M&A: Now It's Chemicals' Turn

Deals involving Lyondell and Huntsman point to further consolidation ahead

With two acquisitions percolating in the chemicals industry and a spinoff of a third on the horizon, the sector is poised for higher valuations and further takeovers.

On the rebound from a failed effort last week to buy Huntsman Corp. (HUN), Basell AF on July 17 agreed to acquire Lyondell Chemical Co. (LYO) for $19 billion, including more than $6 billion in debt. Privately owned Basell, a unit of Access Industries, purchased an 8.3% stake in the company in May, but buying the company in its entirety probably began to look more viable after it lost its bid for Hunstman to a higher offer from Hexion Specialty Chemicals Inc.

Basell's offer translates to a price of $48 per share, 20% higher than Lyondell's closing price on July 16 and a 45% premium to where the stock closed on May 10, the day before the market first learned of Basell's interest in the Houston company.

Huntsman agreed to be acquired for $10.6 billion, or $28 a share, by Hexion Specialty Chemicals, owned by private equity firm Apollo Management L.P. on July 12.

Huntsman's polyurethanes and pigments product lines will no doubt complement Hexion's thermoset resins and other products it sells for wood and industrial markets. But Hexion's overbid for Huntsman is likely part of its strategy to become a more attractive property in preparation for an initial public offering down the road, says Frank Mitsch, an equities analuyst at BB&T Capital Markets.

Also on July 17, the German chemicals giant BASF (BF) said it had received an initial offer for parts of its styrenics business, which generated €3.2 billion in sales last year. BASF didn't disclose the price of the offer but said it would start negotions with the company that extended the offer.

The combination of Netherlands-based Basell and Lyondell would be the largest producer of polyolefins and the third-largest ethylene manufacturer in the world. The merger is a good strategic fit from the standpoint of material balances and product portfolios in North America, according to Ahmed at HSBC.

Lyondell is the sixth-largest producer of propylene, the key building block of polypropylene, which is in great demand for packaging products. Since it makes very only small amounts of polypropylene, Lyondell has a surplus of 1.8 million tons of propylene in North America, while Access Industries, the largest polypropylene producer globally has a deficit of 1.2 million tons pf propylene.

The potential for integration in the ethylene and polyethylene business is far smaller, with Lyondell's ethylene surplus in North America and Access Indsutries' deficit in Western Europe, the HSBC note said.

A competing bid for Lyondell in the low $50/share range from another chemical manufacturer such as Reliance in India or a group of Middle East investors wouldn't be a surprise, Morgan Stanley analyst Charles Neivert said in a research note on July 17. He re-affirmed his overweight rating on the stock.

The high multiple that Basell's offer price represents makes a bidding war for Lyondell improbable in the view of equities analyst Hassan Ahmed at HSBC Global Research. In view of Lyondell's high debt load, the price would be out of reach for a financial bidder, and the only commodity chemical makers with enough overlapping business to make the acquisition worthwhile are Dow Chemical Co. (DOW) and Ineos, a London-based private equity firm.

Neither is a likely suitor, given Dow's resolve to expand only in cost-advantaged regions like the Middle East and Ineos' unwieldy debt load after its $9 billion buyout of Innovene, Ahmed said in a research note on July 17.

A handful of recent chemicals acquisitions begs the questions of who else may be a takeover target, Morgan Stanley said in a research note on July 17. Nova Chemicals (NCX) may be a suitable candidate once it has sold off its underperforming styrenics business, the investment bank said. Nova, which has low-cost ethane-based assets in Alberta, Canada, is profiting from similar trends in ethylene and polyethylene.

"It's made major strides in cleaning up its styrenics business," trimming costs and improving profit margins through joint ventures with Ineos last year in Europe and this year in North America, said Mitsch at BB&T.

Considering the oil industry background of Len Blavatnik, who heads Access Industries, Basell might very well want to keep the lucrative Lyondell-CITGO Refining L.P. unit that Lyondell became the sole owner of last August, Mitsch said.

"There are linkages between the refinery operation and the petrochemicals operation that Lyondell is just starting to realize now that it owns 100% of the refinery," he said.

The market has also begun to acknowledge that the refinery, for which Lyondell paid $2.1 billion for the remaining 41% interest, should be valued closer to $7.5 billion, he added.

The higher valuations for commodity chemical assets that are likely to result from the profusion of M&A activity are justified by the strength of the polyethylene market. Operating rates reached 99% in June, with decent underlying domestic demand and strong demand from export markets, Mitsch said.

Mitsch doesn't own stock in Huntsman or Lyondell, but BB&T Capital Markets expects to receive or intends to seek compensation for investment banking services from Huntsman and Lyondell in the next three months.

HSBC has managed or co-managed a public offering for Lyondell within the past 12 months and expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months.

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