The importance of the Indian chemicals industry in the growth and expansion of the economy can be gauged from the fact that it directly accounts for 2.1% of the country’s GDP. India is the sixth-largest chemicals producer in the world and has entrenched itself as a formidable player in the global chemicals arena. The sector is largely connected to key economic sectors like agriculture, agro-commodities, services and manufacturing.
Indian chemicals companies are facing a peculiar challenge. In a global economic order marked by low growth volumes and a hyper-competitive landscape, profit margins are shrinking fast and operational capacities are dwindling at a speedier pace. A strong dollar has compounded an already gloomy macroeconomic environment and exerted a downward pressure on demand for chemicals.
Sales volumes in the chemicals industry clocked a meagre 2% growth in 2016 on the back of a severe shortfall in industrial production and large-scale right-sizing of inventories by customers. With exceptions in the form of naphtha-based producers clocking handsome profit margins as subdued oil prices led to strong gains of 60-65% for some companies in the form of lower material costs, companies selling petroleum-based products recorded lower-than-normal industry averages owing to lower oil prices.
In order to maintain steady production levels and ensure that profit margins are not eroded in the face of weakened industry fundamentals, chemicals companies are exploring inorganic growth avenues like acquisitions. Limitation on organic growth is forcing firms to look at M&As as a viable alternative for sustained high valuations.
Scalability is the new buzzword in a stagnating industrial terrain as companies attempt to strengthen their positions through increased M&A activity. The consolidation of product lines not only enables them to leverage organisational synergies, it also allows them to venture into hitherto unexplored business areas in alignment with their strategic goals.
For instance, the DuPont-Dow Chemical merger re-jigged the product portfolio of the merged entity into two specialty chemical businesses and one feedstock business, agriculture, material science and specialty products. The balance sheets of companies and investment decisions are also key factors broadly influencing M&A deals. As investor expectations are on the upswing and there is a slowdown in demand, companies are prompted to turn to the M&A route to ensure sustained business operations and profit margins.
Lower oil prices have been instrumental in steering M&A activity in the chemicals sector. As oil prices maintained a largely subdued outlook in 2016, companies whose margins have been negatively affected will need to offload non-core assets for maintaining a healthy balance sheet. Activist investors are also largely responsible in pressurising companies to divest their low-performing assets and place onus on revenue-generating chemical products that can attract better margins and are not highly impacted by cyclical fluctuations.
The M&A route has been traversed by global players like Mitsubishi, BASF, Syngenta, Lanxess and AkzoNobel to gain a strong foothold in the country. Indian companies have also engaged in outbound deals to increase their export revenue and bolster their bottom lines, in addition to gaining much-needed technical expertise to upgrade their products. Investor confidence and backing, R&D efforts, a diversified product line and infrastructural potencies are key factors in positioning companies to emerge as globally-credible M&A entities.
Though heightened M&A activity has been witnessed in the chemicals sector, multifarious disruptors exist that have the potential to change the course of the industry. Several factors largely pertaining to economic growth, interest rates, trade and tariffs could emerge as potential game-changers and influence the direction of deals. Events such as Brexit and the US Presidential election have made chemicals companies adopt a cautionary stand and raised questions on how deal-making activities could evolve for them over a time-frame of 1-2 years. A globally volatile economic environment could prove to be a major hindrance in the smooth execution of M&A deals. Geopolitical factors like protectionism can also prove to be key impediments.
India is on the cusp of becoming a global economic powerhouse and there is a huge scope for the chemicals industry to scale the next growth curve. By strengthening their product development capabilities and creating a robust in-house R&D architecture, Indian chemicals companies can take the lead in identifying potential outbound deal opportunities and expand their global presence in new markets.
Global corporate entities are also aware of the fact that Indian companies are ramping their technological know-how, ushering in process and product innovations, and strengthening their distribution infrastructure. Partnerships and M&A can prove to be the much-needed fillip for international companies to enter the Indian market and utilise its low-cost manufacturing capabilities and research expertise.
A steady political leadership, a strong domestic economy and a government committed to removing business bottlenecks and promoting ease of doing business have the potential to promote India as a global production and distribution hub for several chemicals segments through strategic M&A deals.
The coming years will be critical in determining how the market share for various established chemicals players is spread, and the global M&A landscape will be dominated by Indian and Chinese players who will seek to boost their operational capabilities and strengthen market presence.
-Mahesh Singhi – Founder & MD, Singhi Advisors, an investment banking firm