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The Financial Crisis, Credit Quality and the Outlook for M&A

This article explores the impact of the financial crisis on the credit quality of the North American chemical industry and its outlook for mergers and acquisitions. It discusses the high number of companies in the high-yield (junk) category, the risks of leverage ratios getting higher, and the potential refinancing challenges. It also examines the stalled billion-dollar acquisitions of Dow Chemical and Apollo Management's Huntsman, and provides an outlook for M&A in 2009.

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The Financial Crisis, Credit Quality and the Outlook for M&A

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  1. Joseph Chang Global Editor The Financial Crisis, Credit Quality and the Outlook for M&A ISM Chemical Group New Orleans February 12, 2009

  2. Domino Effect • 1/6/09 LyondellBasell files for Chapter 11 bankruptcy in US • 1/12/09 Tronox files for bankruptcy • 1/21/09 Foamex misses interest payment, defaults on loan

  3. ICIS Petrochemical Index (IPEX) Source: ICIS pricing

  4. Q4 Disaster Source: Companies

  5. Rapid Response

  6. A Heavier Debt Load North American chemical industry credit quality • Out of 75 companies under coverage by Moody’s, 54, or 72%, are in the high-yield (junk) category (under BBB-), more than double the 26 at the end of 2001 • Out of 69 companies covered by S&P, 43, or 62% of the group are rated junk. And 32 have ratings in the B+ to CCC- level, indicating very high leverage

  7. A Solvency Solution?Companies At Risk

  8. Leverage Ratios Will Get Higher

  9. Wall Street Crystal Ball 2009 * As of the close of January 28, 2009 Source: Yahoo! Finance, ICIS Chemical Business

  10. NOVA Chemicals – $250m in bonds expiring April 1 and $126m in preferred shares maturing on October 31 In talks with banks S&P cuts rating to CCC+ Stock falls to under $2 Chemtura – $370m in 7% notes expiring July 15 Asset sales needed to repay debt S&P cuts rating to CCC Stock collapses to under 50 cents Refinancing Risk

  11. Investment-grade companies can still issue debt, but at a high cost Spreads vs. 10-year US Treasury at 6-9% Lubrizol raises $500m in 10-year notes with 8.875% coupon – replaces 4.625% notes Financing Market Not All Dead

  12. Dow Chemical’s $15.3bn ($78/share) cash acquisition of Rohm and Haas put on ice Dow refuses to close the deal by deadline of Jan 27 after receiving antitrust clearance Rohm and Haas sues Dow in Delaware court Dow stalls for time, negotiations under way Dow has $13bn bridge loan commitment from Citigroup, Merrill Lynch and Morgan Stanley expiring on July 8, plus $3bn from Warren Buffet and $1bn from Kuwait Investment Authority Ticking 8% fee means Dow’s purchase price rises by $3.35m/day, or over $100m/month. Maxes out at $500m Renegotiated deal for lower price with a stock component the most likely outcome. Rohm and Haas stock trades at about $54 EXTRA!!BUSTED billion-dollar deal

  13. Busted billion-dollar deal • Apollo Management’s $6.5bn ($28/share) • acquisition of Huntsman falls apart • Huntsman Sr. and Leon Black threw the lawyers out of the room and talked one-on-one • Settled in December 2008 for $1bn in cash ($750m in cash – no strings, plus $250m in cash from sale of Huntsman convertible notes to Apollo) • Huntsman settled for cash now versus multiple years of court cases • Huntsman will continue its lawsuit against Deutsche Bank and Credit Suisse for pulling the financing • Huntsman stock falls to under $3

  14. M&A Outlook 2009 • Billion-dollar deals will become scarce until financing market recovers • Private equity hampered with no high-yield debt market • Strategic buyers focused on own restructuring, liquidity issues • Number of deals and dollar volume set to decline substantially • Small- to mid-size deals get done $ $

  15. Crisis = Opportunity • Distressed assets for sale • Falling valuations • Less competition from private equity AND financially strapped chemical companies • Financing still available for strong investment-grade companies • Companies monitoring developments closely

  16. Pole Position Source: Standard & Poor’s

  17. Recipe for Disaster Wall Street and Management • Private equity leveraged buyouts (LBOs) of chemical companies rise in 1999 and peak in 2005 at 36% of total M&A dollar volume. H1 2007 also hits 28% of deals and 36% of dollar volume. • Chemical M&A peaks in 2007 at $55bn in deals • Loose lending practices with covenant-lite loans • High leverage became more accepted • Stock buybacks liberally used as a tool to boost shareholder value Sources: Young & Partners, ICIS Chemical Business

  18. No Tolerance For Leverage Chemtura Source: Yahoo! Finance

  19. NOVA Chemicals Source: Yahoo! Finance

  20. Celanese Source: Yahoo! Finance

  21. Rockwood Holdings Source: Yahoo! Finance

  22. Change in Attitude Needed • “Optimal capital structure” no longer optimal when cyclicality is taken into account • Companies, especially in cyclical industries, should not take on large amounts of debt • High leverage leaves you vulnerable in tough times – no longer in control of own destiny • Term out debt maturities!

  23. The benefit Can increase EPS in the short term Can prop up or increase stock price The cost Funds could have been used for debt paydown, R&D spending, capital projects, acquisitions Reduces financial flexibility in the inevitable downturn Buyback Mountain

  24. Stock Buybacks (ala shooting yourself in the foot, um, leg)

  25. Thank you! Joseph Chang Global Editor 360 Park Avenue South New York, NY 10010 (212) 791-4224 joseph.chang@icis.com

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