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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