Revival - Global M&A activity contracted significantly in the past 12 months, driven by the worldwide economic recession and continued tightness in credit markets. Recent activity, however, offers signs of hope that the M&A market may have reached a bottom and is poised to recover.

The Steep Decline Seems to Have Abated

By way of background, overall M&A transaction activity in all industries has declined sharply in the past 12 months. According to data provider FactSet Mergerstat (FactSet), in the trailing 12 months (TTM) ended Sept. 30, 2009, there were 5,167 transactions involving U.S. targets, down 29.7% from the same period one year prior. FactSet data show similar trends for transactions with EU targets (down 41.6%) and other parts of the world, with total worldwide transaction volume down approximately 33.7%.
M&A activity in the chemicals industry also felt the pinch. In the same TTM period ended Sept. 30, 2009, there were 332 chemicals transactions worldwide, off 34.9% from the prior one year period. The volume of chemical transactions involving targets based in the U.S. and EU declined by 36.0% and 41.0%, respectively.
An examination of quarterly data shows that activity stabilized in 2009. Worldwide, there were 75-80 chemicals transactions in each of the first three quarters of 2009. While these numbers are low by historical standards, the consistency is encouraging. The key factors behind the collapse of M&A activity were the sharp economic contraction and reduced liquidity in the financing markets.
World economies dropped sharply in the beginning of the year. According to the U.S. Bureau of Economic Analysis, U.S. GDP fell at a seasonally adjusted annual rate of 6.4% in Q1-2009. Eurostat estimated that the decline in GDP in Q1-2009 was 2.4% for the EU27 and 3.1% for Japan when compared to the prior quarter (seasonally adjusted, not annualized). While the rate of decline was already slowing significantly in the second quarter, the economy remained weak, with U.S. GDP decreasing at a seasonally adjusted annual rate of 0.7% in Q2-2009, and GDP decreasing by 0.2% in the EU27 and 0.9% in Japan.
For the chemical industry, the economic contraction in 2009 was compounded by widespread inventory de-stocking that occurred in the beginning of the year. The de-stocking masked the true underlying demand and made it very difficult for companies to forecast their future performance.

Key Reasons to Uncertainty

Although many chemical companies have indicated that their businesses have now bottomed, the uncertainty created by the severe economic environment slowed M&A activity for much of the year for two key reasons. First, for most companies survival became priority #1. Many firms came under financial distress and were unable to focus on transactions. Others with strong balance sheets and ample cash reserves often slowed their investment activities because few could predict how bad it would get. Second, in many cases the uncertain and rapidly changing environment made it nearly impossible for buyers to evaluate an acquisition target's true financial condition and forecast. Owners considering a sale of their businesses faced similar challenges.
During the first half of 2009 the credit markets also remained tight, adding further obstacles to M&A activity. As an example, Chart 4 illustrates the sharp decline in total debt multiples in middle market transactions. During 2007, average debt multiples were above 5.0x in all four quarters, reaching their maximum level of 6.2x in Q2-2007. In contrast to these high leverage multiples, the average debt multiple in Q4-2008 reached a low of 2.6x. Although activity in 2009 was low, S&P estimates that average debt multiples rebounded to 3.8x in the first nine months of 2009. Lincoln is continuing to observe steady improvement in the debt markets.

Signs of a Revival

Is the M&A market on the path to recovery? There are several reasons for optimism.
A major determinant will be clarity in economic growth. As noted previously, the fall in GDP across many parts of the world moderated in the second quarter. Eurostat has not published figures for Q3, but preliminary estimates published by the U.S. Bureau of Economic Analysis indicate that the U.S. economy grew at a seasonally adjusted annual rate of 3.5% during Q3-2009. Many corporations are cautiously optimistic that a bottom has been reached and have increasing confidence in their ability to forecast performance for the next twelve months. The more that the uncertainty of future performance can be removed from the equation the easier it is for both buyers and sellers of businesses to have confidence in completing transactions.
There are recent signs that the volume of activity and the types of deals getting done is improving. The Wall Street Journal and data provider Dealogic reported that August 2009 was on track to be the worst month for M&A since 1995. However, Aug.31 was the busiest single day in U.S. M&A in nearly three months and pushed the volume for the month up 40%. This turnabout was driven by Walt Disney 's announced $4 billion acquisition of Marvel Entertainment and Baker Hughes' purchase of oilfield services company BJ Services for $5.5 billion.
In the chemicals industry, there have been several recent noteworthy transactions in the third quarter, although nothing on the scale of the larger deals announced in 2008 such as Dow-Rohm & Haas or BASF-Ciba. Some of the larger Q3-2009 chemicals transactions have included Dow Chemical's sale of its 45% stake in Total Raffinaderij Nederland to Total for approximately $800 million, including inventory; Hunstman's announced stalking horse bid for certain assets of Tronox for $415 million; Sekisui Chemical's acquisition of the PVA business of Celanese for $173 million; Lanxess' acquisition of Gwalior Chemical Industries for €82.4 million; Ashland's sale of Drew Marine to private equity firm J.F. Lehman for $120 million; and Clariant's sale of its specialty silicones business to private equity firm GenNx360 Capital Partners for an undisclosed sum.
The noteworthy element regarding these recent transactions is the change in deal complexion. Many recent deals are driven by strategic initiatives, such as a desire for growth on the part of buyers or strategic realignment on the part of sellers. This contrasts with many deals completed earlier in the year, which were driven more by desperation and/or financial distress. Healthy companies are beginning to think more about transactions now, both on the buyside and the sellside.
M&A activity for the full third quarter of 2009 remains down compared to prior periods. However, activity in the latter part of the quarter indicates that the negative mindset in corporate boardrooms toward M&A is changing.

Conclusion

The era of the hyper M&A market driven by easy access to financing is clearly behind us. 2009 has been a particularly challenging year for transactions and as with economic performance, transaction activity may take some time to recover fully. There are signs, however, that the potential bottoming of economic growth in many parts of the world is helping generate greater confidence to pursue healthy, strategic transactions.

Weston Anderson of Lincoln International contributed to this article.