Opinion: Keith Pickering

I have been reading some research suggesting that shares in the UK chemicals sector have outperformed the market by 20% this year. In a period when growth is slow or flat elsewhere, this certainly caught my attention.

The interesting thing for me about the chemicals market is that as well as having scale (£2.5 trillion of sales last year) the diversity of the industry means that chemical ingredients can be found in a range of products from industrials to cosmetics and pesticides to anti-wrinkle cream. This diversity has underpinned growth in the market and uncovered some very interesting UK success stories. Croda for example, has an interesting niche in the consumer care market, supplying L’Oreal, Chanel and Estee Lauder with ingredients ranging from anti ageing creams to anti frizz shampoo.

For all the success of businesses such as Croda (and for that matter Yule Catto) many of the big players are struggling to achieve organic growth. We have noted in the mid-market an increasingly strong wave of consolidation in the market financed by non core disposals and cost cutting during the downturn. At a larger scale this appears to be happening too, with two out of three of Croda’s largest rivals snapped up (BASF acquisition of Cognis for €1 billion and Ashland’s buyout of International Specialty Products for €3.1 billion) for example.

I have therefore been thinking through what this means for my own contacts in the sector. One of my conclusions is that those companies that command strong positions in fast growing niches will have scope to grow and drive M&A in the near future. Consumer care for example seems one such niche, particularly if my teenage daughter's spend in this area is to be believed! Factor in ageing populations and the growth of consumer culture in the Far East and I believe there are still businesses to be grown.

On the face of it, being head of a construction or building supplies firm based in Ireland at the present time is probably not the world's easiest job.

Certainly the bosses of Kingspan, Readymix, Grafton and Abbey have had a tough couple of years despite some sensible decisions by most to shore up what they have and hunker down to survive the storm.

The one that continues to catch my eye though is CRH, a veritable deal monster.

I've been reviewing their progress in 2010 this week, ready for yet another piece of work for us in the construction space, and I continue to marvel at their achievements -31 acquisitions, spending over 500 million euros, with 9 acquisitions alone in the (gradually) stabilising US market. Whilst CRH are now as much a global as an Irish corporation, these are seriously impressive statistics when viewed alongside their peers in the sector.

One other nuance to draw from the stats is they produce an average deal size of less than 20m euros. Having previously sold a business to CRH, I know how focussed they are on the quality of the opportunity not just the size. So not all is gloomy in the world of construction and building products manufacture, especially for those with quality businesses that have good growth prospects as there is at least one buyer out there with truly international reach and a strong balance sheet to match.

Finally, back on the topic of being the main man at Irish construction sector businesses – it cannot be all bad unless Gavin Slark (ex of BSS) has called it wrong for the first time in his career.

The wall of investment funds available to the private equity (PE) market and the vast array of advisers and intermediaries allied to the market has, in recent years, meant that in most cases owners and managers of good businesses will have been approached by “the market” looking for an investment opportunity. The discussion that follows is, therefore, relatively standard with the PE Firm(s) going away to run some numbers based on a view of the immediate future of the business to come up a with a valuation.

Whilst this dynamic is still occurring, and producing decent results for owners and managers, I believe a more proactive, intelligent approach will be appropriate for many businesses in the current environment.

To explain my thinking, in addition to having more money to invest than any other group, PE Firms remain the largest single identifiable population of influential shareholders in the UK economy. They also have very transparent and understandable objectives – to turn the cash invested into more cash within a reasonable timescale. Therefore, if you as an individual through your skill set, experiences and contacts, or your business through its market position, trading relationships and operational performance, can demonstrably help a PE firm achieve this objective – either for an existing investment or for one they would like to make – you will be pleasantly surprised by the deal put to you. Whilst they like to pretend they do, PE Firms do not know everything, and they certainly do not know the value you and your business can bring.

So do not shy away from starting the conversation as investing some time now could pay handsome dividends immediately or in the future.

As someone quite famous once (almost) said in a famous speech – ask not what Private Equity can do for you, ask what you can do for Private Equity.

Most markets are pretty incestuous, and none more so than the building products market. On the whole though this leads to a healthy environment where, although opportunities are hard fought, there is grudging respect between certain competitors.

With economic forecasts more challenging by the day, now may be the time to reflect whether these relationships provide a basis to explore if 2+2 can equal 5!

For example, there will be a number of business owners keen to reduce their involvement in their business who recognise a sale today may not achieve value objectives. They also recognise there is risk in simply handing over to the second tier or recruiting an external CEO candidate, whilst knowing organic growth will take years to get the value back to the levels required to make a sale worthwhile. If, alongside this, there is a competing and complimentary business at a different stage in its lifecycle, but with shareholders focused too on long term capital value, then starting a courtship maybe a very sensible strategy. It could well develop into a marriage where synergies and costs can be shared or saved and the best parts of both businesses can be developed.

All of this seemed inconceivable in the good times. Now though the world is different and different skills and strategies are required. Market share only moves truly in a recession, so why can't it be you that benefits from being brave?

It is clear, following the various deal announcements in recent weeks, that the larger private equity funds are back in acquisition mode.

Recent deals completed by H.I.G Capital, Charterhouse, Advent, Bridgepoint and their like demonstrate the drive to start spending the funds raised before 2008 and which most of these funds have now been sitting on for too long.

Most interestingly, (and usefully for shareholders and management teams), these funds are doing deals at decent multiples – they would rather pay a good price for a good business than buy a poor business cheaply – at lower transaction sizes and without the debt element being fundamental at the point of completion. This last point is particularly interesting and is driven by two factors. Firstly, and somewhat perversely, this dynamic is occurring because (as we have seen in our own deal completions) the debt market has loosened up quite considerably in the last four months. Private equity funds have, therefore, got the confidence they will secure a good banking package in a reasonable timeframe post deal, unlike the situation during the majority of 2009 when debt could just not be found no matter how strong the business plan.

Secondly, whilst the debt market has loosened, bringing the debt alongside so it is available at completion is still one of the most problematic parts of delivering a private equity deal. Therefore, private equity houses who are awash with money can (and in some cases want to) part with all of the money required at completion.

The question now is, how long will this last?

It is widely known that the dramatic reduction in bank liquidity post Lehmans has had a significant impact of the ability of corporates and management teams to raise bank debt, particularly when that bank debt is used to facilitate M&A of some kind. Just as we are starting to see some signs of sensible levels of liquidity returning in the transaction market, reforms proposed by the Basel Banking Committee (essentially the global banking watchdog) could impact UK banks ability to lend.

One of the proposals emanating from Basel is that banks would have to deduct their entire pension deficit from their tier one capital ratio, rather than just the next five year’s contributions as is the case now. The potential knock on impacts are constrained lending and dividend policies from the banks affected. Intriguingly, for the Machiavellian Euro sceptics out there, the proposed reform is likely to impact UK banks far more than their US and continental European counterparts as a result of the absence of defined benefit schemes in the overseas competitors.

All is not lost as some analysts argue that the impact in the long term would be negligible as defined benefit schemes are largely closed to new members and therefore deficits should shrink over time. Further, the FSA, which is the UK body responsible for applying Basel proposals, is understood to be sympathetic to the circumstances of the UK banks given their differing pension circumstances. That said, this is all something the relatively fragile banking sector could do without.

Housing Minister John Healey's pledge that all new homes will be zero-carbon rated from 2016 is a long overdue confirmation from the government of something the industry has been planning for over some time. Indeed I've sat for several years now through interminable seminars on what is meant by the phrase zero-carbon. What has struck me most though is that few, if any, seem to know exactly what it means and crucially how it will implemented.

With Healey's announcement though the industry now needs to move on and start providing factual solutions to the problems ahead. Fortunately though we have some of the most innovative manufacturers in the industry across the world based in the UK and so I am confident much can be done.

What this all means for company owners is that, current financing issues aside, many of the larger materials companies around the world will be starting to plan an M&A strategy with the confidence gained from knowing that the legislative agenda has been clarified and with a roadmap of technologies they need to acquire to compete in future. Indeed, some have already started on this journey prior to Healey's announcement, with the likes of Alumasc Plc already well down the path of building a competence in new, fast growth areas utilising technology aimed at the zero carbon market.

Contrary to public belief, I believe these are exciting times to be a manufacturer in the building industry. Let us hope that I am not alone!

Most business owners and managers answer to this question will largely depend on the specific Non execs they have experienced. Unfortunately, this probably means the majority will lean towards the latter answer due to the fact that for every successful businessman operating under this label there are four average and partially retired plc directors, bank managers and Business Link type mentors.

This is a real shame as it will deter many owners/managers from exploring the benefits an NXD can bring to them and their business and, as with most things in life, if you do your homework, define what it is you want and be prepared to pay for the best, you will get excellent value for money.

In addition to the benefits mentioned by Andy[link to JAC blog article], I strongly believe that in the current environment all businesses of any size and complexity need the "outside world" perspective a quality NXD will bring. Over the last 12 months most businesses have had to deal with new issues and communicate those to interested parties (e.g.employees, customers, suppliers, banks, credit insurers, the press). A quality NXD will bring experience from other roles to help you deal with the issues and, possibly most critically, will give confidence to those looking at the business from the outside that the issues are manageable and being sorted.

So if you are an owner or manager reading this, put it on your project pad and give it the time and attention it deserves. If you are an NXD don't believe your flat cv will convince the busy owner/MD to take the jump, be prepared to share case studies of your experience in dealing with all the stakeholders to a business.