Megadeals - What trends are influencing deals in the chemical industry? There are several, according to the latest edition of PricewaterhouseCooper's (PwC)Chemical Compounds report, which analyzes M&A activity in the global chemical industry. The report finds that while the number of M&As dropped during Q3 2011, the proportion of megadeals (deals valued at $1 billion or more) increased.

This also suggests that strategic investors are remaining active. Also, a desire to supplement organic growth and to expand into new markets is driving many companies' M&A efforts. Chemical companies continue to benefit from recent cost cutting and streamlining initiatives, and as cash balances increase, resources are becoming available for larger and more ambitious deals.

The report also shows that deals in China dropped more than 55% in volume and value compared with the previous quarter. However, the analysts weren't surprised: Growth in the slowing Chinese economy - impacted by recent domestic policies and weaker international demand for the country's goods - is expected to fall below double digits for the near term, and China's targeted economic growth rate is 7%, the report states.

2Q & 3Q 2011 Deal Activity and Value Lowest Since Q4 2009

While deal volume continued to decrease in Q3 2011 compared with the previous quarter, deal value improved slightly, to $16 billion. Fewer deals are closing, but they are larger; However, with the exception of Q2 2011, this quarter's deal values are the lowest since fourth-quarter 2009.

The number of deals announced in third-quarter 2011 declined almost 20% from the second quarter, from 286 to 231. However, for the same period, total deal value increased, gaining almost 6.4%, to $16.7 billion. This improvement in deal value was driven in large part by increased deal value for megadeals in the third quarter. While the number of megadeals announced remained steady at four, deal value increased almost 12% to $11.7 billion. Total deal value for medium-sized deals (valued at more than $500 million but less than $1 billion) improved as well, increasing from zero to almost $2 billion. On the negative side, however, smaller deals (valued at $50 million up to $500 million) declined almost 43%, from $4.2 billion to $2.4 billion this quarter.

The Role of Private Equity

Over the past few years, private equity firms have faced considerable fundraising challenges, deterring their participation in the deal environment. Until recently, their involvement remained weak, as availability of credit and low returns constrained M&A activity. In 2010, financial investors' contribution to M&A activity increased to the highest levels since the recession began, setting the stage for further improvement.

However, that trend reversed this quarter, as financial investments accounted for only 1.25% of deal activity. This is the lowest proportion since PwC began tracking activity by investor group in 2006. This shift may be due to the relative advantage that strategic investors have given their ample cash stockpiles. Although the largest deals announced this quarter were not private equity exits, it seems reasonable that currently high M&A valuations could lead PE investors to seek to divest chemical portfolio holdings to strategic investors. This would seem to be the preferred exit strategy for many PE firms, as compared with initial public offerings, given the recently poor equity market performance.

Four Megadeals in Q3 2011

There were four megadeals in the third quarter, the same as in the second quarter. However, deal value for the third quarter megadeals was $11.7 billion, compared with $10.5 billion in the second quarter. Of the four megadeals announced in the third quarter, three were valued between $1 billion and $5 billion, and the fourth was valued at more than $8 billion. Three of the four were by U.S.-based acquirers, and the fourth involved a U.S.-based target.

The highest valued deal this quarter was the announced $8.11 billion merger in July of U.S.-based cleaning and sanitation products manufacturer Ecolab with water treatment chemical producer Nalco Holdings.

In the second deal, in September, U.S.-based Tronox, the world's third-largest producer and marketer of titanium dioxide pigment, agreed to acquire the mineral sand operations of Exxaro Resources, a South Africa-based iron ore and coal mining company, for approximately $1.3 billion. Exxaro's mineral sands operations produce the key titanium bearing ore feedstock used in the production of titanium dioxide pigment.

In the only mega-deal not involving a U.S.-based acquirer, it was announced in July that Switzerland's Lonza Group will acquire all of the shares of U.S.-based Arch Chemicals. The deal is valued at $1.2 billion. The merger helps Lonza Group diversify its product line, and after completion of the deal, Lonza will have the world's largest microbial control business.

Also in July, U.S.-based specialty chemicals manufacturer OM Group announced that it would acquire Vacuumschmelze of Hanau, Germany, a global market leader in advanced materials and specialty magnetics. The deal was completed in August with consideration in the form of cash and common stock valued at approximately $1 billion. The acquisition of Vacuumschmelze, which makes advanced materials for industries such as automotive, clock manufacturing, electrical engineering, and electronics, is expected to help OM Group enter the alternative energy market.

Finally, although not included in the deal activity, it should be noted that in July, the Dow Chemical Company announced a joint venture with Saudi Aramco to create a chemical company called Sadara to develop the world's largest integrated chemical site. With an expected annual capacity of 3 million tons, the facility will be located in Jubail Industrial City II (Saudi Arabia). Valued at approximately $20 billion, construction is expected to begin by year-end. This deal is an example of further movement into this region.

What About BRIC?

In line with lower deal activity in the third quarter, the level of activity related to BRIC countries for deals valued at $50 million or more declined as well. Of nine deals announced for BRIC targets, four were for targets in China, and four were in Brazil. Of nine deals announced by BRIC acquirers, four were by Chinese companies and two were by Brazilian companies.

While an improvement for Brazil, this was a decline in activity of more than 55% for Chinese targets and acquirers. Of the four Chinese deals, all were local market, and while the Chinese market may continue to consolidate, some overseas expansion can be expected in the future by the largest producers. Overall, Chinese deal activity fell to 49 deals (all values including undisclosed) in the third quarter, a decline of almost one-third from the previous quarter, indicating that recent consolidation activity might be slowing.

North America and Europe Drive Local Deal Value

North America and Europe drove local deal value in the first three quarters of 2011, with $30.9 billion and $18.6 billion, respectively. Deal volume was driven by 31 local deals in Asia and Oceania, many involving China. However, these deals were, on average, substantially smaller than those in more developed regions.

The increase in North American deals was driven by activity in the United States, with a variety of regions making deals there; all four of the megadeals involved either U.S.-based targets or acquirers. Europe, on the other hand, was the primary driver for outbound volume and value, with 13 deals valued at $8.6 billion in the first three quarters of 2011. This could be due to European investors seeking higher growth rates than may be available from domestic economies, as well as concerns about local economic conditions.

Conclusion

The third quarter saw a further decline in deal volume, but as the proportion of megadeals increased compared with the previous quarter, deal values climbed. Average deal value increased more than 50% over second-quarter 2011, although it remains below recent levels. Financial deals declined drastically during the third quarter, falling to only 1.25% of total deal volume. Given economic concerns, financial investors might be looking to less cyclical sectors for new investment. Debt fears in the eurozone also add to a general pessimism regarding the economy.

While financial uncertainty remains a reality for global markets, PwC said it expects continued recovery in the chemicals deal market, although at a slower pace than had been predicted earlier last quarter

To read the report in full, go to: http://ht.ly/7CBok