As buyout funds increase their presence in India through investments in comparatively more mature industries with good cash flows, sustainable growth and potential strategic interest; the Indian chemical industry could emerge as a potential attractive sector. The sector has seen limited buyout activity; however, it has started witnessing big value buyouts in certain other industries (like KKR Flextronics or Blackstone Gokaldas). This trend is expected to increase in the next few quarters. With exponential increase this year (2008) in chemical commodity prices, most firms are on track to report good profitability; thus leading to enhanced valuations and a case for promoters to evaluate strategic options.
Globally, among various industries, chemicals are a favourite of buyout funds. Ondeo Nalco, Celanese, Flint Inks, Perstorp are large corporates, which are owned by funds. A recent case in point is a 0.749 million buyout of Greece based firm Neochimiki by Carlyle group. As large chemical majors like Bayer, BASF, GE globally have exited specific non core businesses globally; funds have been keen buyers of these assets.
The bigger opportunity today in India is definitely in the private space, with many large family run chemicals businesses that have developed excellent brand equity but the promoter families may want an exit. A critical advantage in India is that privately held companies in the sector are under-leveraged and hence funds could use these balance sheets for further ramp up and growth.
Various segments of the chemicals industry in India are still fragmented. A crucial part to note is that while a strategic player may be skeptical of playing a consolidation game, a larger fund may want ramp up using the same company as an acquisition vehicle. In some ways, Newbridge played the ramp up game in Matrix through M&A and ICICI Ventures and other funds a consolidation through Arch Pharma. A similar ramp up could be achieved by a buyout fund in India in specialty chemicals.
There are certain critical challenges to buyouts in India. The top management and the main shareholder is the same group in most chemical enterprises. To find a complete new top level team is a challenge for any buyout fund. Another issue is the size of the deal. The average chemical M&A deal size (?critical mass?) in India is the $20 ? 40 million bracket. However, most specialised buyouts funds would typically like to target the $100 million plus segment. Valuation is another challenge ? most Indian promoters compare premiums that a strategic player would be willing to give vis?a-vis a buyout fund?s ability to pay and herein, there is typically a valuation gap.
In the future, there could be potentially three buyout scenarios. While central government privatisations have stopped, future state government divestments (like Gujarat government) may provide some opportunities. In fact, divestment candidates in fertilisers and chemicals could be ideal buyout candidates from a size and ownership perspective.
MNC owned businesses are also great businesses from a buyout angle as there are limited due diligence issues and systems, processes and teams are in place. Either as part of global alignment or as strategic decisions of Indian subsidiaries, chemical MNCs could provide buyout opportunities for funds. Valuations however could be a challenge. Also, strict board level corporate governance systems makes it difficult for the Indian management of these MNCs to look at a one to one negotiated deal. Another potential scenario (and possibly the major one) could be divestment of chemicals divisions by larger diversified Indian groups. Unfortunately though, divestments by Indian groups are generally of identified low margin businesses and rarely are ?strategic?.
Globally, chemicals have been one of the preferred sectors for buyout funds. One of the critical reasons herein is that by its inherent nature, the sector lends itself to spin-offs. Indian chemical entrepreneurs need to view this as a great opportunity to encash on partial value (say, 51%) and yet continue in operational control. The buyout route could also be viewed by ambitious chemical entrepreneurs from a perspective of exponential growth; they could target acquiring large global companies and retain minority stakes. The ideal buyout candidates however for funds would be Rs 100 crore plus privately held businesses, which through restructuring (and potentially inorganic growth) could also be successful IPO candidates in next two years.
Though the buyout action in chemicals in India is yet limited, it could increase exponentially going forward. Areas like oilfield services chemicals, personal care ingredients, fine chemicals, agri-inputs and distribution companies could be of specific interest. In commodity chemicals, with valuations substantially dropping and businesses vulnerable; we may see fair amount of buyout interest. However, it may take some time for Indian managements to get used to a fund as a owner.
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The author is Associate Director, Transaction Advisory Services with Ernst & Young. These are his personal views