It was 30 years ago that the world first chortled at the scene in The Graduate in which a smug Los Angeles businessman takes aside the baby-faced Dustin Hoffman and declares, ?I just want to say one word to you?just one word??plastics.?? To sneer at all things plastic was to offer an instant definition of oneself as among the young, hip, truth-seeking cognoscenti locked in a moral power struggle with an older generation of square, corrupt, greedy, warmongering materialists. More than any other touch, its ridicule of plastic defined The Graduate as a film about the 60?s generation gap.
Struggling chemical plants rarely shut down completely. Most keep ticking over until they can find a new buyer. Creditors of LyondellBasell, which was forced to seek bankruptcy protection for its US arm and a German subsidiary, have been waiting for their white knight for some time.
Two of Europe?s biggest, LyondellBasell and Ineos, have got a Bunsen burner to their feet, thanks to huge debts. Meanwhile, Dow Chemical, the biggest US chemicals group, made a fatal error by agreeing to buy specialty chemicals firm Rohm & Haas for $15.3bn, at a steep 74% premium, just before valuations collapsed. The company issued $7bn in preferred stock and borrowed $9.23bn from a short-term loan to fund the deal. It compounded the error by planning to pay in part with proceeds from a $9.5bn cash infusion it expected this month from its K-Dow commodity chemical joint venture with a state-owned Kuwaiti firm. Blindsided by Kuwait?s withdrawal from the $17.4bn deal a month after agreeing to new terms, Dow has been facing a financing crunch since then.
Further consolidation among the chemical giants was inevitable as companies seek deeper integration and better access to feedstocks as long funds to repay for their past acquisitions made at lofty valuations.
Sabic, the Saudi chemicals group, paid $11.6bn in 2007 to buy GE Plastics, but Gulf companies are suffering from the credit crunch alongside their western peers. China?s focus has been on securing oil and mining resources, not petrochemicals. Chemical makers from Germany?s BASF SE, the world?s largest, to Dow Chemical Co, the largest in the US, are trying to sell low-margin assets such as styrene, which is used to make plastics. Abu Dhabi?s International Petroleum Investment Co bought Nova Chemicals Corp, Canada?s largest chemical maker, for $2.6bn, including the assumption of debt. Huntsman Corp has agreed to buy plants that make titanium dioxide pigment from bankrupt Tronox Corp, barring a higher offer.
Largest-ever transaction by an Indian company?
Reliance Industries has submitted a bid to buy assets belonging to LyondellBasell, the bankrupt international petrochemical group in a close to $12bn deal that would elevate Reliance into the top echelons of chemical producers. The deal, if consummated, would be the largest transaction ever by an Indian company and also the largest single investment by a company from an emerging market in an advanced economy. The LyondellBasell buyout would be coordinated with emergence from bankruptcy and represents a ?potential alternative? to its reorganisation plan.
Reliance Industries has been sitting on a cash pile of more than $4bn and its chairman Mukesh Ambani told shareholders recently that the company, which enjoys a strong balance sheet, was looking to buy global assets in this depressed market. Over the last three years, RIL has successfully spent over $18bn to execute the gas find in the Krishna Godavari basin and the SEZ refinery in Jamnagar, which is the largest and most complex refinery built anywhere in the world and believed to be the best in its space.
LyondellBasell had a market value of $55bn in 2008 and RIL believes this acquisition of a distressed asset at the bottom of the world economic cycle would help it leapfrog into the top echelons of global companies. The acquisition would also enable Reliance to expand beyond its customer base in Asia into Europe and North America to become ?a global player?. LyondellBasell is a manufacturer of value-added products such as polypropylene, polyester and is also the second-largest producer of propylene, in which Reliance excels as well. This deal will, therefore, enable RIL to derive many synergistic benefits.
The Rotterdam, Netherlands headquartered LyondellBasell, the world?s third-largest independent chemical company with revenues of $50.7bn last year, has assets that could be worth as much as $6bn and employs 15,000 people across 19 countries. Reliance Industries generates more than $30bn in annual sales from petrochemicals, oil & gas and retailing. Lyondell?s plastics are used in car parts and other goods. The company operates a second refinery in France.
Lyondell Chemical and other US affiliates of LyondellBasell Industries filed for bankruptcy in January. Lyondell Chemical had assets of $27.1bn, debt of more than $19.4bn and more than 25,000 creditors, according to the petition filed in US Bankruptcy Court in Manhattan.
On November 9, a group of Lyondell Chemical noteholders agreed to talks aimed at settling their lawsuit against dozens of the company?s bank lenders. The lawsuit alleged that Lyondell?s 2007 buyout, financed with $22bn in borrowings, gave the company too much debt and caused it to fail. The group took on billions of dollars in debt obligations a year earlier when billionaire Len Blavatnik led a $12.7bn leveraged buy-out of US company Lyondell by Basell of the Netherlands.
Chemicals makers face a horrible chain reaction. The first step is a collapse in demand for the materials used to make the plastics that go into all the products of cars and houses. However, buyers here are emerging, only thanks to the grand economic stimulus being shelled out and likely to be withdrawn at short notice. Just look at the price of naphtha, which is widely used in the manufacture of plastics. For much of the latter half of last year, naphtha sold for less than the cost of the components used to make it?evidence of a collapse in orders, especially from Asian factories.
The second problem is structural. Hydrocarbons are the industry?s main raw material, so it makes sense for factories to be near where they are most abundant. Indeed, factories in the Gulf have already brought in new capacity, which is undercutting western producers. Making specialty chemicals, such as fancy polymers and protective coatings, offers some refuge. They can still be produced cost-effectively in the US or Europe, which is also where their customers are.
But this segment offers only so much protection. That is why Dow Chemical hoped to set up a low-cost joint venture in Kuwait, producing more generic chemicals for Asian markets.
The final problem is leverage. Germany?s BASF has little. But Dow?s leverage ratios look high after the collapse of the Kuwait deal. James Ratcliffe, who founded Ineos in 1998, and Len Blavatnik, the Russian-born billionaire who owns LyondellBasell, built their empires by rolling up chemical producers cast off from other firms in a series of highly leveraged deals. For a time, the strategy worked. Then the financial crisis hit. Ineos, with debt of $10bn, recently bought time from lenders with temporary waivers on its debt covenants. But LyondellBasell, in hock for $26bn, just put certain subsidiaries into bankruptcy. Reliance is presumably in talks with the bankruptcy court.
Big chemical producers in the US and Europe have been experiencing a difficult period and are unlikely to be interested in big acquisitions. A glut of new capacity, mainly in the Gulf, put downward pressure on prices even before the bottom dropped out of the economy in late 2008. With demand in freefall, margins have been under intense pressure as companies dial back production.
BASF, the German chemicals group, cut about 25% of its industrial production last year. And it has closed its $5bn acquisition of Ciba, the Swiss specialty chemicals group after a protracted period. DuPont shed 6,500 workers and trebled its cost-cutting target for next year from $200m to $600m. Dow Chemical, the biggest US chemicals company, shut 20 plants in the US and Europe. It is also under pressure to shore up its balance sheet after the collapse of a $17bn planned joint venture in Kuwait.
Plummeting orders, impending overcapacity
Orders at chemical companies have plummeted as consumers and businesses ratchet back their spending in the recession. The plastics and chemicals industry supplies the raw materials used to make nearly all consumer products, from water bottles to flat-screen TVs. The steep declines in the housing and auto sectors have hit chemical makers especially hard. Now the lengthening recession is drying up orders in other businesses that had been doing well, such as electronics. Chemical prices have sunk in response to weakening demand, squeezing margins and forcing chemical companies to shutter plants and lay off workers.
Companies with heavy debt loads are finding it hard to stay afloat. The US unit of Dutch LyondellBasell Industries, which was formed in 2007 when Basell International Holdings BV paid $12.7bn to buy Houston-based Lyondell Chemical Co, filed for Chapter 11 bankruptcy protection earlier this year. The company had been struggling to repay the debt from its acquisition.
Dow has said it has a plan to pay back its debt that will include issuing new equity and debt. It?s also looking for partners to replace the Kuwaiti company that pulled out of the joint venture last year. The company is presumably in talks with two state-owned oil and gas companies, and is trying to revive the deal with Kuwait.
Private equity firms that paid top dollar for chemicals producers during the credit boom cannot get the loans they need for deals. Oil majors in the western world, meanwhile, have been exiting the petrochemicals business. That leaves companies in the Middle East, China and India to pursue acquisitions.
Increased competition from the Middle East could decimate the European chemicals industry in years to come. If they are to survive, many European chemical manufacturers will need to seek mergers or joint venture opportunities with Middle East companies, which have expanded recently into petrochemicals and enjoy significant cost advantages due to their ready supply of energy and feedstock. With an abundant supply of cheap oil and gas reserves, Middle Eastern chemicals companies can access natural resources at greatly discounted prices when compared to their western neighbours.
Cheap supplies of petrol and gas not only provide fuel for the energy-intensive chemicals industry, hydrocarbons are the raw material in a number of chemicals products. This has allowed Middle Eastern companies to move up the value chain by producing more of their own petrol-based chemicals, chiefly ethylene, a building block for most plastics. Reliance Industries, fresh from its execution of gas find in the Krishna-Godavari basin enjoys similar advantages. The Middle East-based companies have made the most of their natural resources and transformed their business from supply of raw material to heavyweight, global petrochemicals production.
However, petrochemicals groups, as opposed to specialty chemicals makers (which are not involved in petrol-based products), are particularly vulnerable, especially if the company concerned is highly leveraged. The companies that have done large leveraged deals in the last three to four years are the ones that are now struggling.
Besides, there could be over-capacity in the chemicals space. A total of 53 petrochemicals plants, based mainly in Saudi Arabia and the UAE, could come on-stream by 2012, and the cost advantages enjoyed by Middle Eastern chemicals plants are significant. The average price of 1m British Thermal Units of energy is $8.85 in the US and $6.95 in Belgium. It is just $1 in Oman and 75 cents in Saudi Arabia.
The challenge from the Middle East as well as potential fall-off in demand from key sectors like automotive and housing that could once again happen if the world is to go into double-dip recession (once the central banks end their loose monetary policy), is a potential double whammy.
Notwithstanding this, mergers and acquisitions in the chemicals space are expected to be very active in the back end of the year, especially since interest rates are close to zero and funding acquisitions is much easier.
It reminds me once again of Dustin Hoffman?s admonition in the movie The Graduate, ?I just want to say one word to you?just one word??plastics.??
?The author is a Wharton Business School MBA, and CEO, Global Money Investor