Houlihan Lokey is a global investment bank with expertise in mergers and acquisitions (M&A), capital markets, financial restructuring, valuation, and strategic consulting. The firm serves corporations, institutions and governments worldwide with offices in the United States, Europe, the Middle East and the Asia-Pacific region. Houlihan Lokey is ranked as the No. 1 M&A advisor for all U.S. transactions and all U.S. industrial transactions, the No. 1 global restructuring advisor, and the No. 1 global M&A fairness opinion advisor over the past 20 years, according to Thomson Reuters. The company is among the most active advisors in the global coatings sector, and recently advised on the sale of Dunn-Edwards to Nippon Paint, the sale of Helios to Kansai Paint, the sale of both MetoKote and Crown Paints to PPG Industries, and the acquisition of IGM Resins by Astorg private equity.
Lee Harrs is head of Houlihan Lokey’s Chemicals practice. As a member of the firm’s Industrials Group, he is responsible for managing banking relationships with public and private clients in the global chemical and related sectors, and providing strategic ideas and advice related to M&A activity and capital raising. Harrs focuses on specialty chemicals and related sub-sectors, including formulated products, adhesives, sealants, coatings and resins. He has more than 20 years of investment banking experience in the chemicals industry.
PCI recently asked Harrs some questions regarding the M&A climate in the coatings industry.
PCI: M&A activity in the coatings sector has been brisk recently. What do you see as the key drivers for this consolidation activity? What is motivating buyers and sellers?
Harrs: M&A activity in the coatings sector has been and remains brisk. The sector has seen significant consolidation in the past decade, with the top 10 players accounting for just over half of global sales of approximately $130 billion. Nevertheless, it remains highly fragmented, with over 7,500 independent players globally. There are several drivers of consolidation. Large, strategic acquirers can often achieve significant cost synergies, which lowers the effective multiple (price paid) for an acquisition. Raw material purchasing synergies can be meaningful, with large buyers enjoying volume discounts for purchases of resin, titanium dioxide, etc. Also, typically there are opportunities to reduce headcount, including C-suite employees, and eliminate duplicative spending in areas like IT, compliance and other support functions. In some cases, the savings can amount to as much as 50 percent of the target’s earnings before interest, taxes, depreciation and amortization (EBITDA). This enables strategic acquirers to pay a premium to the price that a financial buyer (who lacks synergies) could afford. Large coatings players typically have lower unit production costs, which makes it difficult for smaller, independent players to compete on price and protect market share. Smaller companies who are at a structural cost disadvantage need to consider the long-term threat of the major players. Differentiation, specialization, product performance and customer service are all key to survival. Aside from the benefits of scale, acquiring companies often are seeking growth and diversification of revenues by product, market and geography.
PCI: Do you expect the pace of M&A activity to remain at a high level?
Harrs: We see no signs of a letup in activity or acquisition appetite among the majors. In fact, recently, we have seen the emergence of players outside the Top 3 (PPG, Sherwin-Williams and Akzo) as consolidators. These companies include Nippon Paint, Kansai, and more recently, Hempel. In an environment of modest organic growth, acquisitions are seen as the means of achieving above-market growth and shareholder value creation. From a selling perspective, smaller companies often sell for “generational” issues, for example when the founders or family owners seek liquidity due to retirement or other financial planning purposes. We also see some sellers motivated by the prevailing high multiples. Large corporates and financial buyers are actively scouting the universe of smaller, private players, and are prepared to pay handsomely for the right company.
PCI: Can you discuss valuations and transaction multiples? What are the trends?
Harrs: Valuations and transaction multiples are at all-time highs. Across the board, we see at least two turns of EBITDA premium to levels of just a few years ago. So if a company sold for eight times EBITDA in 2015, that same company will likely trade for closer to 10 times EBITDA in today’s market. This has given rise to the saying that “10 is the new 8 times” in banker parlance. Premium valuations are supported by a robust economy and the ample availability of capital, including both inexpensive debt and abundant private equity. Particularly attractive assets – those that possess unique quality and scarcity, can sell for well in excess of 10 times EBITDA.
PCI: Can you share your observations on the role that private equity investors are playing in coatings sector M&A? What is driving their increased level of activity?
Harrs: The continued growth of private equity (PE) is underscored by a recent report that there is over $1 trillion (with a “T”) in available, un-invested capital in the hands of private equity investors globally. PE funds represent formidable competition to strategic acquirers of coatings assets. They have demonstrated a willingness to “stretch” their valuations to acquire platform companies in the coatings sector. They have often beaten strategics “at their own game” through a combination of speed, certainty, and, of course, value. PE investors are attracted to the fundamental characteristics of the coatings sector: relatively low capital intensity and maintenance capital expenditures, high free cash flow, diversified customer base, and myriad consolidation or “roll-up” opportunities among the 7,500 independent players globally.
PCI: What does your crystal ball say? What will the sector look like 10 years from now?
Harrs: I think the forces driving consolidation are compelling and not a flash in the pan. I have seen this trend play out over my 20-year career. Companies will always seek above-GDP growth and cost efficiencies. As long as there are willing sellers, there will be a bid for coatings companies. I think the big guys will continue to get bigger, and the “tail” of thousands of smaller companies will remain long, as new entrants bring new services and technologies to what is a fundamentally attractive market.