China, Europe and the changing global chemicals market
Carolyn Buller of Squire Sanders and Yoni Fessel of the China Euro Chemical Capital Fund look at how European speciality chemicals firms can prosper in China
The chemicals industry has grown at a brisk pace for many decades. Whilst the current downturn continues to pose challenges for the industry, particularly in Europe and, to a lesser extent, the US, the markets in Asia and above all China, continue their strong performance. Several macro-economic trends should provide substantial impetus for further growth in Asia and a strong recovery in Europe and the US.
In the first place is the demographic impact. The world's population is forecast to reach 9 billion by 2050, accompanied by a greater drift to urban centres in many countries around the world and an increase in wealth for a larger middle class in emerging economies. This will generate an increased demand for chemicals across a spectrum of sectors including construction, transport and electronics.
In addition, with a growing population there will be a continuous need for improvements in healthcare provision and food supply. This will drive the search for innovative chemical means for treating water, better nutrition and more effective medicines.
However, energy demands will continue to rise, with estimates that as much as 50% more power will be needed by 2030. To meet this demand the search for technological innovation and new, renewable and unconventional energy sources will only increase.
Key products used in insulation materials, efficient batteries, photovoltaic equipment and wind turbines, for instance, will act as stimulants to the chemicals market. At the same time, climate change and environmental factors will be affecting industry regulation, meaning that more efficient products and new compliant processes are required to support industries and consumption.
Buller - 12th Five-Year Plan will have major impact on chemicals
China is at the forefront of much of this change. In 2011, the country approved its 12th Five-Year Plan, a new national development programme focused on higher quality growth with key goals relating to sustainability, R&D and the development of high technology industries. This translates into further investment in high value manufacturing and materials, with concrete benefits for the speciality chemicals sector.
Support from the public sector, combined with the shift in demand to assist higher value industries, will also have a significant positive impact on sub-sectors like biomaterials, advanced materials, fine chemicals, electronics chemicals, cosmetic chemicals and agrochemicals.
Key challenges in China
Over the last four years, chemicals companies have responded aggressively to the economic downturn with cost-cutting and containment and advances in production processes. Most of the margin improvement that can be realised through these methods have now been achieved. For additional improvements to their performance, chemicals companies have been and are likely to continue looking at M&A to secure additional growth.
Inevitably fast-growing markets like China are getting a lot of attention. Yet, as the market in China has grown it has also matured. Now, both Chinese and foreign-owned chemicals companies, as they enter the market, face a number of new challenges such as changing regulations, increasing operational costs and the need for enhanced people management.
In terms of the changing regulatory framework, both the local and export markets in China are evolving rapidly, a situation that demands constant adaptation. Companies are also required to invest more and more in compliance, with the issue of traceability becoming increasingly important.
Fessel - Companies must adapt constantly to changes in China
A major contributory factor to the rise in operational costs for chemicals companies is the increasing attention being paid by Chinese authorities to the impact of the industry on the environment. The pressure of dealing with environmental issues is leading companies to focus on more efficient processes, higher value manufacturing, more R&D spending and more branding.
Finally, companies successful in China will be those which can most effectively manage their people, recruit talent and adopt international best practices. Quality mid-level management is critical to ensuring that growth can be sustained. For foreign players in speciality chemicals, an understanding of cultural aspects can often be underestimated but is critical to ensure that investments turn into successes.
China moves overseas
The story of the past few years has not just been about the growth of the domestic market in China but also about the increased competition from Chinese companies in chemicals markets around the world. China's investment interest, broadly speaking, is moving from natural resources to developed economy assets, such as brands, technology and distribution channels. Chinese companies are moving up the value chain and competing harder in both their home and international markets.
The shift is illustrated by a number of noticeable acquisitions internationally in the last 18 months, for example, China National Agrochemical Corporation's acquisition of Israeli Makhteshim Agan Industries and China National Chemical Corporation's acquisition of Norway's silicon group Elkem.
We can expect more of the same, especially since the constraint of traditional bank financing has been creating new opportunities for investments at favourable valuations. Some local Chinese companies, incidentally, have started consolidating speciality chemicals companies and pharmaceuticals companies.
In 2009 only two of the ten largest chemicals companies were based in emerging markets and none of them were from China. It is difficult to predict the future accurately, but by 2020 up to seven of the ten largest chemicals corporates are expected to be from emerging markets such as China.
China and Europe - increasing ties?
In the past few years, Western Europe has emerged as one of the biggest target markets for chemical acquisitions. In particular, the higher margin niches of the speciality chemicals market have proven attractive targets.
BASF's acquisition of Ciba Specialty Chemicals and, last year, Solvay's acquisition of Rhodia provided both buyers with relatively quick access to additional speciality offerings without the up-front, long-term R&D investment. Similar strategies were at work in the US with Ashland's acquisition of ISP.
Looking forward, Europe and China will probably engage in increased levels of M&A and joint ventures. Each region has something the other wants: Chinese companies are looking for wider access to new technology, new channels for product distribution and simply a new market outside the domestic one. Likewise in Europe, companies are looking for increased access and exposure to the Chinese and other growing markets.
The increase in transactions will also be supported by demographics. In Europe, where there is still a large number of family-owned companies, succession issues challenge many businesses as the baby-boom generation approaches retirement. In China, although the history of the private sector is shorter, a similar trend is appearing, with second generation owners losing interest in the sector.
It is likely that speciality chemicals companies with the ability to operate and understand markets in both these geographies will benefit from enhanced opportunities as new entrants will find it increasingly difficult to penetrate. Supply chain and operational decision-making mechanics are becoming more complex and integrated, creating additional barriers to entry. All the signs suggest that those who are strategic in their thinking and pursue investments over the next 12-24 months are the most likely to prosper.
From Online Issue: October 2012