Refinancing Will Drive Chemicals Consolidation The next five years will be crucial for the development of the global chemicals industry. Which companies will have the strength to emerge as leaders when the dust settles?
Measured against the early part of the century, the restructuring and debt buildup that occurred in the chemicals industry from 006 to 008 was extraordinary. The industry conducted deals worth more than $0 billion over that period, with the majority of deals valued at more than $5 billion (see figure ). By contrast, almost two-thirds of the deals made in 0 were worth less than $ billion, none were worth more than $5 billion, and the industry s deals as a whole were worth only $49 billion, the lowest level since 00. Figure The chemical industry had a flurry of deals between 006 and 008 $ billion and % of value $5 billion $ billion to < $5 billion $0.5 billion to < $ billion < $0.5 billion 45 4 40 6 67 06 4 96 60 0 5 49 9% % 0% 45% % 8% 5% % 0% % 47% 5% % 8% % 5% 4% 6% 5% 6% 7% 4% 9% 7% % 0% 9% 5% % % 0% % % 0% 5% 7% 9% 0% 45% % % 4% 9% 0% 8% 47% 00 00 00 004 005 006 007 008 009 00 0 0 Note: Percentages are rounded. Sources: Dealogic; A.T. Kearney analysis One result of the debt buildup will arrive soon: a wave of repayments that will come due between 0 and 06. At the same time deal activity is expected to increase, thanks to a resurgent U.S. industry seeking project financing for up to 0 new world-scale cracker and derivative plants. The original lenders in this sector have suffered through painful write-downs with companies such as LyondellBasell and INEOS. As a result, industry consolidation is inevitable as lenders and the industry move to strengthen companies prior to refinancing. Overall, these developments are opening up an opportunity for new entrants and companies from Asia and the Middle East to acquire or merge with established Western chemical companies. Any new deals taking place now are occurring within the context of refinancing the debt from that transaction peak. Some companies, such as INEOS, refinanced part of their debt in 0. However, according to our analysis the bulk of the debt repayment is concentrated over the See the Chemicals Executive Report at www.atkearney.com.
next few years, with levels of $ to $6 billion through 05 leading to a peak of $ billion due in 06 (see figure ). This comes at a time when U.S. project activity is increasing because of shale gas, drawing funds into the industry to add significant amounts of new capacity. Looking ahead, any potential oversupply that new capacity causes will depress margins and present significant challenges for those seeking to refinance their existing assets. Figure In the next five years, 7 companies will have to repay $0 billion Chemicals debt profile outlook ($ billion) Interest Principal 4 0 8 6 6 4 0 8 5 4 4 6 4 0 8 6 4 0 0 5 9 9 7 7 0 0 5 7 0 0 04 05 06 07 08 09 00 0 0 0 04 05 06 07 08 09 Sources: Standard & Poor's Capital IQ; A.T. Kearney analysis The Scale of Debt To gain an understanding of the debt situation in the global chemicals industry, we analyzed more than 00 companies, both public and private, spanning different industry sectors in all regions (see figure on page 4); these companies have debt of roughly $80 billion. Companies have used a combination of debt to fund their ventures, including inventory finance, revolving credit for working capital, securitization, bullet bonds, and normal interest-bearing instruments. Lenders look at total debt capacity, and we anticipate demands for standby equity, debt for equity swaps, further equity injections, and even pension fund top-ups where the limits or loan covenants have been reached. In Europe s refining sector, Petroplus collapsed, and there are likely to be parallels for the commodity chemical players. Debt refinancing is likely to be a major driver for merger, acquisition, and divestment activity in all regions.
Figure More than 00 firms provided a global perspective of the chemical industry Geography Company type Primary industry 7 5 8 7 9 7 7 44 00 Asia Middle East and Africa Public Commodity chemicals Europe North America Private Diversified chemicals Latin America Oceania Specialty chemicals Sources: Standard & Poor's Capital IQ; A.T. Kearney analysis Figure 4 Half of the world s chemical companies are poised to lead the next wave of restructuring Global chemical companies Debt-to-equity ratio 00 80 60 40 0 00 80 60 40 0 0 0 5 0 5 0 5 0 Companies likely to have Standard & Poor's credit rating of BBB or above EBITDA margin Notes: Analysis is based on 7 top chemical companies with more than $ billion in revenues. Classification is based on chemical standard industrial classification (SIC) codes excluding fertilizers and industrial gasses. EBITDA is earnings before interest, tax, depreciation, and amortization. Sources: Standard & Poor's Capital IQ; A.T. Kearney analysis 4
Investment-Grade Companies Will Lead the Restructuring A look at the debt-to-equity ratio and EBITDA margins compared to available credit ratings shows that the chemicals industry s investment-grade companies have debt-to-equity ratios below 90 percent and EBITDA margins of greater than 0 percent (see figure 4 on page 4). About half have Standard & Poor s credit ratings of BBB or above and should be able to maintain and increase their debt relatively comfortably to become potential leaders during the industry s inevitable restructuring. The rest will need to restructure quickly, but some will inevitably find this difficult and fall prey to bankruptcy or takeovers. To add to this picture of large-scale refinancing, there will be a major pull on project finances, which may be followed by a cyclical low in the commodity markets based on overbuilding in the United States. The availability of natural gas liquids from U.S. shale developments has resuscitated the U.S. chemical industry, and a new round of investments is underway via expansions and new construction. Any new deals taking place now are occurring within the context of refinancing the debt from the transaction peak of 006 to 008. We created two scenarios for the chemicals industry to understand its possible development going forward. Under the first scenario, feedstock availability is already equivalent to the generation of eight new world-scale ethane crackers, but the scale of investment could be much larger if companies exploit liquefied petroleum gas and condensate as well as ethane (see figure 5 on page 6). Our second scenario, in which the United States maximizes output, shows another 5 million tons per year of feedstock in addition to the ethane story that is already well understood. Companies in the Americas have higher debt-to-equity ratios than other regions, which would generally make them vulnerable to takeovers. But the shale gas revolution has handed many of them an unexpected lifeline, with the market now expecting improved profits and a long-term cost advantage. However, this development will not benefit everyone. Cracker owners will likely keep the lion s share of the value, reinforced by a recent ruling by the U.S. Internal Revenue Service that extends the use of master limited partnership structures for building gas crackers. U.S. commodity companies without a feedstock advantage will either need to buy into a condo cracker a term for crackers built in partnership by several companies or find a partner that can finance a new build to stay independent. Cracker owners will look to acquire such companies to secure their olefin sales, which will also drive consolidation. The United States will become a major product exporter, reversing a trend of growing imports and driving companies in the country to secure EBITDA is earnings before interest, tax, depreciation, and amortization. 5
Figure 5 In our base case scenario, up to.6 million tons of North American feedstock capacity could be built Projected ethane-based petrochemical projects in North America in scenario (Million tons per year) New ethylene capacity:.6 million tons Announced: 8 million tons (69%) Potential:.6 million tons (%). 0..9.4.0.4 7.7 8.4. Potential additional use of natural gas liquidsbased chemical feedstock in North America (Million tons per year) 79.8 5...8.5 +4 (+7%) 64.9. 5.5.5 0.5..8.5 9. 0.5.0.0 4. 4..0 Existing demand 00 Restart Flexibility Debottlenecking New facility Potential Announced Existing Total 07-08 As is 0 Gas oils Scenario : Industry uses flexibility 00 N-butane Ethane Scenario : North America maximizes output 00 Naphthas Propane Out of 0.7 million tons of ethane, about 4.5 million goes toward new capacity, which becomes.6 million tons of ethylene capacity (.5 ethane = ethylene) (80 percent) Announced new capacity = 0 million tons of ethane (restart -0. million tons + debottlenecking - million tons + new facility -7.7 million tons) = 8 million tons of ethylene Sources: SRI Consulting, Chemical Market Associates Inc., Chevron Phillips Chemical, Alembic Global Advisors; A.T. Kearney analysis market access, especially in Europe. We expect cross-border transactions between chemical companies in the United States and Europe, driven by a need for U.S. exporters to access the largest available market option for exports. A Look at the Big Questions Following are some of the major questions the chemicals industry faces in the coming years. What would a bubble in America s ethylene supply mean for the rest of the world? If America experiences a bubble in its supply of ethylene one of the chemicals industry s most important chemicals then Europe will become less attractive for debt in the chemical sector. Europe is likely to come under significant pressure as exports from North America and the Middle East focus increasingly on this market. Large-scale naphtha crackers in Europe, which 6
provide the building blocks of many derivative chains, will face financial pressures, and significant closures are inevitable with five to 0 crackers likely to close. Refinancing will need to take place in the context of oversupply and asset rationalization and for holders of the $76 billion debt held by the Europeans. The knock-on effect for cracker derivatives will also put pressure on the industry to restructure. At this point, an essential question for companies and governments in the Middle East will be Who should be the partner of the future? What impact will this have on investment in the Middle East? To date, foreign investors have seen the Middle East as a long-term supply source for advantaged feedstock and energy supplies and as a key supply point for the ever-expanding China. With existing players squeezed for additional advantaged feedstock, Iraq represents the new regional player, but the costs of accessing their feedstock and building an industry more or less from scratch will require deep pockets. The U.S. shale revolution has completely changed the investment climate for major players, with cheap feedstock based on transparent market pricing mechanisms, low energy prices, a highly skilled workforce, an excellent execution track record, and low capital costs. We also estimate re-shoring of manufacturing to North America to be worth more than $600 billion, with the market opportunity for chemical products likely to increase sector growth rates significantly. For debt providers, this could be like a royal flush of financing, with managing oversupply the only major factor to contend with. At this point, an essential question for companies and governments in the Middle East will be Who should be the partner of the future? U.S. companies will choose to focus their debt raising and resource capacity on their home market, so the Middle East will have to expand its partner base to companies that can provide elements such as funds, guarantees, and resources, along with players that are not distracted by investments in their home markets. Players in India, Southeast Asia, and China have lagged behind but must now move up the list of desirable partners in this region. The key for the region is how to attract partners from India and Asia when other regions offer better economics and market access. High project and operating costs cannot be sustained by higher-cost feedstock and commodity margins, so regional players will need to restructure and improve performance. The region will also need to further secure downstream markets to avoid chemical-sector failures and continue raising finance for new chemicals mega-projects. This will drive acquisitions of overseas positions in deficit chemical markets to consolidate their access to market and spread demand risk. How will companies in China and Asia react to the changing world? From a transaction perspective, Asian acquirers are the most active in today s chemicals industry. Since 006, Asian companies have made more than 40 percent of all deals globally, 7
Figure 6 Asian acquirers have made more than 40 percent of all chemical deals Number and % of transactions Asia North America Rest of world Europe Middle East and Africa 845 807 69 85 95,4,5,40,4,8,69 979 4% % 4% 5% 4% 5% 5% 5% 5% 5% 5% 5% % % % % % % % % % % % % Region CAGR % 5% 9% 5% % % 4% % 7% % % 4% -% 4% 6% 9% 5% % 8% 7% 7% 6% 7% 4% -4% 46% 7% 9% 8% 9% 5% 9% 4% 45% 48% 45% 44% 46% % 00 00 00 004 005 006 007 008 009 00 0 0 Note: All percentages are rounded. Sources: Dealogic; A.T. Kearney analysis by number of transactions (see figure 6). Since 00, when Asia accounted for only 7 percent of deals, activity has increased at a CAGR of percent.in 0, Chinese companies backed off on deal activity, and most transactions now are taking place within the region. The marginal producer in Asia is Korea, and major players will remember what happened the last time there was a depression in operating rates, with margins collapsing below cash costs when Korean Petrochemical Company failed. There has been substantial restructuring in Korea, but the smaller players in the region, especially those based on imported feedstock or intermediates, will find markets difficult to compete in, and as a result, debt capacity will be squeezed. The Indian chemical industry remains small in global terms with only a few players achieving scale. Protection from imports continues to be high on the agenda, and the larger, internationalfacing companies ability to raise debt will remain strong if they can identify incremental growth opportunities, and if the Indian market remains relatively highly priced. Indian companies have already taken positions in liquefied natural gas exports from the United States, and we would expect the Indian majors to invest in the chemical sector both in the United States and Europe. China s chemicals industry has the ambitions to become self-sufficient in chemicals, but the country will remain a net importer of chemicals until at least 00. China was able to finance its own developments, but most deals between Chinese entities are relatively small. The larger concerns will need to participate further in the Middle East, United States, and Europe as part 8
of a long-term strategy to secure technology and resources. Coal to chemicals and the potential for a China shale development revolution are many years away, so they are unlikely to have an impact before the next decade. Multinational chemical companies will continue to be encouraged by the Chinese government to reinvest their profits in Chinese production, but this looks increasingly less attractive as stakeholders seek to generate more fungible cash. Who will be able to afford to play in the industry s consolidation? The companies with the strongest balance sheets will be the active buyers, and they will lead the industry s consolidation. The credibility of their management teams and the coherence of their long-term strategies will be crucial for attracting funds for any merger or acquisition. Figure 7 Players with strong balance sheets could lead consolidation in the chemicals industry Global chemical companies Debt service ratio 0 9 8 7 6 5 4 0 0 5 0 5 0 5 0 Favorable debt service ratio and EBITDA margins EBITDA margin % Notes: EBITDA is earnings before interest, tax, depreciation, and amortization. Debt service ratio is defined as total debt/ebitda. Sources: Standard & Poor's Capital IQ; A.T. Kearney analysis Figure 7 demonstrates the ability of companies to cover their debt repayments relative to their EBITDA margins. Although there are no hard-and-fast rules that define an acceptable debt service ratio, and each company will be covered by its banking covenants, the players whose ratios are low will struggle, especially when they drop below -to- for an extended period of time. Companies in this zone with access to low-cost feedstock, strong market positions, or the leading technologies will prove the most attractive targets to acquirers with the means to make purchases. We may also see the return of inorganic chemicals to the acquisition trail as they look to monetize shale deposits after a decade of deconsolidation and divestment in this sector. 9
Tracking the Developments The landscape for deals in the chemicals industry is shifting. As the industry s debt situation reaches an important stretch with a wave of repayments due, the shale gas revolution is changing the marketplace. Those companies in the best financial shape will be able to take advantage of the conditions and pursue a long-term advantage. Authors Philip Dunne, partner, London philip.dunne@atkearney.com Andrew Walberer, partner, Chicago andrew.walberer@atkearney.com Richard Forrest, partner, London richard.forrest@atkearney.com The authors wish to thank George Smith and Yuvraj Kapoor for their valuable contributions to this paper. 0
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