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By Andrew Hinz, Managing Director, Mergers and Acquisitions Grace Matthews Inc. in Adhesives and Sealants: 2018 Review and Outlook

hen discussing merger and the looming threat of tariffs, most areas of Activity is predicted acquisition (M&A) activity commercial construction are expected to in the adhesives and continue growing at a healthy pace in the to continue sealants industry over the near- and medium-term. Wlast several years, we have found ourselves Given this backdrop, we expect the as conditions repeating many of the same themes: M&A environment for formulators of buyers are active and aggressive; “bolt- coatings, adhesives, sealants and other for mergers, ons” of small- and mid-sized companies construction products to remain strong. remain a key focus; cross-border activity Recent notable transactions include acquisitions and is prominent; and capital from lenders and RPM’s acquisition of Miracle Sealants private equity groups is abundant. and Bostik’s acquisition of XL Brands. divestitures remain As we review M&A activity in 2018 Both of these deals were classic strategic and begin looking ahead to 2019, we see bolt-ons that allowed the buyer to expand favorable. each of these key themes again taking its product portfolio and leverage existing center stage. While the business cycle distribution channels. Looking ahead, may be starting to reach the later innings, we expect the construction segment to be conditions for mergers, acquisitions, and among the more active areas for M&A, divestitures remain very favorable, and we with high fragmentation and above- would not be surprised to see this market average growth driving interest among persist for quite some time. potential buyers. The automotive industry is another end End Markets Remain Strong market driving strong demand for adhesives Key adhesive and sealant end markets, such and sealants. While down from the peak as construction, automotive and electronics, of 17.5 million units sold in 2016, vehicle have performed well in recent years and are sales in North America are expected to supporting strong levels of M&A activity. reach 16.8 million units in 2018—well The U.S. construction market is wrapping above the lows of 10.4 million units seen up another solid year, with housing during the Great Recession. Growth in sales starts expected to increase 7-8% in 2018 of automotive adhesives and sealants has and another 8-9% in 2019. Commercial been supported by underlying strength in construction spending has grown at a rate vehicle sales, coupled with ongoing efforts of more than 5% annually since bottoming to improve fuel efficiency through weight in 2011, recently eclipsing its pre-recession reduction as metal components are replaced highs set back in 2008. with composites that can be bonded with While some U.S. manufacturers are adhesives. taking more of a “wait-and-see” approach A recent hot spot for M&A activity— to facility expansions amid increasing particularly in the automotive industry—is construction costs, rising interest rates, and the electronics and engineering adhesives

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Figure 1. Grace Matthews’ Adhesive and Sealants Index (average enterprise value/EBITDA multiples). that included the TONSAN Adhesive and Cyberbond businesses, which were acquired in 2015 and 2016, respectively. In addition, it now also includes portions of recently acquired Royal Adhesives & Sealants. We expect H.B. Fuller to continue using M&A as a means of increasing its presence in this market over the next few years. Additional major players in the engineering adhesives market, including Henkel, Lord and 3M, are other likely suitors for acquisition targets in this attractive segment.

Fragmented Industry Supporting M&A Activity

Source: Capital IQ and Grace Matthews The current structure of the adhesives and sealants industry is highly conducive to M&A activity. With just five companies segment. As noted above, while analysts Highly engineered adhesives that are accounting for roughly one-third of the are not expecting U.S. vehicle sales to often sold by the gram instead of by the $50 billion global adhesives market, the show significant growth in the near term, gallon are experiencing growth rates remaining two-thirds consists of hundreds trends toward vehicle lightweighting of 5-10% annually, and major adhesive of small- and medium-sized companies and building “smarter” cars are boosting suppliers are jockeying for position that form a diverse pool of attractive demand for electrical components, in this attractive market. H.B. Fuller, acquisition candidates. Only a relatively touchscreens, and composite panels that for example, created an Engineering small number of these companies have require adhesives. Adhesives operating segment in 2016 revenues over $100 million, allowing

24 ASI • November 2018 • www.adhesivesmag.com Table 1. Net debt/EBITDA multiples of select adhesives and sealants companies. their ownership of Royal, Arsenal completed eight add-on acquisitions Company Net Debt/ EBITDA (August 2018) and built the company into one of the 3M 1.3x 10 largest adhesive suppliers globally Arkema 1.0x before selling it to American Securities Ashland 3.8x in 2015. Separately, Merit Capital and BluArc, along with management, Avery Dennison 1.5x recently acquired and merged Choice BASF 1.0x Brands Adhesives and Slocum Adhesives DowDuPont 1.5x to form Choice Slocum Holdings, a H.B. Fuller 5.4x manufacturer and distributor of industrial adhesives serving construction, furniture, Henkel 0.7x automotive, and other end markets. Huntsman 1.5x Private equity-backed entities like Illinois Tool Works 1.4x Meridian Adhesives Group and Choice PPG 1.6x Slocum Holdings can offer sellers an attractive alternative to a purely RPM 2.7x “strategic” sale involving one of the Sika AG 2.2x industry majors, as private equity buyers Summary Statistics generally provide sellers the ability to retain equity in the combined business Mean 2.0x and maintain an active role, if desired. Median 1.5x This “win-win” scenario encourages High 5.4x owners and other key managers to Low 0.7x remain involved in the business through a transition period (or longer), and Source: Capital IQ also provides a “second bite of the apple” when the larger entity is sold in potential buyers to pursue multiple, Firms including Audax Group (Boston), the future—in effect, allowing sellers highly strategic “bite-sized” targets Arsenal Capital Partners (New York), to participate economically in the without taking on excess risk. and Merit Capital (Chicago) are looking company’s future growth. Acquisitions of adhesive and sealant to build upon existing platforms in the We expect momentum from private formulators can generate meaningful adhesives and sealants market, while equity groups to continue building as they synergies for buyers based on improved Mason Wells (Milwaukee) and Huron aggressively seek bolt-on acquisitions raw material purchasing, leveraging sales Capital Partners (Detroit) are among and new platform investments in the and marketing organizations, and creating a a number of groups actively seeking adhesives and sealants market, as well as more efficient manufacturing footprint. With platform investments in the adhesives and the broader specialty chemicals industry. costs for many chemical raw materials rising sealants and broader CASE (coatings, With more than $1 trillion of uninvested throughout much of 2018, procurement adhesives, sealants, and elastomers) private equity capital ready to be savings have represented a key source of markets. Private equity groups are more deployed, and banks offering acquisition synergies in recent M&A transactions. As frequently partnering with former industry financing at attractive interest rates, deal an example, sourcing improvements are executives who can provide true insider activity from private equity groups should expected to account for nearly half of the knowledge when assessing acquisition remain robust. projected $50 million in annual cost and opportunities and offer a way for groups to revenue synergies associated with H.B. stand out from their peers in a competitive Valuations Remain High Fuller’s acquisition of Royal. M&A process. Strategic buyers have executed an active This past summer, Arsenal Capital acquisition strategy throughout 2018, Private Equity Getting Partners created Meridian Adhesives driven by strong balance sheets and the in on the Action Group following its acquisitions of constant need to demonstrate growth. Private equity buyers have played an privately held Adhesives Technology While down slightly (at the time of this increasing role in specialty chemicals Corp. and Epoxy Technology Inc. We writing) from the recent peak reached in M&A activity in recent years, accounting were not particularly surprised to see 2017, average enterprise value/EBITDA for roughly 25% of chemical industry Arsenal acquire another adhesives multiples for publicly traded adhesive transactions. The adhesives and sealants business, as they effectively wrote the and sealant companies remain well above market has been targeted by private playbook for executing a “roll-up” historical levels (see Figure 1). Although equity given its fragmented nature, strategy in adhesives and sealants private, middle-market transactions (with generally stable cash flows, and relatively through their five-year investment in enterprises values between $50 and low capital expenditure requirements. Royal Adhesives & Sealants. During $500 million) typically trade at a

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buyers with existing platforms seem particularly well-positioned, as they can generate (and pay for) synergies while also executing transactions with speed and efficiency. However, large strategic buyers have demonstrated their willingness and ability to pay a valuation premium when needed to secure a deal. Smaller, bolt-on transactions will continue to be the norm. These deals can be highly strategic and accretive to a buyer, and they generally carry lower risk. That said, larger, more transformational deals are still possible globally. With Royal Adhesives & Sealants now off the market, however, we see fewer opportunities for transactions in excess of a few hundred million dollars, particularly in North America. We also expect major adhesive and sealant companies to use cross-border deals as a key pillar of their global expansion strategy. Emerging markets, where GDP is growing at 4-6% or above, are particularly attractive. Companies like Sika, Arkema, and Henkel are active across a variety of geographies and discount to public company valuations, transformational deals without taking on should continue executing a relatively that discount has begun to narrow. This excess risk. We note that H.B. Fuller’s net borderless strategy for acquisitions. year, we have been seeing high-quality debt levels are considerably higher than In the U.S., recent tax cuts may provide specialty chemical transactions with its peers, reflecting its recent purchase a tailwind to corporate investment, as multiples around 8-10x EBITDA, with of Royal (funded largely with debt). As a buyers are able to immediately expense some larger, highly-synergistic deals result, we expect H.B. Fuller to remain on certain acquired assets and repatriate exceeding 10x. H.B. Fuller’s acquisition the sidelines for additional M&A until its cash from overseas divisions. This could of Royal for more than 11x is a good debt levels become more normalized later support or even boost M&A activity in example of the latter. in 2019 or in 2020. 2019 as companies begin seeing liquidity One of the key drivers of high For private equity buyers that rely on effects from the tax law changes. On valuations in recent years, somewhat bank financing to help fund transactions, the other hand, escalating trade wars counterintuitively, is the relatively slow lending multiples exceeding six times have the potential to restrict economic pace of GDP growth in the U.S. and EBITDA for larger, high-quality activity and could cause companies to other developed economies. According to companies are not uncommon, while impart some element of caution into their estimates from the International Monetary smaller companies (under $100 million in M&A strategy. The net effect of tariffs Fund, GDP growth in the U.S. and the EU enterprise value) can usually obtain three remains uncertain but will undoubtedly is currently tracking under 3% annually to four times EBITDA, and sometimes have an impact on certain segments of the and is expected to dip below 2% by 2020. more. All of these factors are contributing chemicals industry. With many adhesive and sealant companies to a strongly competitive M&A market Overall, consensus suggests that we operating in markets growing around the for adhesive and sealant companies. are closer to the end of this business rate of GDP, M&A is seen as a tool to ramp cycle than the beginning, which we agree up the earnings growth that is coveted by Looking Ahead with. However, current conditions in the investors. Credit availability and strong For the remainder of 2018 and into adhesives and sealants market are ideal to balance sheets play a role as well. 2019, we expect the M&A environment support healthy M&A activity in the near As shown in Table 1, balance sheets for adhesives and sealants companies— term, and possibly beyond. ASI for most major adhesive companies show and the broader specialty chemicals net debt (total debt less cash reserves) industry—to remain robust. Relatively For more information, visit www.gracematthews.com. of less than two times EBITDA. Healthy high transaction multiples should balance sheets for public companies allow continue, with large amounts of capital Any views or opinions expressed in this article are flexibility to execute both smaller, bolt-on chasing a relatively small number of those of the author and do not represent those of ASI, acquisitions as well as larger, more high-quality companies. Private equity its staff, Editorial Advisory Board or BNP Media.

26 ASI • November 2018 • www.adhesivesmag.com