Valuing chemical assets

C&I Issue 17, 2009

The global financial crisis is destroying value throughout the chemical industry through bankruptcies, deteriorating stock prices and plummeting bond values. From July 2008 to March 2009 the S&P Chemicals Index lost more than half its value. Besides falling stock exchange prices, there has been a massive loss of debt in the chemical industry. Many bonds are trading below par, leading to a potential destruction of wealth for the industry in the order of several tens of billions dollars.

LyondellBasell, INEOS, Hexion Specialty Chemicals and Huntsman are all good examples of individual companies that have been severely impacted by the recession. Bankruptcies could destroy yet more wealth, as the value of old equity and bonds is destroyed. Meanwhile, a bankruptcy filing substantially reduces the value of senior debt. While chemical companies continue to contend with weaker demand, often without knowing what will happen beyond the next few months, some will additionally confront maturing debt at a time of tightened financial markets.

Companies are responding by squeezing working capital, cutting capital expenditure and closing plants. A proper valuation of chemical companies is the basis of most negotiations with debt holders and shareholders. However, a common question is how to value a business in times of a downturn where often no short-or medium term forecasts are provided any more.

Valuation is the process of deriving the market value of a complete business, or parts of it, in a transparent and reasonable way. While several valuation techniques can be used for this purpose, many pitfalls lurk along the course of the valuation process. Basically, trading multiples, transaction multiples and the discounted cash flow approach – also referred to as fundamental valuation approach – are the methods most often used. However, the first two do not seem to be the proper approaches in times of a falling and turbulent market.

When using trading multiples, the firm’s value is determined by comparing the performance of a peer group that most closely resembles the target business to be valued. A peer group analysis includes the identification of comparable companies in terms of industry, lines of business, similarity of portfolios, geography (local, regional, national, international), size of business, for example, in terms of revenue, performance criteria, etc. It has, though, to be noted that no two perfectly alike companies exist and thus the selection of a peer group is always subject to the individual appraiser’s experience and perspective.

To date, most peer group selections have comprised mainly companies from Western industries, while companies based in emerging nations from the Middle East and East Asia (China and India) are underrepresented. On the other hand, many of these companies lack transparency with respect to financial information, which makes a proper analysis more difficult. The appraiser needs to have experience with those emerging players in order to avoid the potential pitfalls.

In addition, the market capitalisation of many companies has markedly decreased during the financial crisis, accompanied by sharply falling trading multiples. The trading multiple compares the enterprise value/earnings ratio, usually EBITDA, earnings before interest, taxes, depreciation and amortisation, of a target with its peers. Enterprise value is the sum of equity value – market capitalisation at stock listed companies – and net debt.

Figure 1 shows that both speciality and basic chemicals companies traded at 4.5–5 times EBITDA in 2008, which is roughly half the value compared with 2007. Does this mean that these firms lost 50% in value in just one year? Or is it possible that the stockmarket just over-reacts to headline-catching events in the recent past? Trading multiples have to be handled with care, especially in times of turbulent and volatile markets.

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