Chemicals Investment Banking 101: Walter White Meets Gordon Gekko?
If you want to make more money than you know what to do with, nothing beats becoming a drug dealer and using your knowledge of chemistry to build a crystal meth empire.
Sure, you might have to kill a few dozen people on your way to the top, dodge multiple assassins, and take out some drug cartels, but what fun would it be if it were easy?
If, on the other hand, you still want to make a ton of money but you want to stay on the right side of the law (well, sometimes, maybe…), the finance industry might be a better bet.
And if you want to combine the two, chemicals investment banking is right up your alley.
You [probably] won’t get to advise actual drug dealers, but you’ll come as close as humanly possible by advising companies that make all sorts of legal chemicals, drugs, and the like.
Here’s the full molecular diagram of what’s in store for you today:
- How to apply your science skills to a different type of madness as a chemistry major
- What to look for when identifying trends and disruptive forces
- How to value chemicals companies, plus sample pitch books and valuations
- Why the exit opportunities just might beat the ones offered by the “drug dealer” career path
From Beakers to Book Value
Q: So how did you get into chemical investment banking coverage? I assume you didn’t start by cooking up your own drugs in an RV in the middle of the New Mexico desert…
A: Similar to many healthcare bankers, I originally wanted to get into science. My family saw I had a knack for chemistry, and I liked the concept at first – until I got to the lab.
People get wrapped up a little too much in their tabletop sets, but I prefer seeing an immediate impact from my work.
With investment banking, I knew I would tackle strategic assignments that made an immediate impact – raising capital to pay down debt, finance an acquisition, grow the company, consolidate, or for “general corporate purposes” (smile).
Q: And how did you learn the technical side if you were a science geek before this?
A: I leveraged your online courses to gain a firsthand perspective on how to connect the three financial statements in at least 4 different ways.
Yes: I said 4 different ways. I went over the concepts non-stop until I absorbed everything “by osmosis.”
My interviewer was pretty impressed that a chemistry major knew what he was talking about.
I saw the economy as another chemical formula: different elements come together, and the right mixture produces something of value.
Q: So your interviewer liked you so much that she wanted you in her group?
A: Yeah, simply keeping in touch with my interviewer helped me to navigate the group placement process.
It wasn’t so much stating what you want; it was more about asking the other person how their day went, forwarding interesting articles, and introducing interesting people to the person who’s in your corner championing your candidacy.
Complex Compounds and Molecular Mazes
Q: How does your role fit into the broader investment banking department?
A: Depends on the firm. At Credit Suisse, the Chemicals area is its own vertical within the industrials group; at Deutsche Bank, on the other hand, Chemicals falls under natural resources.
In any case, it’s a pretty specific area similar to paper, packaging, and forestry products.
Just like you see in a lot of groups, staffing is fairly lopsided; there are definitely some lazy bums who get away with doing not too much, and then there are other analysts who can’t seem to say “no” to their staffers.
Q: So how is your coverage divided then?
A: Here’s how I see the world of chemicals:
Major Diversified: This area includes companies such as DuPont, BASF, Dow Chemical, and Praxair. These firms can have as many as 13 different lines of business, grouped into categories based on economic characteristics and the similarity among production processes.
Agricultural: This area includes companies such as Monsanto, Syngenta, and Potash. These companies produce seeds, fertilizers, and related items, including biotechnology that enables plants to protect themselves from pests and harmful bacteria strains. On the seed front, these items focus on cotton, corn, and soy varieties.
Specialty: If you’re wondering what “Specialty” means in this context, it’s easiest to explain by looking at the comps in this sector. They include companies such as LyondellBasell (petrochemicals and plastic resins), PPG Industries (Coatings), and Sherwin-Williams (paint). See the Grace Matthews investment banking chemicals practice overview to get a sense of the other areas in this segment (NB: it is a rather diverse set of products to cover).
Synthetics: This area includes companies such as Axiall, Tronox, and Minerals Technologies. By definition, these firms offer compounds such as aromatics (ex: phenol and acetone) and chlorovinyls (ex: caustic soda and chlorine).
Q: I see you’ve skipped the drug cartel sector, but let’s move on anyway…
What drives each of those sectors above?
A: It depends a lot on the target, acquirer, and issuer in question (if you’re talking about key deal drivers). The financial health of the end user, for example, determines the demand for the compounds created in the chemical sector. But let’s go back to those main areas I just mentioned:
Major Diversified: These companies take a portfolio approach to strategy, managing seemingly disparate lines of business united by a common vision. The aim here is to leverage one unit’s capabilities into another vertical, not so much for synergies, but to leverage another’s progress in the production of a compelling concept.
So the effectiveness of these companies depends on how well they can do that, plus the health of the underlying industries that their business lines operate in.
To be a bit more specific, the customer base is comprised of mostly companies in the consumer and industrial sectors. Applications include adhesives, aerospace, automotive, personal care, power generation, textile chemicals, and dyes – so demand for all those items will influence the performance of these companies.
Agricultural: Weather conditions affect crop yield, as do farming practices (ex: crop rotation); market and economic improvements also play a hand in how farmers deliver.
To guard against fluctuations, companies deploy irrigation to guard against draughts and they use futures contracts to lock in energy prices (ex: oil and gas). Public opinion on what practices are acceptable also constrains how profitable a company’s offerings can be. According to Monsanto:
- Traits’ market success depends upon: product performance (in particular, crop vigor and yield for row crops and quality for vegetable seeds), customer support and service, intellectual property rights and protection, product availability, and planning and price.
- Seeds’ competitive success depends upon: performance and commercial viability; timeliness of introduction; value compared with other practices and products; market coverage; service provided to distributors, retailers and farmers; governmental approvals; value capture; public acceptance; and environmental characteristics.
Specialty: Most firms in this space focus on [weatherproof] coatings for the automotive aftermarket, or they produce paint – for both houses and motor vehicles.
Imagine finishes sold to vehicles, transport units, and so on; the health of the transportation sector will influence all of those.
And the aerospace sealants product line would naturally be driven by aviation traffic.
Weather conditions would influence both areas in terms of preventing wear and tear, or maintaining upkeep on a [most likely residential] property.
Both auto sales and home sales fuel the demand for specialty chemical products. On the cost side of things, raw materials availability, including supply disruptions, are factors to consider.
It’s not so much “Do the companies in my universe have material to work with?” It’s more “Do the suppliers have the capacity to provide adequate product through the value chain?”
According to PPG Industries:
- Coatings’ success depends largely upon: product performance, technology, quality, distribution and technical and customer service.
- 70-80% of the cost of goods sold is contributed by raw materials: both organic (primarily petroleum-based) materials and inorganic materials, including titanium dioxide.
Synthetics: While some companies focus on process or product, firms that focus on synthetics compete via research and development.
Inorganic minerals and related products are used in the paper, building materials, paint and coatings, glass, ceramic, polymer, food, automotive, and pharmaceutical industries. Refractory materials are used in high-tech applications including mining and glass fabrication.
With that said, the market for synthetics is still highly cyclical and depends on factories such as:
- Paper: Number of bankruptcies or paper mill closures
- Construction and Automotive: Housing starts
- Steel (Refractory Products): Production levels
From a cost standpoint, raw minerals (lime, carbon dioxide, magnesia and alumina) are the major factor; just like in the metals and mining sector, the availability of these resources and transport costs (read: fuel) affect the cost of goods sold here.
- Synthetic minerals’ (read: limestone and talc) success depends upon quality, price, and geographic location.
- Refractory materials success depends on performance characteristics of the product (including strength, consistency and ease of application), price, and the availability of technical support.
Valuation: The Meth Business, or the Money Business?
Q: So how is valuation different? Any new metrics, multiples, or methodologies?
A: Not really – the standard methodologies still apply:
Comparable Company and Precedent Transaction Multiples: You focus on EV / EBITDA multiples. You determine your peer set of public comps based on similar end markets, domicile, exposure to industry [cyclical] patterns, and participation in industry fundamentals; precedent transactions are similar, but also include dates as criteria.
At the individual plant level, multiples are presented in terms of assets and operating metrics; plant production capacity, production costs ($/lb, etc.) and utilization rates are the focus.
Sometimes you’ll also see more attention paid to gross margins and gross profit multiples, but EV / EBITDA still tends to dominate.
[Implied] Premiums Paid: When evaluating an acquisition offer, you take the offer price and compare it to closing prices, the 30-day volume weighted average price (VWAP), the 3-month average, 52-week high, 52-week low, and so on.
Consolidated Sum of the Parts Valuation: This is most important for companies in the “Major Diversified” segment above – you would create sets of comparable company analysis and precedent transactions for each different business segment, multiply the medians by the appropriate metrics, and adjust for overhead to calculate the total value. You might also plot these multiples over time to see how they fare against the target’s trading multiple history.
Then you have the DCF analysis based on Unlevered Free Cash Flow, Wall Street equity research analyst price targets, historical share prices, LBO analysis, contribution analysis, implied exchange ratio analysis, and future stock price analysis (project future TEV based on an assumed multiple, back into Equity Value, and discount the share price to its present value).
Q: I’m still disappointed. There’s really nothing different?
A: One difference is that pensions can be a bigger deal in this industry because many chemicals companies are older, more mature businesses and sometimes have significant (unfunded) pension obligations.
So you’ll see more attention paid to that and acquirers may have to explain exactly what is included / not included in the purchase price.
For example, when PPG Industries acquired AkzoNobel’s decorative paints business, they included adjustments for working capital and pensions when explaining the purchase price.
In terms of metrics, you’ll see references to production capacity by chemical type as well as distribution channels (e.g. store locations), but you generally don’t turn these into valuation multiples as you would in oil & gas.
Q: Let’s see some real life examples with pitch books and Fairness Opinions, please.
A: Here you go:
Merger of PPG Commodity Chemicals Business with Georgia Gulf Corporation:
- Presentation to Analyst Community by Axiall (fka: Georgia Gulf Corporation)
- Georgia Gulf Fairness Opinion by Barclays (page 146)
- Georgia Gulf Fairness Opinion by Houlihan Lokey (page 153)
PPG Industries Acquires AkzoNobel’s North America Paints Business (oka: Architectural Coatings):
Eastman Chemical Acquires Solutia:
- Case Study by Dealogic
- Opinion of Financial Advisors: Deutsche Bank (page 95), Moelis (page 98), Perella Weinberg (page 108)
Merger of DuPont and Pioneer Hi-Bred:
- DuPont Fairness Opinion by Credit Suisse (page 43)
- DuPont Fairness Opinion by Salomon Smith Barney (page 47)
BHP Billiton’s Tender Offer for Potash:
Clean Desk Policy: What to Do After Chemicals Banking
Q: Great, thanks for sharing all that. Who are the top players in the chemicals investment banking arena?
A: The top (bulge bracket) financial advisors by product group include:
- Mergers & Acquisitions: JP Morgan, Deutsche Bank, and Goldman Sachs
- Debt: Bank of America Merrill Lynch, JP Morgan, and Citi
- Equity and Equity-Linked: JP Morgan, UBS, and Credit Suisse
The boutiques that compete in this space include: Young & Partners, Valence Group, Natrium Capital, Grace Matthews, Quarton Partners, and Blaige.
As you can surmise from those “rankings” above, deals are split pretty evenly across M&A and capital markets here.
Chemicals production is capital-intensive (think of how much Walter White and Jesse Pinkman spent on their RV and “seed” chemicals for meth production, and now multiply that by a very large number) so companies are always looking to raise funds, but there’s plenty of consolidation in each sector so M&A activity is also substantial.
Q: What should our readers take a look at if they want to follow in your footsteps?
A: I recommend Chemical Week, ICIS Chemical Business, and the reports by Deloitte Corporate Finance.
Q: What are some of the exit opportunities for our readers?
A: You definitely have a leg up when it comes to corporate development careers; commodity funds also take a particular interest in chemical bankers.
Unlike other niche areas, you’ll find that chemical coverage is pretty diverse and the skill set is broadly applicable.
You can easily move into other groups from here as well – I have seen people in other industrial verticals move into chemicals coverage, too.
Q: Any last words before we wrap this up?
A: Yes. Too often, people are so caught up in seeking out exit opportunities that they don’t realize life is happening before their eyes.
Case in point, a friend of mine went straight from school to banking to private equity, and now he doesn’t know what the next challenge is.
I heard another story of someone becoming a Partner at a law firm, and then quitting the next day because the opportunity didn’t turn out to be as awesome as he had imagined.
So don’t pick this group just because you’re planning your life out 10 years in advance and are hyper-focused on getting the exact exit opportunity you’re lusting after – pick it because you’re interested in the sector and you want to work on deals here.
Q: Thanks so much!
A: Anytime. And remember, you’re not in the money business or the meth business: you’re in the empire business.
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Also what does a vertical mean in this context?
“Depends on the firm. At Credit Suisse, the Chemicals area is its own vertical within the industrials group; at Deutsche Bank, on the other hand, Chemicals falls under natural resources.”
“Vertical” just means “Industry group” so Chemicals at CS is an actual separate group within industrials whereas at DB it is part of the natural resources group.
By the way what are the 4 different ways to the connect the three statements?
See this video for a few tips: https://breakingintowallstreet.com/biws/video-10-3-financial-statements/
I generally just use the “Net Income flows into top of CFS, reflect changes in BS items on CFS, project most of CFI and CFF independently there, and then link those to the BS” method.
Not sure exactly what the interviewee was referring to as I don’t think there are 4 different actual methods to link the statements.
Is a chemistry/biology or science background necessary to break in here?
In an interview if you say you want to work in the chemicals/heavy engg sector because deal flow could be high , is it shallow ? Or would i have to blabber a bit about chemical/heavy industry specific modelling
Definitely not necessary, but it could only help.
I would not talk about strong deal flow, a better argument would be exposure to a variety of deal types and some type of personal interest in the sector.
Thanks a lot for posting this article which is laden with links to the various presentations.. Can we get into the peek into the excel model as well used for these presentations or is that askin’ for too much :)) (can’t help being an excel junkie..!!)
I wish we could – unfortunately, those Excel models are proprietary and owned by the investment banks that created them. So it’s pretty much impossible to get the files unless you can go into the bank and take them without anyone noticing.
“pick it because you’re interested in the sector and you want to work on deals here.”
So absolutely true. People should realise that working on something in which they are genuinely interested increases their chances of success disproportionately. Passion for something will automatically will automatically make one “go the extra mile”, which in turn leads to superior performance and better opportunities down the row.
Thanks for your input!
How is the Chemicals group at Barcap? I heard their Chemical group rests inside NatRes
Yes, it is part of Natural Resources there. I believe it’s a solid group but may or may not be as active as the ones above.
Don’t forget about BASF! >€78 Bil Sales in 2012, would fall in the Major Diversified section above.
Thanks, just added that. I think he only listed US-based firms for the examples.
Can you get into chemicals/healthcare banking without a science degree?
I did scientific research in high school, but in college I’ve gotten more into economics/comp sci, etc . but I’m still interested in healthcare. Would it be possible to apply for/get into healthcare banking in particular later
Sure, it doesn’t require a science degree at all, it’s just helpful since it demonstrates your interest in the sector. Healthcare is possible as well, just depends on how you spin your story.
Hmm. Does the include ECs etc . . ?
I’m actually in a neuroscience class right now, but my internships/minor are all in different science-related fields. Would saying I was interested in science in high school, but also interested in econ and exploring new topics in high school, and especially after taking this class, want to combine the two? (That was most of my college essays, btw. )
Sure, that’s fine. Anything can work in your story if it is told properly…