Market Risk in Fine Chemicals Acquisitions – Bringing Market Validation to Acquisition Decisions

ABSTRACT Financials can be audited, physical assets can be touched and management systems can be assessed in an acquisition process. Post-acquisition  actions typically lower SG&A expenses, optimize capital structure through asset sales and refinancing and minimize global taxes. In short, the focus is on cutting future cost while there is a clear expectation to grow revenues. Future revenue growth is equally critical to value creation and yet it is often projected in a simplistic fashion. In particular the market potential of newly launched products and the R&D pipeline in the fine and specialty chemicals industry is sketchy at best. As a result, price increases and sales volume growth are projected without a clear understanding of limiting market factors such as demand drivers, market size or market share trends. The predictable outcome is that cost-reduction programs are generally implemented successfully while hitting post-acquisition  revenue targets eludes execution. Clearly, the present acquisition process manages operational risk better than the market risk. This process has become inadequate in a dynamic, globalized economy. The only way to improve market risk management is to gain access to quality market research. The strategic alliance between Corfina and MarketChemica  enable us to sharpen target identification, improve valuation, support negotiations and give market direction to post acquisition value creation. Corfina’s access to unique market research capabilities sets our acquisition process apart and improves post-acquisition  outcomes in terms of target quality, corporate fit and future revenue realization. INTRODUCTION Many industries have access to affordable market information and run their business based on smart business intelligence such as market size, market share and market trends. Pharmaceutical  industry stakeholders, from executives to management and investors know the company market opportunity and market position. The continued monitoring of market size, market share and trends helps the business decisions process both on a tactical and strategic level. Market information in the fine and specialty chemicals is difficult to piece together at an affordable price point. The markets for the roughly 100,000 industrial chemicals are highly fragmented and tremendously complex in terms of associated value chains and demand drivers. Time pressure considerations  specific to the acquisition process only add to the challenge of managing market risk through adequate market research. This is why the use of market information in the fine and chemical industry is mostly the prerogative of global companies with adequate resources to access information and hire expertise. Small and medium size companies are essentially foreign to the concept of using market size, monitoring market share or tracking market trends. The surrogate substitute for competitive intelligence in the SME sector relies on company’s whisper information collected in the field, or from competition website and trade magazines. Not surprisingly, investment houses servicing the fine and specialty chemicals sector generally mirror this view of the world. While use of market information varies it is safe to say that market research remains a small fraction of the overall due diligence effort. Unfortunately, this gap in managing market risk is the leading cause that prevents value creation for the shareholders in terms of reaching revenue targets.
One of the reasons for the present situation in the fine and specialty chemicals industry is the lack of accurate, affordable and on-demand global market information. This gap has been recently addressed head on by MarketChemica’s  pioneering BusinessCopass™1 product line. Market size and market share information on fine and specialty chemicals have finally become available in a time and cost efficient manner. The recent strategic alliance between Corfina and MarketChemica  lowers the market risk in our acquisition process. BusinessCompass™ helps Corfina’s target identification and valuation stage, provides support during negotiations and gives directional market guidance for post-acquisition  value creation. DISCUSSION 12.17.13 Image 1 (MC) Figure 1: MarketChemica  is the leading source of competitive intelligence in the fine chemicals space In order to understand Corfina’s market research capability it is important to have a look at various segments of the chemical industry and their sources for market information. The chemical industry provides a huge variety of products in a wide range of prices and volumes (Figure 1). Commodity chemicals are generally large volume/low price. These basic chemicals are the foundation of many industry branches and provide the building blocks for the high volume commodity polymers and the higher added value fine and specialty chemical industry. Polymers are increasingly replacing natural materials in construction, automotive, textiles and packaging industries to name but a few. Most of them fall under the commodity heading. The polymers industry also has a number of higher value added applications such as coatings, adhesives, synthetic rubbers and plastics. Commodities are huge markets that prompted the development of market information specialists such as IHS and ICIS that gather continuously market information for several hundred basic chemicals in support of various business decisions in this sector. Commodities are used to build increasingly complex molecules called intermediates. The intermediates are lower volume and higher value added chemicals. They lead ultimately to more than five thousand active ingredients that are used in the formulation of pharmaceuticals,  pesticides and other specialty chemical products. Finally, pharmaceutical products are low volume/high price products with a global market of nearly 1 trillion dollars. The pharmaceutical, personal care and food markets were certainly large enough to justify the presence of market information providers such as IMS and Nielsen. Fine chemicals include nearly 100,000 intermediates and more than 5,000 active ingredients. The intermediates markets are highly fragmented and therefore much smaller than commodities. Demand drivers for any given intermediate in this box is coming from a crisscross of consumer market applications. The added complexity of determining the market size for these products combined with small markets for one intermediate at a time has eluded a practical solution that provides global market information for chemical intermediates in a time efficient manner and at an affordable price point. It is important to note that most of the fine chemicals end up in active pharmaceutical  products. Bulk APIs are part of the fine chemical industry and should not be confused with the finished pharmaceutical  product. Bulk API result from a chemical process while pharmaceutical  products are mixtures of actives with excipients. The bulk API markets are B2B markets as opposed to the pharmaceutical  markets that are B2C2. IMS and Nielsen information cover the B2C markets only. These competitive intelligence providers do not presently cover transactions of bulk API in the chemical/pharmaceutical B2B market. The advent of globalization provided increased reporting transparency in fine and specialty chemicals information from around the world. The creation and opening to the public of governmental databases at all points of contact between government and private business can provide great insights in the global markets for any given product or supply chain. At last but not at least, remote access by Internet to legal, technical, regulatory and commercial databases from around the world allowed MarketChemica  to launch in 2013 BusinessCompass™, the first in-class competitive intelligence product piecing together global information for the fine and specialty chemicals industry. Investors can gain access to unmatched global market intelligence in the fine and specialty chemicals as a result of Corfina’s strategic alliance with MarketChemica.  Through this strategic alliance Corfina can manage the market risk of the acquisition process based on strategic competitive intelligence including market size, market share and market trends. Why Market Size, Market Share & Market Trends? Markets in the fine and specialty chemical industry are ultimately driven by demand in the consumer markets. The total demand for any given product is therefore inherently limited by consumption. Market size is ultimately an expression of the societal needs. It is important to understand that even if a company has 100% market share the management cannot increase sales beyond the market size threshold. Market size provides therefore a ceiling for the commercial potential of any acquisition target. A large consumer market can disappear quickly if demand is shrinking while new markets can explode if the demand is quickly increasing. The developments in the consumer markets will impact the size of the markets at the level of each link of the value chain. This is why acquisitions in the B2B fine chemical markets always need to pinpoint the connections along the value chain to consumer markets through market research. This uncovers powerful insights in the revenue potential of chemical producers. The link to consumer markets is important because B2C trends are well defined. IMS data for instance can determine the market size of any pharmaceutical  market. It can also predict with actuarial precision the growth expected in any given therapeutic market broken down by geography. Less accurate predictions for competing brands are also available. By working backwards from competing brands one can identify the market leader and then work on the value chain to identify leading suppliers of bulk active ingredients (Ac.I.), advanced intermediates (Ad.I.) all the way down to basic intermediates (Figure 2). Each major supplier along the value chain could be considered as an acquisition target with high growth potential. Figure 2 also points out that parallel use of any given intermediate in other end markets should also be checked in order to identify all market drivers. Market research can quickly generate a list of potential acquisition targets at the level of each supply chain link by mining a combination of technical, commercial, regulatory and legal databases from around the world. Using screening criteria imposed by the buyer can quickly result in the identification of a satisfactory acquisition target. 12.17.13 Image 2 (MC) Figure 2 Connecting societal needs to acquisition opportunities By way of example, important characteristics  of the baby boomer generation are experimental interest, individualism and free spirit. Baby boomers behavior will lead the use of pharmaceutical  drugs. These traits are driving the booming demand for the use of sildenafil citrate (Viagra) as a life style choice as opposed to its strict use as a medicine. This spells a huge opportunity for manufacturers  of the active pharmaceutical  ingredient and advanced intermediates all the way to the starting material 3-propylpyrazole-5-carboxylic acid ethyl ester. The opportunity is however different in emerging economies than in advanced economies due to legal considerations. Weak patent protection allowed Indian and Chinese producers an early entry in the value chain of this drug and prevented Pfizer’s sales to reach full potential in those countries. Teva and Actavis on the other hand entered the generic EU market only on June 24 2013 on the very day Viagra’s patent expired in this jurisdiction. Generic producers in US will have to wait until 2020 due to a ruling that confirmed patent protection to 2019 followed by a legal six months patent extension. In another example, it is a well-known fact that the Apple brand serves the high-end touch screen smart phone market. Apple launched the iPhone in response to the broad societal trend towards increased global communications in the mobility sector. When the iPhone was launched in 2007, the touchscreen was not the norm; nevertheless, Apple’s credibility as a trendsetter in the industry sent an early signal that the demand for pressure sensitive adhesives (PSA) used in multilayered touch screens is set to increase. By: Axel Hochgesand, Partner, Corfina AG & Bogdan Comanita, President, MarketChemica Inc 1 See 2 Pharmaceutical market also includes a B2B component when the drugs are sold to hospitals. For the purpose of this discussion we included sales to hospitals in the B2C market. 3 Ac.I. stands for Active Ingredient and Ad.I. stands for Advanced Intermediate 4iPhone has eventually captured buyers’ attention and magination, its features quickly became the standard by which all other smartphones were judged. The touchscreen, multiItouch, and dedicated apps were now seared into customer expectations. See Harvard Business Review Blog, Niraj Dawar, November 1, 2013 10.15.13 NPD Process I (MC) Image6