Industy Review & Analysis: Chemicals, Plastics & Advanced Materials Group
Q & A WITH CHRIS CHILDRES
Chemical M&A activity heated up when we entered the second half of 2010 as numerous assets came to the market hoping for a calendar year-end close. However, due to the tremendous level of private equity dry powder built up over the past eighteen months, we are likely heading into a sellers’ market. This quarter we are pleased to present the views of Edgewater Capital Partners, one of the key private equity players in the middle-market chemical industry.
What are some differentiating characteristics that Edgewater Capital brings versus other private equity funds?
Edgewater is differentiated by the partners’ and operating partners’ expertise in deal flow, markets and operations in certain select, high value added industries such as specialty chemicals, technical materials, and specialty components. The aggregate operations, financial and technical knowledge allows Edgewater to be highly selective in its investment targets.
What kind of characteristics do you typically focus on when evaluating various subsectors within the chemical industry?
Edgewater focuses on certain macro characteristics for the sub sectors we believe are attractive. These include:
- attractive growth prospects for the overall market and products,
- proven and stable technologies that carry a lower risk of substitution,
- low risk of regulatory changes, and
- low risk to human health.
Effectively, Edgewater seeks investments in specialty chemicals, fine chemicals and technical materials that are purchased for their performance characteristics rather than mere compliance with material specifications. We look for products that are purchased for what they do rather than for what they are.
Drilling down, what are some specific qualities in a chemical business that would make it a good investment for Edgewater?
Edgewater seeks businesses in unique niches with high barriers to domestic and international competition in the markets for their products. We look for specialty chemical companies with complex and difficult chemistries, strong customer-oriented technical application expertise, proprietary or trade secret manufacturing techniques, and expertise in the use and handling of difficult raw materials and processes.
What were some of the key factors to successes in your chemical investments and can you share an example?
Some of the key factors to our success have been:
- excellent management teams with in depth expertise in their markets, products, and customers,
- world class operations that are dedicated to “best in class” quality,
- embracing tougher chemistries, including handling of difficult materials, and,
- an entrepreneurial management style that allows businesses to remain creative and nimble.
Royal Adhesives – Strong branding, customer service and relationships led to robust growth trends. Expertise in industry permitted enhancement of operations. Earnings growth and operational enhancement led to multiple expansion and high rate of return.
P-Chem – Strong technical application expertise and trade secret manufacturing lead to growth in excess of 10% per year in sales and EBITDA over six year period.
Syrgis Performance Products – Recruited professional management whose team development, branding, marketing and technical development efforts led to strong growth in product portfolio, sales and EBITDA.
Gabriel Performance Products – Strong proprietary chemical products and expertise in difficult materials and processes lead to robust sales and EBITDA growth during “great recession” of 2009.
Could you talk about some pitfalls that other funds looking to invest in the chemical industry should look for and provide some examples from your own experience?
Investing in the chemical industry requires a strong level of market, manufacturing and overall industry expertise on the investment team, either internal to the investment firm or contracted specifically for the transaction. The greatest pitfall for investors in this industry is the inability to distinguish specialty chemicals from commodity chemicals in product due diligence, and failure to identify inadequate safety and environmental protocols in the manufacturing due diligence. Commodity suppliers can be erroneously identified as “specialty” chemical producers simply because they have a complex reactive production process, whereas certain specialty producers may have a simple formulation with outstanding technical service. In addition, due diligence on the safety and regulatory issues in chemical manufacturing requires years of experience and specific expertise, particularly in investigating the ongoing safety and compliance processes and protocols (as opposed to a simple review of a facilities history).
When investing in and growing platform investments, how do you prioritize organic growth opportunities versus growth through bolt-on acquisitions?
Edgewater, in conjunction with its management teams, prioritizes capital investments based on their ability to impact the value of the Company and probability of success, assessing the strategic need and value of a bolt-on versus the requirements to grow organically. We are extremely supportive of our management teams’ organic growth efforts, while constantly monitoring acquisition opportunities. This is one of the values Edgewater brings to each of its portfolio companies.
You’ve been able to successfully put your platform acquisitions together with highly capable and experienced executives. As you build out your network of CEOs and executive operating partners, what are some qualities you look for in a candidate’s experience?
We have been extremely fortunate in the relationships we have developed in forming our portfolio’s management teams and operating partners. Edgewater focuses on candidates with superior leadership qualities and significant industry experience. We feel it’s imperative to have leaders who truly understand their markets and can build talented operating teams around the opportunities in their industries.
Based on the numerous opportunities you’ve seen, what is your outlook in Chemical M&A for the rest of 2010 and going into 2011?
That’s a bit of a trick question. While we focus on businesses that have limited competition from other manufacturers, we also seek to buy them in circumstances that limit our competition against other investors. Therefore, we prefer to buy in markets with lower levels of M&A activity, where buyers expectation are more limited and competition is more scarce. Right now, we are seeing an increase in overall activity in terms of transactions in the pipeline, transactions closed in the market, and available credit for acquisitions.
Based on what you’ve seen in your current portfolio companies, what is your outlook for overall specialty chemical volumes and pricing in the near future?
At the moment the macro and micro economic indicators are far too volatile to offer a prediction on the overall industry outlook. Recent trends seem to indicate a continued increase in volumes, but at a less accelerated rate than early 2010. Raw material prices have seen a recent spike, which will be passed on to customers and consumers in the long term.
What have you seen in the lending market in terms of asset versus cash flow lending, and what kind of leverage multiples have you been seeing in the chemical industry?
Within our market niche we have seen a gradual improvement in credit availability over the past three fiscal quarters. In 2009 we were able to solicit proposals and close transactions at total debt multiples in excess of three times EBITDA, but not without a significant collateral base. It appears to us that available cash flow lending has become more available, but that total debt to EBITDA ratios will remain around three times for the foreseeable future.