Because the chemical industry is cyclical, its leaders have had to work harder when broader economic conditions shift against them. Now, as the industry works to break out of two-plus years of underperformance in total shareholder returns (TSR), we see a clear case for companies to take bold action, including pursuing aspirational transformations, more aggressive capital allocation, and breakthrough innovation.
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Mergers and acquisitions are one of the most effective methods to achieve these objectives. And, after two years of declining M&A activity, we see indications of an upturn. After hitting a low point in the first quarter of 2023, deal value in the chemical, materials, and energy sectors continued to grow through the year. This suggests that now is the time for chemical acquirers to consider their M&A capabilities and prepare for the upcoming wave of deals.
Achieving excellence in M&A execution can be difficult. Moreover, the chemical industry has some specific nuances that acquirers should consider when tailoring their integration program.
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Industry underperformance requires bold action
Last fall, we wrote about the unique challenges facing the chemical industry, which has recently underperformed the world index in TSR (Exhibit 1).
Several factors have historically driven chemical industry outperformance, including growing exports to Asia (mainly China), increasing chemicals penetration, functional excellence-driven performance improvements, price increases, and strong fundamental demand. These have become less and less prevalent in the past ten-, five-, and two-year periods. Chemical companies are now seeking new ways to thrive within the current paradigm, and M&A can be a catalyst for the needed strategic shifts.
Patterns in chemicals M&A
Chemical industry M&A has been hit even harder by the challenges that have depressed global deal activity: persistent inflation, high interest rates, historically high valuations, and geopolitical tensions. Exhibit 2 compares chemical industry M&A activity with that of other industries. Total chemical deal value in both 2022 and 2023 was 30 percent lower than the average during the eight years prior. That is more than twice the reduction in all M&A globally in the same period.
Even against the backdrop of major market corrections across all sectors, the chemical industry has underperformed compared to the broader market in the past two years. In this context, we are not surprised to see that M&A and other bold moves were much less prevalent in the chemical industry.
A closer look at chemical M&A over the past decade reveals two patterns
First, M&A activity tends to follow sub-sector themes, shifting away from large, diversified business portfolios that have sometimes been built over 100-plus years. We have, for example, seen segment-level consolidation in agriculture chemicals and pigments and coatings over the past few years. Most recently, there has been a rise in deals in flavors, fragrances, cosmetics, and personal care. We expect to see these waves continue as owners of fragmented, highly diverse portfolios seek to build global leadership positions with synergies, and improve their competitiveness at the segment level.
Second, the data shows spikes in chemical megadeals, which we define as those greater than $10 billion. In 2016 and 2019, for example, these megadeals made up more than 60 percent of total chemical deal value (Exhibit 3).
The prevalence of megadeals in chemicals could be explained by the industry’s ability to successfully create value through large deals. Our 15-year study of M&A archetypes has found that, across industries, a programmatic approach—defined by two or more small or mid-sized deals per year—generates the most value on a risk-adjusted basis, presuming the deals have a meaningful size, (i.e., a median of 14 percent of the acquirer’s market cap purchased). However, for chemical companies, the large deal approach to M&A—defined as less frequent but larger acquisitions (with at least 30 percent of the acquirer’s market cap purchased)—has also been a successful strategy in generating excess TSR. Exhibit 4 compares the performance of the program types since 2013.
While not all large chemical deals are successful (as shown by a higher standard deviation in Exhibit 4), it is true that the chemical industry has succeeded with large deals more than other industries. When we explored why, we found that successful large chemical dealmakers often used these deals to pursue more focused platforms, with the aim of gaining greater geographic or product depth as pure-plays, or by stepping into higher-margin sectors.
These themes fall in line with broader research that has shown that focused portfolios perform better than large, diversified conglomerates. Notably, even successful large deal acquirers tended to complement this strategy with a programmatic approach that includes smaller deals and divestitures, with an average of 2.6 events a year.
Recent drivers of programmatic chemical M&A
In addition to the above drivers of larger deals, we noticed three factors that are prevalent in chemicals programmatic M&A.
Consumer markets. Companies are pivoting their positions, driven by shifts in consumer trends, including increased demand for products such as electronics, batteries, lightweighting, food and nutrition, and personal care. Companies are capturing important growth opportunities and building more promising R&D portfolios. Moreover, consumer markets are attractive for their lower capital requirements and higher ROIC. This is a prevalent trend—although moving downstream can be a challenging pursuit, given high multiples and historically lower TSR.
Sustainability. More than half of the announced chemical industry deals in 2023 had sustainability drivers, continuing a trend of recent years. These drivers include securing advantageous green feedstock, building a reliable and green energy supply, pivoting toward a greener product production portfolio, increasing exposure to sustainable end markets, and enhancing circularity of the portfolio.
Geographic optimization. Chemical companies are pushing to be closer to customers. Driven by supply chains and local needs, global companies are requiring a more tailored local approach to serving dispersed end markets. The current post-COVID climate, further complicated by geopolitical tensions, has spurred companies to evaluate their footprint and ensure they have local partnerships that can accelerate customer access or facilitate movement of supply.
Considerations to improve M&A execution in chemicals
At a basic level, the keys to success in chemical deals are no different than for other industries. Whether pursuing a programmatic agenda or large deals, companies must take several steps to beat the market. Successful programmatic dealmakers, for instance, prioritize their targets, firmly commit to their strategy, and carefully chart progress. The best large dealmakers minimize business disruption during integration while outperforming their aggressive synergy targets and institutionalizing new ways of working in the new company.
Beyond these keys, chemical acquirers should address some industry-specific nuances when designing integration programs. They must tailor the integration approach to their growth and capability-building objectives, ensure they have planned for the day one risks particular to the industry, and protect and nurture the technical talent that generates the most value and is hard to replace.
Tailoring the integration plan for value creation
Chemical companies have historically used M&A as a means of realizing growth, with deal models centered on new capabilities or business models, significant revenue synergies, or entering new markets. Last year was no exception, with at least half of the deals announced signaling significant value creation from non-cost mechanisms. Successfully delivering on transformational expectations requires avoiding two typical failure modes we have seen in chemical integrations.
Failure mode one: Applying an integration playbook focused solely on cost synergies. Cost synergies, such as consolidating functions or centralizing sourcing, are of course implicit to almost any deal and important to capture. However, they will not suffice to deliver the benefits expected of these deals. Because cost synergies are more easily measured and quickly captured, hitting these targets may give management a misleading sense of achievement. They do not guarantee that the future company is equipped with the capabilities required to deliver on the real opportunity. They may even prevent integration leaders from driving overall business success.
Failure mode two: Setting unrealistic, unfunded, top-line targets. Aggressive revenue targets can convey a convincing ambition to the capital markets and make sense on paper. However, achieving them typically requires intense focus, mobilizing the entire organization in a cross-functional approach, and additional capital and operational expenses. Moreover, acquiring high-growth “nuggets” requires the acquirer to resist the temptation of “embracing the target to death”—that is, overwhelming them with processes and structures and distracting them from their growth objectives. Thus, companies often fail to capture the planned impact of these investments. If the newly integrated company fails to deliver growth as promised, management teams then push for further productivity improvements, including headcount reductions, to meet earnings targets.
Successful acquirers start by establishing a strong understanding of each deal’s rationale. For deals predicated on revenue synergies, these acquirers establish—early on—cross-functional teams that can identify precise sources for these synergies. In deals involving acquisitions of new IP or entering areas of new opportunity, winners hold off on consolidating the teams for cost savings. Instead, the integration leadership starts by designing a future operating model that will protect the target’s culture and its “special sauce”—what makes the target company unique and successful. In deals requiring capitalizing on joint innovations, winners avoid counterproductive steps such as racing to close labs or prioritizing a more cost-efficient footprint.
Ensuring day one operational readiness
Chemical company integrations tend to pose more significant operational risks on day one than mergers in other sectors. Even when it appears that little is changing day to day, chemical integrations bring supply chain and logistics risks triggered by legal entity changes and product registrations. Day one success thus means addressing regulatory and compliance risks due to the integration of quality systems, legal entity changes, and new markets. Environmental and safety risks are also of high concern given the nature of chemical operations, which can be disrupted when combining organizations with different safety procedures and protocols.
Chemical integration leaders should therefore go beyond the typical day one preparedness topics like financial and HR systems. Companies must thoughtfully design chemical-specific day one readiness plans with a focus on critical systems, processes, and interdependencies across functions. They must rehearse these plans with all stakeholders, such as commercial, operations, legal, IT, and environmental health and safety groups. The integration team should invest time to define day one critical escalation processes across both companies for potential risk scenarios, such as supply chain, quality, safety, or customer issues. Deal partners must put ample time into understanding each other’s protocols, deciding if they need any changes on day one, and, at a minimum, ensuring visibility in case of an emergency. For example, how will communication procedures be deployed to mark all employees “safe” if the two companies are still on different telecom and internet systems on day one? Successful chemical acquirers will also stand up a Week 1 “command center” where issues can be escalated and managed rapidly.
Protecting and nurturing value-creating technical talent
Talent retention is a critical topic in any integration, and much effort (and capital) will typically be allocated to ensuring the best leaders stay on with the new company. Chemical acquirers must address not just the standard “high potential” talent pools, but also their most valuable talent—researchers, scientists, and innovation directors. These colleagues carry institutional knowledge, capabilities, and sometimes “only-in-the-industry” experience that creates significant value for the organization. Many of the chemical deals we reviewed in 2023 were motivated by innovation factors such as access to new patents, technology, and processes. Delivering on the chemical acquisition deal thesis usually requires retaining and nurturing technical talent pools.
Much has been written about talent retention in integrations, but retaining technical and R&D talent requires more than traditional financial retention measures. Successful chemical acquirers put innovation at the forefront of integration planning and offer creative incentives, such as special research assignments, innovation awards, or the opportunity to pursue independent research. The integration strategy must also be thoughtful on the location and structure of day-to-day work. Where will the innovation teams be located? Will they have to relocate to a new headquarters? How will they be integrated? Companies must take care to design the optimal location strategy. There are many anecdotes describing target companies’ top scientists leaving for jobs at local universities rather than relocating to the new headquarters. At the same time, research has shown that a virtual-only tech workforce may be less innovative than in-person teams. R&D organization integration requires thoughtful measures like rotations or hybrid strategies to ensure sufficient co-location to support the pace of innovation.
M&A will continue to be one of the most critical strategic moves for chemical company management teams, and we expect activity to pick up in the coming months. In all cases, creating and executing an effective M&A strategy requires understanding both the M&A execution basics as well as the chemical industry’s special nuances that can determine a deal’s success.
