownership of initiatives to
capture synergies.
With the road map and leadership in place,
immediately set up an integration infrastructure with a strong and dedicated
management team. To do that, engage dedicated high-performance people both at
senior and junior levels from both companies. This integration-management team
needs to oversee and coordinate the integration process on a day-to-day basis,
including handling interdependencies across work streams, managing stakeholders,
and communicating and tracking progress along the master plan’s critical path.
Approach cultural integration with the same rigor as business
integration
Many mergers fall short of their full
potential because of the failure to recognize and act upon cultural
differences, or misalignment on management philosophies. In the chemical
industry in particular, we have often heard management teams dismiss cultural
integration as “soft stuff”—but this is a serious misconception.
Overinvesting early on cultural
integration is crucial to truly bringing the companies together and capturing
maximum value. Organizing events so both parties can undertake a mutual and
appreciative discovery of each other is imperative, including operations visits
and activity workshops. In all too many cases, we have seen the individual deal
partners’ management philosophies persisting in NewCo in an unaligned fashion,
or found a perception lingering in the organization that one party has been the
winner. We also recommend being sure to address head-on key differences in
management practices and ways of working, and to overexplain to all employees
the new ways of working and the rationale behind them.
What we have seen working well is a fully
dedicated work stream that includes a comprehensive diagnostic of both
cultures, identification of potential pain points, and includes rigorous
communications work to resolve differences. Mutual discovery needs to play a
key role in all work streams—both businesses and functional departments—to find
the best of both worlds and to build the path forward together.
Acquiring a bolt-on business to bring
growth brings specific challenges: it is essential to balance the rigor of
integration with the need to preserve the entrepreneurial spirit and culture
that the bolt-on brings. Otherwise, the acquirer runs a high risk of loving the
new toy to death.
Our research shows that mergers with a
dedicated effort focused on culture have a success rate that is three times
higher than mergers where cultural integration has not been on the top of the
agenda.
Keep the business running
Focus on the day to day: all the synergies
that can be captured cannot make up for sales left on the table because
management and the sales force were not paying enough attention to their
customers. Make sure that undistracted attention is being devoted to customer
relationships on both sides, continue to develop opportunities, and fulfill
business plans right up to day one. This includes continuing to push forward
already ongoing programs such as sales-force effectiveness and cost-reduction
initiatives, since the benefits from such programs will also be essential
components of the future company’s success.
Avoid dis-synergies: an integration is
always a time of uncertainty. Competitors will certainly seize any opportunity
to poach your customers and your top-performing employees. Communicate early on
to your customers the rationale and new value proposition of the combined
company. Especially in cases when a long period of regulatory approval extends
the date of closing, a clean team can help prepare the sales force to hit the
ground running on day one with clear account plans and responsibilities, a view
of the integrated portfolio, and the services the joint company will provide.
This way you avoid losing ground in the weeks after day one.
Chemical company leaders face an
unprecedented wave of deals where transactions are becoming more complex and
more challenged from a value-creation point of view, and clearly need to
further sharpen their merger-management capabilities. Embracing the five key
elements outlined above can drive successful merger integration and lead to
significantly higher value capture.
JANUARY 2018 https://www.mckinsey.com/industries/chemicals/our-insights/managing-m-and-a-in-chemicals-meeting-the-new-challenges?cid=other-eml-alt-mip-mck-oth-1802&hlkid=4186978f561a4c1ea65173135f62299b&hctky=1627601&hdpid=4e1f0fda-fd83-4c42-ad04-2238e441e666
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