A Fragmented Industry - The global specialty chemicals industry has revenues in excess of $550 billion and is quite fragmented with 350 industry sub-segments and considerable geographic diversity. While the industry provided considerable growth and added value characteristics through the early 1990s, it has been on the path of commoditization for over a decade.

The economic crisis that peaked in 2009 featured a significant decline of revenues in North America and Europe but comparatively better performance among Asian specialty chemical sectors.

It has regained strength in the beginning of 2010 and has reached today all time highs with historically high earnings before interest, tax, depreciation and amortization (EBITDA) margins for nearly every specialty chemicals company due to excellent utilization rates and a partially regained strength to pass raw material prices to customers.

The world of specialty chemicals has evolved today to be a world of extremes - dominated by larger players or new larger entrants that lever diversified portfolios, scale and more sophisticated management approach, offset by the more traditional focused and multi-business smaller cap specialty players. The development in and after the economic crisis while having tested the robustness of both focused and larger diversified players has not driven the level of consolidation thought likely by many industry observers and has interestingly underscored the financial resiliency of this segment.

The industry shift to larger diversified portfolio structures and the commodity-light approach has been a theme that has been employed by many successful industry participants. The shift rightfully reflects a higher value financial path for these companies looking at sustained cash flow potential and asset intensity.

Big is Beautiful: Scale and Portfolio Diversification

Increasingly today, the specialties market is becoming dominated by larger portfolio players with multi-chemical capability bringing management sophistication, scale and global reach. These sophisticated players are pursuing complex, multi-technology growth markets and platforms in nutrition, electronics and other attractive product areas that are supported by strong macro-level growth trends.

These are large and long duration investments that also usually require acquisitive entry for at least in part. We have been seeing a range of acquisitions by companies like Dow, DSM and BASF over the years that are strategically motivated filling in the "mosaic" pieces that fit with longer-term strategic ambitions and increase entry barriers for smaller, less sophisticated players.

Consequently, following global megatrends and incorporating them into the strategic portfolio management as well as finding new growth through innovation provides large opportunities for the specialty chemicals industry if companies can leverage their capabilities and size. For small specialty chemicals companies it will be difficult to finance long-term innovations that help to solve the key challenges of humankind and generate the amount of profit in return.

China and the Middle East: Aggressive Growth in Specialties?

Asian companies currently have a ravenous appetite for cross-border deals to access more specialties growth to cover the rising need of specialties countries like China. The specialty sector in many ways is illusive to these new entrants - except, of course, to the more commoditized parts of the industry that have far lower entry barriers. Much of the specialty sector is rife with commercial complexity that includes a product technology and customer complexity dimension that present very significant barriers to easy entry.

The desire to grow in specialties and need to access intellectual capital will likely drive some additional cross border deals. These transactions will serve to provide an impetus to develop a more common view of return criteria and we believe are healthy for the normalization of the industry. A couple of large sophisticated players in China have emerged that will help consolidate the fragmented China market and build meaningful capability in specialties moving forward.

Furthermore, the Middle East - which has focused on base chemicals based on cheap feedstock rather than on the development of specialty chemicals over the last 25 years -will mainly boost itself through acquisitions or joint ventures. The search of opportunities in the specialty chemicals market (instead of more petrochemicals) as strategic portfolio alternatives has been triggered by changes in feedstock availability and prices.

This also goes for local or government-owned petrochemical companies that have to search more for alternative products and markets that create value through the process chain and a higher specialization rate via application services. On top of it, there is a clear demand in this region to increase the specific employment rate per ton produced (which is 10 to 50 times higher in specialty chemicals compared to petrochemicals) to contribute to the efforts and needs to overcome high unemployment rates in some of the Middle East countries.