Indian chemical industry: Will M&A be a game changer?

by / Saturday, 12 August 2017 / Published in News & Updates

The importance of the Indian chemical industry in the growth and expansion of the economy can be gauged from the fact that it accounts for around 2.1 per cent of the country’s gross domestic product (GDP). India is the sixth largest chemicals producer in the world and has entrenched itself as a formidable player in the global chemicals arena. This sector is also largely connected to key economic sectors such as agriculture, agro-commodities, services and manufacturing.

Chemical companies in India are facing a peculiar challenge today. In a global economic order marked by low growth volumes and a hypercompetitive landscape, profit margins are shrinking faster and operational capacities are dwindling speedily. A strong US dollar has compounded an already gloomy macroeconomic environment and exerted a downward pressure on demand for chemicals. Sales volumes in the chemical industry clocked a meagre 2 per cent growth in 2016 on the back of a severe shortfall in industrial production and large-scale rightsizing of inventories by customers. Of course, there are exceptions. For instance, naphtha-based producers clocked handsome profit margins as subdued oil prices led to lower material costs and strong gains of around 60-65 per cent. However, others selling petroleum-based products recorded lower-than-normal industry averages owing to lower oil prices.

In a bid to maintain steady production levels and ensure that profit margins are not eroded in the face of weakened industry fundamentals, chemical companies are exploring inorganic growth avenues such as acquisitions. In fact, the limitations of organic growth are forcing firms to look at mergers and acquisitions (M&As) as a viable alternative for sustained high valuations.

Scalability is the new buzzword in a stagnating industrial terrain as companies attempt to strengthen their positions through increased M&A activity. The consolidation of product lines not only enables them to leverage organisational synergies, but also allows them to venture into hitherto unexplored business areas, which are in alignment with their strategic goals. For example, the DuPont-Dow Chemical merger rejigged the product portfolio of the merged entity into two specialty chemical businesses and one feedstock business. Balance sheets of companies and investment decisions are also key factors, which are broadly influencing M&A deals. As investor expectations are on the upswing and there is a slowdown in demand, companies are prompted to turn increasingly to the M&A route to ensure sustained business operations and continued profit margins.

Lower oil prices have been highly instrumental in steering M&A activity in the chemicals sector. As the oil prices maintained a largely subdued outlook in 2016, companies whose margins have been negatively affected will need to offload non-core assets for maintaining a healthy balance sheet. In order to achieve a well-balanced and economically bolstered portfolio, companies are increasingly rejigging their business operations and divesting non-core assets to streamline their organisations and achieve scale. What’s more, activist investors are largely responsible for pressurising companies to divest their low-performing assets and focus on revenue-generating chemical products, which can attract higher margins and are not highly impacted by cyclical fluctuations.

The M&A route has been traversed by reputed global chemical players such as Mitsubishi, BASF, Syngenta, Lanxess and AkzoNobel to gain a strong foothold in the country. Big-ticket chemical companies have engaged in large-scale acquisitions and partnership deals to foray into the Indian market. Consequently, Indian companies have engaged in outbound deals to increase their export revenue and bolster their bottom lines in addition to gaining the much-needed technical expertise to upgrade their products. Investor confidence and backing, concerted R&D efforts, a diversified product line and infrastructural potencies are key factors in positioning companies to emerge as globally credible M&A entities.

Although heightened M&A activity has been witnessed in the chemical sector, multifarious disruptors exist, which have the potential to change the course of the industry. Several macroeconomic factors, largely pertaining to economic growth, interest rates, trade and tariffs could emerge as potential game changers and influence the direction of various deals. Events such as Brexit and the US Presidential election, which has long-term, deep-rooted policy ramifications, have made chemical companies adopt a cautionary stand and have raised intrinsic questions on how deal-making activities could evolve for them over a time frame of one-two years. A globally volatile economic environment could prove to be a major hindrance in the smooth execution of M&A deals. Geopolitical factors like protectionism can also prove to be key impediments in slowing down the momentum of M&A activity.

India is on the cusp of becoming a global economic powerhouse. With a pro-industry government in power and initiating programmes like Make in India, aimed at igniting the latent potencies of domestic industry, there is a huge scope for the chemical industry to scale the next growth curve. By strengthening their product development capabilities and creating a robust in-house R&D architecture, Indian chemical companies can take the lead in identifying potential outbound deal opportunities and expand their global presence in new consumer markets.

Global corporate entities are also aware that Indian companies are ramping their technological know-how, ushering in process and product innovations and strengthening their distribution infrastructure. Partnerships and M&A can prove to be the much-needed fillip for international companies to enter the vast Indian market and utilise its low-cost manufacturing capabilities and research expertise. A steady political leadership, a strong domestic economy and a government committed to removing business bottlenecks and promoting ease of doing business have the potential to promote India as a global production and distribution hub for several chemical segments through strategic M&A deals.

Deal executions over the past few years and a volatile business environment have given rise to a new normal – an industry landscape whose business strategies are significantly altered and characterised by a hypercompetitive environment in which companies must engage in constant competition for bolstering their profits in global markets. The coming years will be critical in determining what the market share will be for various established chemical players and whether the global M&A landscape will be dominated by Indian and Chinese players who will seek to boost their operational capabilities and strengthen their market presence.